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Deficits killing the economy

When the government spends more than what it earns, it covers this deficit by borrowing in the markets by issuing bonds, writes Dr Bhaskar Dasgupta.

india Updated: Dec 15, 2003 20:30 IST

The India Babble

This week was good, with the index powering up almost 300 points on the week. Aside from a rather desultory Monday, Tuesday saw good interest (up 98 points) coming into the market, on the back of good noises from the Indo-Pak talks, overnight rally in the US markets and the financial institutions were really piling in across the board. Wednesday saw sharp volatility with slightly higher than average volume and the Sensex ended the day, 56 points up and touching a 44 month high. This rise was mainly due to the old economy sectors as the NASDAQ had dropped two per cent the previous day. Same thing happened on Thursday with the markets being extremely volatile with a fair bit of profit taking whilst closing 14 points up. Textiles were also hit despitenews that Wal-Mart was increasing its purchases from Indian textile companies. On the other hand, housing finance companies moved up on news that housing finance business is going to boom. Friday continued to boom and the Sensex closed 16 points to close at 5316.

The Reserve Bank of India (RBI) is moving to free exports from exchange control. In a landmark circular issued on December 5, the RBI chief general manager said that exporters now have full freedom to write-off or delay realisation of proceeds to the extent of one-tenth of the export billing in a calendar year, as evidenced by the GR form, which covers the export realisation liability. In other words, an exporter can keep 10 per cent of the earnings outside India without needing permission from RBI or its authorized dealer. The enforcement directorate too cannot question the exporter over the 10 per cent outstanding amount. The only RBI control is by way of an annual statement on the calculation of the 10 per cent entitlement.

I know I regularly moan about the fiscal deficit that the country is running and well, this is another moan. The amount of deficits is really killing the economy. A small tutorial here. When the government spends more than what it earns, it covers this deficit by borrowing in the markets by issuing bonds. How to make sure that people do buy these bonds? By making it compulsory for the banks and financial institutions to hold these bonds. The Indian financial landscape has a serious amount of capital locked up in these bonds, some even estimate up to 40-50 per cent. It would have been ok, if we would have seen this sheer mind boggling amount of investment giving some return, but if the deficit is going to pamper rich farmers or to pay for the subsidies for fertiliser or for grandiose projects, then the question arises, are we really investing well? As we well know, Indian governments are well known to waste public money and this is exactly what is happening.

We take one years of plus seven per cent growth and extrapolate it to call it as the Golden Age beginning. Well, so it might be, but not if the government is sucking out all the available capital in the economy. Have you tried getting a loan from a bank if you were an SME? I tell you, it is very difficult and this is what is stopping the small and medium scale enterprises from growing up. They are capital starved because the government has gobbled up all the capital. So we get hit twice, first we get hit because this deficit is not really funding worthwhile investments in the public and government sector and secondly, the poor SMEs and other industrial enterprises are starved of capital. We have to free up the SMEs, the vast bedrock of any industrial economy to grow up and prosper and till we address this fiscal deficit, we will never get this done.

Now here is an interesting story. There are 43 sick sugar factories in Maharashtra and the central government has now refused to allow the state government to fund working capital to these factories. These factories are not sick, these factories have given up the ghost, they are beyond the pale and they should be buried as soon as decent as they have stinking up the place. No sugarcane to operate them, loaded under tremendous debt, no market, equipment made in the time of Baba Alam, and a state which is creaking on the financial edges already, and the state government now wants to pour 900 crore rupees down this bottomless pit. Sometimes I despair of any economic logic in our politicians. Take 1/10th of that money, train the workers on some useful work such as working on machine tools or simply educate them and get them into some kind of productive long term work! No use throwing scarce good money after bad.

The Babble in the World

Apart from a bit of a hiccup on Tuesday and Wednesday, the DOW was moving on up through the week. On Monday, the DOW closed 103 points up on optimism on the economy and corporate earnings, the highest for the year. The Nikkei also added 37 points to close at 10082 on hopes that the rising economy will bolster corporate profits but on Tuesday, the slowly spiralling yen and bad news from chip makers brought the Nikkei down below 10,000 in a two per centfall and this carried on to Wednesday when the rising fears about the weakening dollar caused the Nikkei to further drop another two per cent to close at 9910. Following Tuesday's excellent numbers from the USA where the DOW briefly broke through the psychologically important 10,000 mark after a feeling that the Fed will keep the interest rates at bay, Japan moved up for the following two days to close the week at 10169. Japanese businessmen are feeling more confident with the Tankan business survey moving up 11 for this calendar quarter.

Wednesday saw the DOW treading water and falling back slightly by two points, but after the Fed meeting was digested on Thursday, the DOW closed firmly up above the 10,000 mark. The Fed reported that the risk of inflation was going to be low for the forthcoming future and the interest rates will be kept on hold. The rate of layoffs seems to be plateauing off as well based on the figures from the Labour department. On Friday, inspite of a rather down consumer sentiment report, the DOW moved on up beyond the 10k mark and closed the week at 10042.

We all know the problems which were caused by the requirement to have credit ratings on German companies around the Basel II negotiations. Simply speaking, the problem arose when German regulators and negotiators pointed out to the BIS that the vast majority of the German companies were unrated and therefore will attract higher risk capital charges.The result there was a pure and simple bodge. Still, it did not matter to the vast majority of German companies but to a small minority which had an international profile. Well, these rated companies got a rude shock when they found that S&P put their credit ratings on watch.

Because of the way the German companies treated their pension obligations. ThyssenKrupp, one of the biggest companies in Germany found its rating to be slashed to junk status. They were furious and commissioned a study to investigate.The study essentially rejects S&P's ratings system as inappropriate to German companies and secondly calls the current way that US & UK companies treat pension funds for balance sheet purposes as fatally flawed.In the rarefied world of pension funds, arguments are flaring and given the recent EU directive on EU wide pension funds coming up, this argument will impact almost every pension.

While the issue of constitutions are not usually the topic of this column, the EU constitution will significantly impact the continent and is therefore worthy of mention.Former French President D'Estaing and his team spent 16 months coming up with a proposed draft which the economist judged it to be a monumental effort fit for the dustbin. That was based on the draft, but according to Gisela Stuart, a UK Labour MP, who was part of the 13 member steering group, the reason for this half backed abortion of the incomprehensible draft was the sheer incompetence of committee, the secretive deals, French language chauvinism and vested interests. So much so that she calls the constitution as useless. Now, Tony Blair, why are you so interested in foisting this junk on us?

The EU is again trying to raise the WTO talks on farm and agricultural trade in a distinctly strange manner. It has clearly said that it will only talk about export subsidies and that too if all other countries are ok with this, no discussion allowed on direct farm aid support and no to any discussion on absolute amounts of farm support. Umm, guys, please note that giving money to European farmers is taking money away from poor farmers, and the developing countries have become quite smart in getting this fact right in their minds. This new attempt will fall by the wayside just like the previous Cancun talks, and simply because of the intransigence of Europe and USA. Nothing will happen at all.

The Financial Times reported on a strange case of the American city of Boston Mayor who wants to defy rules forbidding the import of cheaper drugs from Canada for his city. Basically speaking, the FDA of the USA has said that importing drugs is unsafe and nobody in the USA should be allowed to do so. Fair enough, after all, nobody in the USA wants to get a drug made in Sudan, do they? Sudanese don't matter to most of the world anyway but my worry is, just why Canadian drugs are unsafe? I thought Canada was a developed nation, with a very good health care system and I would have expected that the Canadian drugs were pretty safe as well as cheap. Could it be that the FDA and the US government is in hock to Big Pharma? Heaven forbid, God no, that cannot be right, so the truth is that Big Pharma gives expensive safe drugs to the Americans while giving cheap bad and impure drugs to Canadians. (snicker and chuckle!)

Another very interesting news item that more than 100 countries have signed an United National Anti-corruption pact. This should help hunt down corrupt officials and to recover illicit funds. This convention will force countries to criminalise bribery, embezzlement, money laundering and abuse of power. For the first time, it includes provisions that commit its signatories to return assets stolen and lodged overseas to their country of origin. For example, it will require public officials to officially state any foreign bank accounts that they hold and this will be monitored. About time too, corruption hollows out states from the inside and hurts the poorest of the poor. The politician - bureaucracy - criminal nexus has to be broken and frankly, tarring and feathering is one excellent way out, but these people have such thick skins, one despairs of any progress. One hopeful sign is that judiciaries have been active now and that would hopefully get some action going on this front. It will be a long fight but for the sake of our societies, we have to win against these worms and insects.

(Dr Bhaskar Dasgupta writes a weekly Monday round-up on markets and indicators. He holds a Doctorate in Finance and Artificial Intelligence from Manchester Business School and works in London in diverse capacities in the banking sector.)

First Published: Dec 15, 2003 20:30 IST