Sucheta Dalal :Bangkok Vs. Bengal
Sucheta Dalal

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Bangkok Vs. Bengal  

May 19, 2004

How bad can the policies be and how bad would the impact be? The crash is indicative of things

By Debashis Basu

Institutional investors and big punters who determine the fate of shareholder value over the long and medium term have been given a new set of political and economic equations to juggle with and judge their impact on the economy and markets. Their first reaction has been one of utter panic. They pondered for the day the general election results were declared and then sold so severely the next day that various indices collapsed by 12%-16% in what seemed like a worst day for the market in living memory. The severity of the fall on Friday even escaped the sensationalist pink daily, which focused only on the absolute figure of fall in Sensex and thereby missed the extent of crash. Fall in Sensex was among the lowest in major indices. On Monday the fall was even severe – more than 10% in 15 minutes and 15% when trading was halted for the second time. On that day, hot money, that had created a parabolic rise in December and January, tried to get out of India.

Did investors and punters overreact, as the media seems to be asking and then attempting to reply? That is an irrelevant question for two reasons:

·         Short-term market reactions can be hugely irrational. Markets always shoot too much to one side. Sensex rose 800 points in December ‘03 alone to create a 100% rise in Sensex in 9 months between April and December. How rational was it?

·         In any case, if the market shoots too much downwards, investors/traders pay for their irrationality, if any. On the other hand, bureaucrats and politicians go scot-free for their irrationality while making others pay for it.

The key question: what can we expect from the new Sonia Gandhi-led,Left-supported Congress-dominated government, based on their recent record? Also, how would that government deal with serious economic issues that would gain in importance over the medium-term? The answers to these questions will determine whether the market has acted in haste.

Sonia Gandhi is all set to become the PM but what are her thoughts on models of economic development? The idea of controlled economy is dead. Even the communists talk of “changing with the times” – at least they did so before this general election. There are two kinds of development models now: continuous liberalisation vs. reluctant liberalisation. In parts, the Narasimha Rao and BJP governments followed the first model. States like West Bengal are following the second, having bankrupted themselves with a controlled and anti-business policy for decades. What is the economic ideology of Sonia Gandhi? Nobody knows. She has never uttered a word on what ought to be the economic policies under a Congress rule, too busy trying to keep the party together.

We do not have a successful Congress model at the state level either which we can refer to. In the past six months Congress has lost the state elections of Rajasthan, Chattisgarh, Madhya Pradesh and Karnataka. In all these states, it has had reasonably progressive and performing governments but voters kicked them out, putting into doubt the very idea of whether “reformist” governments work. If so-called “reforms” did not work in the states why would any politician take the risk of trying it at the national level? The rout of Chandrababu Naidu and success of Laloo Yadav in Bihar would only strengthen this view. The first move of Rajashekhar Reddy in Andhra was to make power available free of charge to farmers! In any case, Gandhi’s only interest in the states that the Congress once ruled, seemed to be the cash the CMs could contribute to party funds.

 If businessmen think that the presence of Manmohan Singh and P Chidambaram in the cabinet is all very positive, it may be wishful thinking. On the other hand, the market may even be pleasantly surprised by a set of bold policies of Gandhi once she becomes the PM. We simply do not know. The chances of this happening are remote though. There are always too many vested interests leading a confused and an ignorant leader to wrong decisions. And Gandhi has not shown any knowledge about the role of economic policies in the mechanics of wealth-creation. If a bold liberaliser like Narasimha Rao faltered within a year or two, despite having consolidated his position, what probability is there for Gandhi to be any bolder?

What to expect ?

·         No privatisation proceeds

·         Higher govt. expenditure

·         Higher fiscal deficit

·         Higher taxes

·         Higher interest rates

·         Higher inflation

·         Lower rupee

·     Lower stock prices?


The other major aspect of Gandhi becoming the PM is her complete lack of policymaking experience. She has not held the position of any junior level minister and has straightaway become the PM. Rajiv Gandhi too had similarly parachuted into the PM’s office. His lack of economic knowledge and the influence of vested interests lead to immature policy decisions including massive short-term borrowings to fund imports of consumer products and components. The dramatically rising short-term debt (from zero to $6 billion between 1985 to 1990) culminated in the economic crisis of 1991.

The institutional structures are more transparent now, the world has become more globalised since the mid-80s and the rupee is subject to more market forces. But then India also has huge foreign exchange reserves for the politicians to play around with. Besides, the lack of knowledge of the PM and consequently the wrong policies, may not hit the economy in the same way, but in a completely different source. What could be that source? It could be largesse for the poor and the rural folk through the budget, something that the Left might insist on. But it is not just that policies (especially made under a coalition with the Left) would be regressive. But it could even be an inability to deal with the currently changing economic environment.

Things will be far worse because of the kind of cyclical period the Indian economy is entering. The stubbornly high budget deficit was being brought under control by a massive and successful programme of disinvestments. This will be virtually abandoned now, leading to higher fiscal deficit. Unfortunately, the cyclical sweet spot of low interest rates and low inflation is also going off slowly as we have been warning for the past five months now. A new, insecure government, led by an inexperienced, foreigner, standing on the crutches of a bunch of ignorant, opinionated and self-serving communists that have bankrupted West Bengal, is not the best combination to deal with a turning macroeconomic situation. Does that mean that the market has to react in such panic? To get back to the phenomenon of the market crash, investors are often irrational. But the huge fall over two days can be explained.

One-sided Market: For over one year, the market has been completely in the hands of just one kind of player: the foreigners. We don’t know who these people are. All we know that they have taken the market 150% up on an annualised basis even as retail investors, domestic mutual funds (got a trickle of subscription) and Indian promoters sold. They were so eager to buy the India story that at one time they held 18% of free float of top 200 companies worth $40 billion. If “everybody” in the market wants to buy, a change of fundamentals will make the same “everybody” sell. As we have mentioned several times in the past, with their money and enthusiasm and limited knowledge of Indian politics, foreigners are great at creating market tops – as has happened in 1994, 1998, 2000 and 2004. They have done it again. We have elaborated on this in the next article.

Bengal Vs. Bangkok: The bigger the information gap the greater is the volatility. This applies as much to individual stocks as much to the market. When the FIIs were putting in money into the Indian market they were dealing with known factors and people like Jaswant Singh and Arun Shourie. The general elections not only threw out these people from power but also brought in people like Sitaram Yechury and YSR Reddy to the forefront ably assisted by a motley bunch of discredited and regressive politicians like HS Surjeet, VP Singh, Chandra Shekhar and Laloo Yadav. Foreign investors sitting in Hong Kong or Singapore are used to Bangkok. Suddenly, they have to deal with Bengal. They had sky-high expectations. It has been replaced by deep disappointment.

A one-sided herd like buying for months followed by a sudden discovery that it was all a big illusion for so long, can only lead to a market crash. More about this, in the next article.

-- Sucheta Dalal