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The Imperatives of Power

The euphoria led to unrealistic expectations by the market

Why did the stock market collapse after the announcement of the proposals in the Union Budget by Finance Minister Pranab Mukherjee (FM)? There was more than one reason why the Budget was greeted with a thumbs-down by the bourses. These included unrealistic expectations about what is euphemistically described as second-generation reforms such as divestment of the government’s shares in public sector undertakings (PSUs) and an opening-up of the economy to more foreign investments, both direct as well as in the form of portfolio inflows.

What added to the woes of those who were predicting a big-bang Budget that would expedite the process of economic liberalization and integrate the Indian economy with the rest of the world, were higher taxes on the corporate sector and a larger-than-anticipated fiscal deficit as a proportion of the country’s gross domestic product (GDP).

An apparently bigger faux pas was the hope that many of the policy prescriptions outlined in the Economic Survey released a few days before the Budget would find place in it: an expectation that should not have been there in the first place simply because the wish-list is put together by a team of economists in the Ministry of Finance (MoF), led by the Chief Economic Adviser, whose work is different from that of the FM who is perforce a political animal. For instance, the Survey talked of the desirability of raising “at least” Rs 25,000 crore a year by divesting 5-10 per cent of the government’s equity holdings in profit-making PSUs. This is very fine in theory. But Mukherjee has to think of the opposition to divestment from within his own party as well as its partners in the UPA coalition.

The stock markets may want to be flush with shares of navratna PSUs, but the FM has a different set of concerns that go well beyond the valuation of these shares. The government’s rules specify that all the proceeds derived from divestment have to go from the Consolidated Fund of India to a special fund called the National Investment Fund  (NIF) that currently has a corpus of Rs 1,814 crore.

After Prime Minister Manmohan Singh made a speech at a function organized by the Standing Conference on Public Enterprises in September 2004 wherein he remarked that the proceeds of divestment should be used for providing basic social goods, a note was sent by the Prime Minsiter’s Office (PMO) to the MoF to set up the NIF. After a decision by the Cabinet Committee on Economic Affairs, the Fund was formally operationalized in January 2005. Importantly, the government decided at that time that the corpus of the NIF would be invested in three PSU mutual funds and only the interest earned on these investments could be spent, three-quarters of it on the social sector and the balance on the PSUs themselves.

Finally, the markets were anticipating a cut in the central government’s fiscal deficit at a time when the rate of growth of the economy had slowed down and the world was going through an unprecedented economic crisis. This was clearly unrealistic at a time when almost each and every country on the planet is borrowing like crazy to spend on infrastructure, the prescription of the late British economist John Maynard Keynes (1883-1946) who advocated an interventionist government policy to mitigate the adverse effects of recession. If India’s budgeted fiscal deficit — 6.8 per cent of GDP for the Union and an additional 4.5 per cent for the states — for the current financial year is supposed to be on the high side, it should be noted that the comparable proportion is much higher in most major economies, with the exception of China.

The short point: if you think the moon is yours for the asking, there is every chance that you will end up falling flat on your face. That’s just what happened on July 6.

This article appeared in the July 2009 Issue of Mutual Fund Insight