Revenge of the Red Dragon?

What was it? Many wondered as the Bombay Stock Exchange plummeted on that fateful Monday
What was it? Many wondered as the Bombay Stock Exchange plummeted on that fateful Monday

A story of fiscal deficit
Finance Minister Arun Jaitley has regularly evinced confidence in the Indian economy. He said that trends in sectoral growths, tax collections and corporate sentiments indicate that the economy is on an upswing. Unfortunately, experts feel differently. They point to limited hike in private investments, below-the-average monsoons, iffy corporate results and spiky and inconsistent growth in core and infrastructure sectors. Several CEOs, who sang Modi praises in the past, have publicly said that this government has under performed in the past 15 months.
Modi’s failure is his inability to walk his talk and fulfil the promises he weaved during his election campaign and after he assumed power. The last monsoon session of Parliament provided evidence that this government, like the previous regime, may fall into the policy paralysis trap. The opposition managed to stall crucial reforms like Goods and Services Tax, and land acquisition. Given the NDA-2’s minority in Rajya Sabha, the future may witness more of the same.
If the investment sentiment and growth prospect remains subdued, Jaitley has to raise the estimated 69,500 crore through disinvestment of government’s shares in state-owned entities. Thus, he needs to escalate the pace of privatisation, especially what he dubbed as ‘strategic sale’ in his second Budget. This is where local factors impact Indian stocks. Past experiences prove that whenever India wishes to raise the disinvestment tempo, public sector stocks go for a toss.
This is exactly what happened in the run-up to Black Monday. Over the past few weeks, several public sector stocks took a beating. In the past two weeks, Coal India, with a decline of 18 percent, featured among the top five losers in the last fortnight. Even on 24 August, they were among the most badgered among all the stocks. GAIL was among the top five losers with a 13 percent decline, followed by ONGC (11 percent). Ironically, this was the day when the disinvestment of state-owned Indian Oil Corporation began. Luckily it was oversubscribed on the first day.
A banking narrative
Among the biggest losers on Black Monday were the banks, both in the public and private sector. The reason was obvious to everyone who knew about the crisis in Indian banks. Experts have predicted that ‘stressed’ loans, which include bad loans (non-productive assets) and those that are likely to become one, would cross the 8,00,000 crore mark. Almost 40 percent of these loans will constitute bad loans. The crisis in sectors like coal, steel and power can peg this figure higher.
Even though the government hailed the auction of coal blocks as a huge success it may turn into a bane over the next 12 months. The allocation of the mines to private and public sector players earned a mind-boggling 4,00,000 crore. But due to several factors, these captive mines and related-user industries (steel and power) may turn unviable and, hence, unprofitable. This will further stress the banking sector, which has huge exposures to all the three sectors.
Experts contend that the government will then attempt to save these sectors, as well as the banks. Its only option will be to hike power tariffs, which is likely to have a multiplier, but negative, impact on the economy. The experiences in other natural resources, like spectrum (telecom), hint at a hike in power charges. The only sufferer then will be economic growth.
The biggest fear in the corporate sector and the banking sector is a slump in rural demand due to below-average rains. This will hurt corporate earnings over the next few quarters, and result in good loans turning bad in even the consumer sectors. This is a situation that the government can ill-afford. So, it has to get growth at any cost. But the fiscal constraints remain. Jaitley cannot let the fiscal deficit to go up because that may lead to a global downgrading of India’s rating.
In addition, bad monsoons can cripple the agriculture sector, which is ailing with emotive and crucial issues like farmers’ remuneration, debt and suicides. During his election campaign, Modi promised that his policies will hike farmers’ incomes by 50 percent. While this government has rejigged the numbers to show lower suicides, the situation in several parts of the country is grave. Debt and low productivity remain the major issues that plague the lives of farmers.
A nightmarish scenario
Imagine this scenario. Inflation levels go up, guided by the continuous rise of food products. In Delhi, onion prices threaten to reach 100 a kg. The central bank refuses to lower the interest rates since it wishes to focus on price rise. High interest regime impacts growth; growth remains low as sentiments fail to improve, and private players play the wait-and-watch game. The rupee takes a beating due to global factors, which has a negative impact on CAD.
Obviously, corporate earnings fail to improve; in fact, faced with a decrease in rural demand due to bad monsoons, several companies incur losses. The effect on the Indian stock markets is imaginable. Most stocks will plummet, and foreigners will exit in a great hurry. As foreign money flees, it will put further devaluation pressure on the rupee, which will increase CAD. Higher prices of imports will impact demand for such products, which will further curtail growth.
As production slumps and supply reduces, prices of several products are likely to go up. It is a typical demand-supply- price curve. The central bank doesn’t touch interest rates; sentiments within the business community become more negative. The downward cycle goes on and on. Within a couple of years, India is back to an era of high inflation and low growth. The latter affects the incomes of people and the former hikes their expenditures: A double whammy for the citizens. Imagine the economic consequences! It is a nightmarish scenario for Modi and Jaitley.
Now imagine the political consequences of such economic developments. While the country’s economy spirals downwards, the ruling regime takes several political hits. The BJP and its coalition partners lose several state elections over the next couple of years. They don’t manage to get the required numbers in the Upper House and, hence, are unable to push through any policy, critical or minor. It is caught in a classic policy freeze. Finally, imagine the consequences of such politico-economic trends when the country goes to the polls in 2019 to elect the next prime minister!