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Published on: Feb. 8, 2021, 12:59 a.m.
Wounded tiger, chasing dragon
  • Any action based on envy is sin

By Ajit Dayal. The author is Founder, EquityMaster and Quantum AMC

For decades the image of India was associated with that of an elephant: large, bulky and slow moving. The nationalisation of companies by the dictatorial Mrs. Indira Gandhi and the stranglehold that the bureaucracy had on India was stifling.

Then, the next images that made the rounds were that of an India depicted by a caged tiger and waiting to be unbound. While Prime Minister Rajiv Gandhi's tax-reducing budget in 1985 allowed the elephant to undergo the first stages of the metamorphosis, the budget under Prime Minister Narsimha Rao ensured we ended up in the image of a tiger. Yet, the tiger remained caged and unable to gallop to its full potential.

If there is an image that would describe the state of the Indian economy since March 2020, when the lockdown due to COVID-19 began, it would be that of a wounded, cornered tiger.

After years of slowing rates of annual rate of growth in GDP, unrecognisable job creation and rising unemployment as shown by the consistent decline in the labour participation rate, the Indian economy was dealt a further hefty blow by COVID. While countries with near-full employment, strong balance sheets and access to global capital markets were humbled, India was ready to be knocked out - particularly if the anticipated health crisis from potentially hundreds of millions of COVID cases flooding a dilapidated health care system were to become a reality.

The severe lockdown of 24 March 2020 prevented that dark scenario. But it had a crippling blow on the economy - some jobs may be gone forever - even as it strained government resources. Lower tax revenues due to lower economic activity and higher spends to look after tens of millions affected have, as per the estimates in the budget presented on 1 February by Finance Minister Nirmala Sitharaman, spiked the fiscal deficit to 9.5 per cent of GDP for the year ending 31 March 2021. And we should recognise that much of the data on the fate of the medium and small enterprises is unknown and not fully accounted for in the budget numbers. Demonetisation and GST have increased the share of large companies in economic activity. Many of the beneficiaries of this shift in market share of economic activity are the large listed companies. Stock markets are rising, in some sense, at the cost of the medium and small scale businesses.

In normal circumstances, a declaration of a large fiscal deficit would have been catastrophic but the China virus' global spread was not a normal circumstance. COVID has forced even fiscally prudent counties to print money and run deficits that would have been unimaginable one year ago. All bonds issued by Germany now trade at below zero per cent: you need to pay the government to keep your money. Such is the state of a world pummelled by COVID.

Wounded tiger.

A wounded tiger, however badly it may have been weakened by unemployment and the hollowing out of medium and small scale businesses, is not likely to fade away. Its instinct for survival forces it to make that one leap, take that one last swipe at the foe to see whether it will emerge alive or face death. It is against this backdrop, that the annual budget for the year starting 1 April 2021 needs to be viewed.

There is no doubt that the Finance Minister has leapt out of her comfort zone and made that one forceful swipe.

But she may have made a leap for the wrong reason: envious of China, India wants to play catch-up. Any action based on envy is a sin: is the leap being made in the wrong direction by ignoring the lower income and the middle-class, the medium and small companies, and the pressing issue of unemployment?

Based on the proposed budget, how we land as a country or how we fare as an economy will be a function of many factors, many beyond our control. Take the main points of focus:

~   Health: this is the one factor within our control; the vaccines are manufactured in India and we have a plan to deploy and protect the population. Additionally, the spend of Rs65,200 crore over six years to build health clinics is a much-needed boost to upgrade India's health system to better react to future pandemics - and, yes, there will be more;

~    Cleansing the banking system of bad debts - while the details are awaited, the objective is clear. This will require foreign capital and favourable conditions to ensure that India remains an attractive investment destination;

~    Privatisation - the proposed sale of Air India has, once again, been proposed. An IPO of LIC has, once again, been proposed. The combination of a divestment and a privatisation programme can be powerful. This, too, is a very powerful leap from a wounded tiger chasing the dreams to achieve the rates of growth of the China dragon. But, this, too requires the buy-in of foreign capital;

~    Infrastructure - the decision to spend money on roads, metros, railways and pipes for drinking water is another decision that will have far-reaching implications. At one level, the drinking water will improve health and, at another level, the concerns that the country is spending less on air pollution and more on the things that enhance air pollution will be scrutinised. The budget may not be a winner in an environmentally-friendly scorecard. But, to be fair, a wounded tiger is not looking for a health certificate. Here, too, the success of much of the spend will be a function of money availability - and an expectation that long-term foreign capital will seek investments in Indian infrastructure projects;

~   Supply chain for the world - the incentive to finance the creation of factories in India to offset the world's dependence on China in a post-COVID world is also relying on the goodness and desire of foreign multinationals to invest in India. The policy assumes that the US and Europe are at war with China and that this war will intensify.

~   India, as per the calculation, will then benefit. Maybe - maybe not. The day after the budget speech by the Finance Minister, the US pharmaceutical giant Bristol Myers sold one of its five manufacturing plants in Switzerland to a Chinese pharma company. It was the first pharmaceutical factory in Europe purchased by a Chinese company. Did you read about this? Did you read about any protests from the EU or the US governments? What if, in a world now ruled by governments that are happy to do business with China (now that Trump is out of power), the West and China patch up? What if? Will MNCs still look at India as supply chain? They could - for lower cost labour or to set up shop to feed domestic demand. But...

Look within, wounded tiger.

A wounded tiger has to make that one leap.

But it better be an intelligent, calculated leap: its survival depends on it.

An attack that has the highest probability of succeeding is one which relies upon the spring in one's own step, not on the direction of a gale force wind of international money flows or geopolitics to enhance the intensity of the leap.

I loved the leap.

It shows determination and, more importantly, probably the first real understanding of the dire straits the economic growth engine of India has been pushed to after years of missed opportunities, poor policy and questionable implementation.

From demonetisation to GST, from labour laws to farm laws: every policy addressed a problem that needs to be reformed and the government deserves full marks for trying to uncage the tiger. But every policy was poorly crafted and/or badly implemented. If unemployment is the final measure of the outcome of every policy action - and given that we add 10 million young people to the working force every year that should be the one measure to grade the social stability of a country - India has not done well.

Hence, India was weakened way before COVID and nearly knocked out by COVID.

The budget in a nutshell is hoping that a financial restructuring and change in ownership along with infrastructure-led investment will boost economic growth - and it is silent on how precisely jobs will be created.

The bad loans will head to a bad bank. It will presumably be bought by a foreign-funded entity. The banks that have been cleansed of their bad loans will now be ready to lend again but we don't know to whom they will lend, or for what businesses.

The sale of shares will bring revenues to a government that badly needs money - furthermore, once sold Air India and other PSUs will no longer require the government to invest good money into bad companies. Here, again, foreign money is presumably expected to help resolve the problem.

The port and roads we build will generate tolls and then we can package that into an infrastructure REIT and the foreign funds will invest.

Somewhere in the broad statements of all this financial reengineering, is the assumption that an investment-led recovery will boost employment creation, will act as a catalyst for consumption and result in higher tax collection.

Investments take time to fructify; job creation takes time: and what about the immediate job losses that may accompany any privatisation?

The Indian tiger has over one billion people to lift off from and a billion people to protect: it can be a domestic consumption engine. It was wonderful that there was no tax increase but is the lack of a negative really a positive?

What if the budget had focused on reviving consumption demand with an expectation that this would boost employment? What if this demand revival was directed at production from smaller companies, to help offset the pain they have seen from demonetisation to GST? What if:

~    The tax cuts given to corporate India in September 2019 were reversed. The estimated value of the tax gift was Rs1.5 lakh crore. It was supposed to boost investment and boost employment. It did neither. In fact, corporate India laid-off labour during the pandemic. They enhanced their profit margins during the lockdown by reducing costs, mostly labour.

~    What if that same tax money was passed on to the salaried class today: the Rs1.5 lakh crore tax cut given to companies would end up in the hands of consumers. This would add 1 per cent of GDP to consumption demand.

~    GST on products manufactured by larger companies was increased and that of products manufactured by smaller companies was reduced?

~    Stamp duty cuts or waivers in the state of Maharashtra boosted demand for housing. Real estate, like farming, is a state subject. If a national law can be made for farming, how about a stamp duty compensation scheme for states that do reduce stamp duty on prices for low and middle income homes? The budget made a provision for the ready reckoner prices for tax purposes - but for lower income homes, and kept the homes for the middle-class out of the exemption.

~    What if a "good bank" was created to raise $100 billion from international investors at the prevailing low rates of interest solely for financing purchase of homes up to Rs3 crore in price? I have written about this earlier with a belief that this will lead to an immediate spike in demand and rapid employment.

In each of the above points, the success of the policy lies on what people within India do, not on whether the US is at war with China or not - or whether foreign investors will rush to India because interest rates are very low in their home country.

If a tweet from individuals like Rihanna or Greta Thunberg scares the government, they should be having sleepless nights watching the movement of financial flows and trade flows in a very unsettled world.

On another point, many commentators are using the thrust of this budget as some sort of victory that investment in the private sector will enrichen India and this is a "right of centre" budget. Giving handouts will not help, they argue.

They are correct: dole is a waste of money from a return or long-term regeneration perspective.

But where the money is invested is also a conscious choice: what if, at one extreme, the entire expenditure was on rural India for rural roads, for water ponds, for irrigation canals, for rural power plants. What if that investment would create employment, generate incomes in rural India and drive consumption growth - all of which would boost GDP. What if that questionable Rs22,000 crore on a coastal road being built in Mumbai was, instead, spent on irrigation canals and water ponds in the state of Maharashtra? Most companies will tell you that the rural demand during COVID was nearly 2x higher than the demand from urban India. Keep those engines humming!

It is not a slam dunk proposition that investments in urban India projects (metro, coastal roads) are superior to investment in rural India. The city-centric and urban-focused, corporate-investment mantra is a bias that will continue. Ignoring the needs of rural India is a danger in itself and any thorn in the tiger's paws could impact the strength of the leap.

As it is, the tiger is relying heavily on capital flows to make it to safety.

I admire the desire to make the bet.

India is now, to use an expression at a poker card game, "all in".

The wounded and sickened tiger has made the leap.

Now we need to track where and how it lands and hope that the four pillars of any economy (GDP, Inflation, Interest rates and the FX rate) are in good shape to deliver the only thing that really matters: employment and wealth for its citizens.

For now we have a booming stock market but we need to recognise that rates of return for investors are - in the final analysis - a by-product of the health of a society. A lot is riding on this leap: chasing dragons can be a dangerous game.

This column was first published on Equitymaster.com. Reproduced with permission.

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