Economy Aug 27, 2013
Sometimes, it is worth looking at the bright side of things. Even as the Sonia Gandhi-led UPA sinks the economy further in the short term with the passage of the Political Insecurity Bill - a.k.a. the Food Security Bill - it is worth making a few predictions about the next five to six years of the economy. These years will include not only the next nine months of this decrepit government, but possibly one or two more short-lived governments going all the way to 2018-19.
It is difficult to see Sonia Gandhi as a key player in pushing reforms, but the chain of dangerously high expenditures set off by her Food Security Bill will leave her with no other option. We will see costs rising, growth slowing further, serious job losses, and belt-tightening on all fronts.
Politicians opt for reform when they exhaust all other options. The key prediction I would like to make is that 2014-19 will be a period of great reform and great pain, no matter who forms the next government. It may start in small doses, but the trend towards bankruptcy of the central and state governments will prompt greater reform. Without reform the state machinery will collapse over the next few years. One presumes even a UPA-3 will not let that happen.
We can already see change coming from the frenzied way in which Finance Minister P Chidambaram is making announcements about FDI in every possible area, apart from offering clearances for several lakh crores worth of stalled projects. The only FDI areas left untouched are possibly foreign investment in political parties.
That these projects may not take off before the Congress government bows out of power is another matter, but they will start taking off once the next government is installed. We are seeing even the UPA embrace reform because, as Manmohan Singh famously reminded us, "money does not grow on trees." In fact, it grows only in the RBI's printing presses, but the cost of growing money there is unending inflation and falling growth - as everyone has rediscovered. This combo is what is prompting reform. Sonia Gandhi's NGOs, normally hyper-allergic to reform, are maintaining radio silence on this.
The current account and fiscal deficits are two numbers that are prodding the government towards change. The CAD is forcing the government to open up the economy more to bring in dollars, and the fiscal deficit is pushing the government to start reducing subsidies.
Over the next few years the Food Security Bill - under-funded and with costs grossly under-estimated - will unleash so much subsidy bleed that reform will be the only way out.
But deficits aren't the only indicators suggesting future reforms. The truth is many, many government-owned corporations and undertakings are headed towards economic ruin without reform.
Take banks. Or insurance companies. Or oil companies. Or power companies. Or Air India, BSNL and MTNL. Wherever you look, the UPA regime's policies have reduced them to stretcher cases.
According to outgoing RBI Governor D Subbarao, public sector banks will need at least Rs 90,000 crore (over and above their internally retained profits) to meet capital adequacy norms under Basel-3 by 2018. This is without accounting for the additional capital needed to cover up their bad loans - caused largely by the UPA-induced slowdown and resultant corporate bankruptcies. Business Standard reports that public sector bank shares have fallen so hard on the market that their valuation is only half their net worth (book value).
The newspaper says that the market value of 25 listed public sector banks is now Rs 2.3 lakh crore when their net worth is Rs 5.12 lakh crore. At this kind of valuation, they won't be able to raise capital on decent terms, and the government will have to bail them out.
The government simply does not have the money for it, so it can either print notes to recapitalise them - and increase the fiscal deficit, risking a rating downgrade - or dilute its stakes in these banks. Over the next five years, all soft options like dilution to 51 percent will be exhausted, and at least some banks will have to be willy-nilly privatised.
Another soft option, asking the Life Insurance Corporation to subscribe to banks' capital, was used to the hilt last year, and it could happen again this year as banks are desperate for capital. But even with its huge investible resources, the LIC cannot bail out all banks for years on end. As things stand, the LIC itself will need capital as its solvency ratio is among the lowest among life insurers.
LIC's solvency ratio, or solvency margin, is 1.54 - which means its assets are 1.54 times its liabilities to policyholders. Compare this to Bajaj Allianz's 5.4 percent, Birla SunLife's 2.99 and ICICI Pru's 3.71. It's obvious that if the LIC is asked to pump in more money into disinvestment and public sector banks, it will be slipping towards imprudence.
It is a safe bet that LIC will be seeking more capital in 2014-19, and the government will again have two choices: print more money or start divesting shares in LIC itself.
The story of the oil companies is too fresh to repeat: let's be clear that all the oil marketing companies are humongous loss-makers, if not bankrupt, had it not been for the subsidies doled out by the UPA government. In two terms, the UPA government would have dished out nearly Rs 7,50,000 crore of taxpayer and investor funds to subsidise petrol, diesel, kerosene and LPG - and the losses even today amount to Rs 389 crore per day. The subsidy bill is shooting up by this amount daily despite the steady increases in diesel prices all through this year.
Over the next five years, we should therefore see either full petroleum price deregulation (barring kerosene and LPG), or privatisation. Probably both.
If petroleum prices are deregulated, it is difficult to see coal pricing remaining unaffected. The demand for coal will shoot through the roof as oil becomes costlier, raising prices both domestically and globally. This will call for slow deregulation of every possible energy source - from coal to gas.
As this begins to happen, the companies left to suffer will be power and fertiliser - both heavily subsidised right now.
The procurement needs of the Food Security Bill will force more intensive cultivation using more fertiliser and power, which will push up central subsidies on fertiliser and state subsidies on power. Since food prices under the Food Security Bill will be frozen for three years, it means not only the food subsidy bill, but the fertiliser and power subsidy bills will also bloat beyond tolerance levels in the next three years. The accumulated losses of state power distribution companies currently exceed Rs 2,00,000 crore despite tariff increases in the last one year. The clean-up of the power sector done by the NDA has been completely nullified by the UPA.
Food, power and fertiliser subsidies will drive both centre and states towards technical fiscal bankruptcy - forcing deregulation of urea prices and power tariffs. Higher power tariffs will make even solar power look competitive. We are now moving towards a high-cost economy, and deregulation and reform are the only ways out.
Let's also not forget bumbling public sector red-ink champions like Air India, BSNL and MTNL. None of them can survive without government cash and bailouts. But when government runs out of cash, what will they do? Privatisation again is the only way out. Otherwise, taxpayers will be paying for keeping comatose companies alive.
Over the next five years, India will be on sale. And it will bring serious reforms, good reforms. The chain of events and bad economic management will finally lead to a more efficient economy - but we have to go through years of pain before that. A pity UPA blew the opportunities it had over two terms.
Sonia's Food Bill may provide the tipping point to bankruptcy and then reform.
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