Now that the election is done and dusted, all eyes are on the Budget and the reforms that the government needs to front load. The way a market is structured reveals a lot about the stage of development of the country. Indian regulations for markets and money have evolved piecemeal, solving problems as they came along. But the rules that worked when the economy was at $500 billion are already under stress as India rises to hit $3 trillion. The journey to $5 trillion and then double of that will need new rules of the game. Here are three areas that are crying for change.
One, as India moves from a financially repressed economy, the rules around forced investment into government bonds will need to change. Financial repression is when the government uses its dominant position to put in rules of the game such that it appropriates a bulk of the savings of the nation. It also means that the government, through the central bank, uses its power to set interest rates that are below the inflation rate. In the first case, household money finds its way to government bonds through banks and insurance firms. In the second, the government is able to inflate away its debt. Look at the rules for Indian banks and insurance companies and you see a text book case of financial repression. Banks are currently forced to keep 19% of their deposits in government securities as part of the statutory liquidity ratio (SLR) requirement and another 4% currently as the cash reserve ratio (CRR) requirement with the RBI. So of every ₹100 of deposits that a bank collects, it cannot put ₹23 to use (for lending). Insurance rules are similar. A bulk of the ₹32 trillion assets under management of Indian insurance firms buy government bonds. Notice how tough basic reforms have been in both banking and insurance in India, while stock market reform has been much easier. But this was the paradigm of a low-income, low-tax-paying and low-growth economy. A faster growth with more people paying taxes that result in a higher tax-GDP ratio will give the government the elbow room to relax these regressive rules that punish household savings. The Narendra Modi government should rethink these rules specially since an inflation-targeting central bank will keep inflation under the lid and the Fiscal Responsibility and Budget Management (FRBM) will keep deficits under control—the need for forced household savings will reduce. A rethink in investment rules in insurance, in particular, will open the door for change that stops the huge mis-selling that is in turn driven by high commissions. To read this piece click here
The 8,153-word speech by finance minister Piyush Goyal, who was stepping into the shoes of the ailing Arun Jaitley, had some giveaways and some promises to both India and Bharat. But if you look for a subtext, it is this: “We inherited a struggling economy that was crying for structural reform after years of policy paralysis. Our macro report card is good—inflation is down, deficit numbers are within a whisker of the glide path recommended in the FRBM Act and the economic growth numbers are strong. To fix the micro, that means things that will make a difference in your life, give us another chance. And, by the way, to help you help us, here are some rewards targeted at those who most need them.”
A doctor friend will occasionally send a desperate SMS asking for clarity on the Narendra Modi government’s track record. He says he can’t make sense of the truth, flooded as he is with WhatsApp forwards, news, views and chatter that is so polarized that it looks like the messages are talking about two different countries. The next 10 months will see this divide get sharper and nastier as we roll up to Elections 2019.
The first thing we need to do when we enter this debate is to discard evidence by anecdote. For every anecdote from one side of the debate, the other side can give two more. My anecdote will always be more real to me than your story. Let’s stay with numbers. But numbers can also be hotly debated—depending on whether the GDP number is up or down, the validity of the data has been discarded or accepted. While numbers like the GDP or inflation or even manufacturing growth or investment are subject to a methodology which can be open to debate, the one number we can’t either fix or ignore is the Sensex, the broad market index made up of 30 companies. The Sensex seems to like it when Modi Sarkar wins elections. Look how it rose and then fell as the Karnataka elections changed colour from saffron to a muddled something.
If the Uttar Pradesh election was the referendum on demonetisation (demo), as was being said before the recent Assembly election results, then the answer from the people is clear. In a column I wrote (you can read it at: bit.ly/2mmdYeZ) immediately after 8 November, the day demo was announced, I had flagged the risk, both personal and political, that Prime Minister Narendra Modi was taking by putting the average citizen and the traditional voter base of the Bharatiya Janata Party (BJP)—the traders—through pain. Despite predictions at that time, the nation did not break into riots, the economy did not collapse, stock markets remained buoyant and the global view on the future of the Indian economy did not change.
The sudden shock of the currency ban and an unexpected election result in the US caused markets to open 6% down on 9 November. But a day later, the story has changed—all markets are up. So why are stock markets surging? Why are bond markets happy? Why are real estate magnates walking like zombies? What lies ahead for your money?
Readers of this column are hopefully smug with their financial plans and asset allocation in place and are not wasting time wondering if stocks are a good ‘bet’. But let’s deconstruct why markets are up on Day 2 of the #currencyban. Day 0 was 8 November, when Prime Minister Modi made his #currencyban address to the nation.
Some of us in India have paid, what I call, the ‘honesty tax’ for decades. Our money is salaried, there is nothing on top, we pay our taxes, keep our accounts clean, pay for large spends by card, do real estate deals in white and become the guys who obey traffic signals while others in bigger cars zoom away with a smirk. We pull out our cards and carry home our small shopping bag. The guy in the next aisle pulls out a brick of cash and thumbs out a lakh in notes to take home the high-value gadget. We drive our Maruti home with the EMI (equated monthly instalment) sitting in the backseat, the luxury SUV guy comes with a sack of cash and scrapes our car out of his way. We wait to buy a house with white money, don’t get the choice set, pay more and end up feeling like losers for being honest.
When I began this column in March 2009, I remember writing my first piece on the macro mess India was in and how a spendthrift government, which took an 8% growth rate and a 26% rise in tax revenues in the previous years as the new normal, messed up big time. You can read that column here: http://bit.ly/2bynE0d . With elections around the corner, money was splurged on massive loan waivers and many other let’s-give-them-money-and get-their-votes schemes. It worked and the government came back to power. The next five years got the country closer to disaster, with bank books getting stuffed with questionable loans, policy paralysis and big corruption in the central government and bureaucracy.