Sore heads to follow India's stock euphoria By Kunal Kumar Kundu
BANGALORE - With the grand old party of India - the Congress - bagging more
than 200 seats in the general election in India and the pre-poll alliance of
UPA (United Progressive Alliance) coming tantalizingly close to the magical 272
mark (chalking up 260 seats), India, after a long time, voted decisively.
The market reacted with a "wow" on the first trading day after the election
results were announced, on Monday. India's bellwether index, the Sensex,
reacted as never before: up by more than 2,000 points and hitting two "circuit
breakers" in about a minute (40 seconds in the first instance and 20 seconds
after the market re-opened following a two-hour cooling off period) - the first
time that trading has been halted after the Sensex breached a daily limit set
by the market regulator.
That the market would open stronger was a foregone conclusion. The expectations
prior to the election results were of a fractured
mandate for the new government and nobody was expecting such a resounding
verdict. All the exit polls, considered a close reflection of reality,
indicated a neck-and-neck affair between the Congress-led UPA and the led by
the National Democratic Alliance led by the Bharatiya Janata Party (BJP) - and
both alliances were expected to come up far short of securing a parliamentary
majority.
The dominant fear was that numerous regional parties, with their disruptive
politics, would have to be enrolled into the government, with a deleterious
impact on the economy. With that worry blown away, the bulls had a ball.
The question is, was the euphoria warranted? What actually changed so
dramatically between Friday and Monday that warranted such a reaction? More
importantly, is it backed by fundamentals?
The answer has to be "no". Sure, there's been some positive development, but
nothing to warrant such a positive outlook.
The Sensex has now surged by more than 75% in two months nine days flat; it
gained 17% on Monday alone. It is worth recalling that the Sensex tanked from
its peak of 21,000-plus as the global financial crisis took root and there was
a clear indication that the Indian economy was slowing from its annual 9%
expansion over the preceding several years.
On one thing we should be clear: the worst for the global economy is yet to
come. In the case of US, while the financial sector's problems are close to
being played out, its transmission to the real economy has resulted in a
gloomier scenario. Rising unemployment and falling retail sales have resulted
in increased saving, thereby depriving the economy of its much-needed oxygen,
that is, consumer spending.
In addition, the possibility of further financial trouble cannot be ruled out.
According to a Wall Street Journal analysis, commercial real-estate loans could
generate losses of US$100 billion by the end of next year at more than 900
small and midsize US banks if the economy's woes deepen. Such loans, which fund
construction of shopping malls, office buildings, apartment complexes and
hotels, could account for nearly half the losses at the banks analyzed by the
Journal, consuming capital that is an essential cushion against bad loans.
Total losses at those banks could surpass $200 billion over that period,
according to the Journal's analysis, which utilized the same worst-case
scenario the federal government used in its recent stress tests of 19 large
banks. Under that scenario, more than 600 small and midsize banks could see
their capital shrink to levels that usually are considered worrisome by federal
regulators. The potential losses could exceed revenue over that period at
nearly all the banks analyzed by the Journal.
In Europe, things are hardly better, if not worse. And the less said about
Japan the better. At this point, the US seems to be the country most poised,
among developed economies, to come out of recession, but that's not going to
happen soon. Clearly, more economic pain awaits the world.
In the case of India, growth in the financial year coming to an end on June 30
is expected to be less than 6.5%, and the country will be lucky to see
expansion of 6% in the following 12 months. So domestically, nothing much has
changed that points to an immediate turnaround in fortunes.
What has changed is the impending formation of a stable government. Indications
are that punters placed a bet on this outcome prior to the elections and
Monday's unprecedented rally was a culmination of this expectation. The basic
expectation of a stable government is that the difficult parts of economic
reforms will be carried through. However, if history and the previous
performance of the UPA government is anything to go by, that expectation can be
met only partially.
Populist policies were very much a part of the UPA's election manifesto. Hence
there is a very real danger that the newly elected government will be obliged
to go the populist way. Nor has the alliance covered itself with glory in its
attitude towards reforms.
There are still some low-hanging fruits from the economic reform basket that
can be taken advantage of, but major and politically sensitive reforms are
likely to continue to struggle to see the light of the day.
The UPA is also crucially dependent on the Trinamool Congress and its
shenanigans are now well known, even beyond India, given its decisive role in
forcing Tata Motors to move its Nano car project out of West Bengal. The party
is led by a person, Mamata Banerjee, who has also shown her sense of
opportunism by aligning with different parties at different times (also true
for many other allies of UPA), irrespective of the ideologies. This clearly
brings to question the ideology of the party itself. On top of this, the lady
delighted in carrying a resignation letter in her pocket (or wherever she can
fit one in) whenever she was a minister, as a threat if things did not go her
way.
To India's benefit, the communists, with their penchant for obstructionism,
have been decimated in these elections. Yet it is doubtful whether the
Trinamool Congress, which ousted the communists in West Bengal and supports the
mainland Congress, offers a better alternative.
The country is in dire need of administrative reforms, since only these can
ensure improvement of delivery mechanisms. While such steps would be easily
accepted by the Indian populace, they remain little more than occasional lip
service for political leaders.
Reforming the outdated labor laws is a case in point. Nor are subsidies going
to be scrapped, specifically those on fuel, a majority government or otherwise.
Such changes were not made before and look even more difficult to pursue now as
they run counter to populism - by which Congress and its allies live and die.
Correcting the mess that is India's fiscal position is also not going to happen
overnight, especially given the slowing economy and global recession. Wasteful
government expenditure is not going to be reduced, particularly as subsidies
are not going to decline. On the plus side, lower fuel prices will put less
strain on government coffers, but that has nothing to do with the election or
with the benefits of a stable government.
What is most likely to happen is more sales of government-owned enterprises,
given that the communists (who relentlessly opposed disinvestment) are no
longer part of the equation. That will help keep a check on the fiscal deficit,
(including below-the-line items such as oil and fertilizer bonds) at present
running at nearly 12%. Yet in some cases even this will not be easy.
Such government sell-offs will be the best way to fund intended development
projects, which otherwise are unlikely to materialize, given the limited leeway
the fiscal deficit gives the government.
The need of the hour will be to formulate a policy that will facilitate labor
reforms, start administrative reforms in earnest, scrap controls on fuel prices
to cut subsidy costs, increase long-stalled foreign direct investment, in
insurance and pension funds and remove all barriers that are holding back
road-building and expansion of power generation.
Populism, notably in the form of a waiver on farm loans, helped the UPA to
retain power, but the new government led by Congress will have to go easy on
such handouts. The government faces a widening deficit, slowing economic
growth, falling exports and factory output, and huge expectations for fresh
stimulus to protect growth and jobs. Whether the new government can deliver is
a moot point - it probably can, albeit partially.
At this point, the stock market euphoria seems to be built too much on optimism
rather than hard fundamentals. Some hope regarding India's future is valid;
runaway optimism is not. Experience teaches that caution is justified.
Kunal Kumar Kundu, a former senior economist with a leading bilateral
chamber of commerce in India, now works with the Knowledge Service Division of
Infosys BPO Ltd. He has a Masters in Economics with specialization in
econometrics from the University of Calcutta. The author here is expressing his
personal views.
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