Economic Highlights

New Delhi, 15 February 2007

Stick To Economic Logic

Blind Opposition will Slowdown Growth

By Dr. Vinod Mehta

As of today the economy is booming and foreign investment firms have raised India’s investment ratings implying that Indian business can now raise funds abroad on easier terms.  It is perhaps the best time to take advantage of the situation and give a big push to the decisions which are holding us back from realizing our full growth potential. We have already missed the growth bus once compared to ASEAN countries and China and let us not miss it again.

If Indian companies can take over companies abroad why can’t they takeover domestic companies, especially the sick ones? Or, why can’t we allow foreign companies to take over sick Indian companies provided they bring in latest technology and infuse funds into it?  Similarly, why not allow loss-making public sector units to be taken over by strategic partners either domestic or international?  Isn’t it strange that Tatas can take over steel company abroad and Birlas aluminum company but we do not allow the ailing Indian Iron and Steel Company to be taken over? Similarly, there are other areas of concern, like the deployment and management of pension funds, creation of mega companies, introduction of GM (genetically modified) crops, FDI and so on.

Consensus on these issues can unleash more forces, which can have salutary effect on the economy  as a whole.  Economic laws have their own logic and the governments can either facilitate certain developments in the economic sphere or obstruct certain developments, but they cannot change the economic logic.  For investment to increase, a nation professing any ideology--capitalist, socialist, social democratic, totalitarian, mixed economy, or religion based---the domestic savings will have to be increased, and if they are not enough these will need to be supplemented by foreign savings in any form -- either through borrowing or direct foreign investment.

The partners in the UPA Government must have a clear understanding of the issues and not just blindly oppose any policy of the Government from their ideological standpoint.  What is the harm if the Government proposes that five per cent of the pension funds may be invested in equity market? Over a long-term period it will give a higher rate of return than if all the funds were invested in Government bonds. The General Pension Scheme for Government employees was discontinued in 2004 and replaced by Contributory Pension Scheme but because of the opposition from some of the UPA partners these funds have not yet been properly deployed.  The losers are the prospective pensioners and not the political leaders.

It is to be understood that every political decision on economic issues involves economic costs  which the individuals as well as the country as a whole have to pay. It could be less rate of return to pensioners or non-revival of sick units or less investment or more than necessary subsidies.  Therefore, it is high time that blind opposition to any policy measure gives way to rational thinking.  Therefore, for the good of the country's economy, it is important that there is some broad understanding on major policy issues relating to economy among the coalition partners as well as political parties.  Broadly speaking, there will have to be some broad understanding in the following areas.

First of all there has to be some broad understanding in the area of fiscal policy.  The trend in the past four years has been to progressively bring down the direct and indirect tax rates. This has been an important departure from the past wherein the excise and customs duty on individual items were drastically changed in either direction every year.  This has been a healthy development. The direct tax rates have more or less stabilized but excise duties need to be further streamlined and custom duties aligned with the ones obtaining in the ASEAN countries

There is also a need for a broad understanding on the quantum of subsidies which are doled out to various sectors.  The old adage that "cut your coat according to your cloth" holds true for the country as a whole.  At a time when there are distortions in the economy or there are demands on social justice, every country has to provide subsidies in one form or the other, but this is also true that subsidies cannot go beyond a certain point and if the economy attempts to go beyond that point it will lead to various other problems like inflation, distorted price structure, waste of precious resources and so on. 

It is then high time that the coalition partners as well as political parties agree that the quantum of subsidies will never exceed a certain proportion of the national income every year and that every case of subsidy will be thoroughly reviewed every three to five years so as to enable the policy makers to decide whether there is a case for its continuation or not and what are the other new areas which need subsidy.

Thirdly, there must be some broad understanding among the coalition partners as well as political parties on disinvestment policy towards public sector undertakings. There must be a broad agreement as to the method of disinvestments, mergers, de-mergers and whether the Government would hold majority shares or will have minority stakes and a kind of political understanding that losses of public sector units would not be made good from budgetary contributions; the public sector must be allowed to function like commercial organizations and must aim at earning normal profits for its investor, namely the Government. 

Merger of public sector units including banks, if it leads to reaping the economies of scale, should attract the attention of all the political parties.  If, for instance, the merger of Air India and Indian Airlines can help cut operating and maintenance costs of the two airlines there is no need to keep them separate units.  Hopefully, the two airlines would be merged in the next two months.  It will strengthen the competitive strength of the airlines to compete with the domestic private and international airlines.  A broad agreement on merger policy towards public sector units among the various political parties will be in the best interest of not only the public sector but also of the country as a whole.

The fourth most important area where there is a need for a broad consensus among the coalition partners and political parties relates to the area of foreign investments.  Foreign investments are needed for basically two reasons.  First, the domestic savings are not enough to meet the country's investment requirements and second, the technology available within the country is obsolete and  that there are no resources to undertake such kind of fundamental and applied research. In an interdependent world, blind opposition to foreign investment will not make much sense. 

If we don't want foreign investment for fear of some kind of colonization then we should be prepared to raise enough resources to make the necessary investments in infrastructure and other industries like steel, cement, computer hardware, infrastructure etc., and also be prepared to bridge the technological gap between India and other countries in the shortest possible time. The people should be taken into confidence and told that there are the economic costs which the country will have to  pay if foreign investment is disallowed.  And if the public were to calculate these costs it would find that it would run into billions of rupees.

Every political party knows that the country, at the current stage of development, cannot do without foreign investment. Therefore, it would be in the interest of the country to have a broad political consensus on foreign investment in India and if we wish investment to go into certain areas in preference to other areas then we will have to make investment in that area more attractive.  That is how the other countries in the Asia-Pacific region have achieved their economic goals.

In other areas like pension funds introduction of GM seeds etc., the Government must be allowed to move fast.  The GM seeds not only make crop resistant to certain diseases and to that extent reduces the use of pesticides but also increases the productivity.---INFA

(Copyright, India News and Feature Alliance)

Economic Highlights

New Delhi, 8 February 2007

Emergence of Indian MNCs

RUSSIAN MARKET REMAINS UNTAPPED

By Dr. Vinod Mehta

About three years ago, I had stated in this column that the process of liberalization and the opening up of the economy in 1990 was now bearing fruits in the form of changed mindset of our business community. A large number of them, who rarely looked beyond India, were now looking outside India for more profits.

The acquisition of the Anglo-Dutch steel company Corus by the Tatas recently, is the result of that new mindset and the liberal business atmosphere that is prevailing in the country. The significance of the acquisition is that the Corus Steel is a much bigger company than Tata Steel and that Tatas were able to sign the deal despite competition from a Brazilian company. 

Skeptics are doubtful if the Tatas would be able to turn the Corus around because of the volatility in the international prices of steel. The Tatas might have factored all these while finalizing the deal; one has to wait and watch to answer the skeptics.  Incidentally, the skeptics had criticized the Tatas when they had decided to enter the car manufacturing sector a few years ago. Any way, the acquisition of Corus by the Tatas, have emboldened other Indian business houses to think of acquisitions abroad on similar lines.  It could be just that we are witnessing the emergence of Indian MNCs.

So long as the Indian industry was protected from foreign competition the Indian industrialist was not willing to look beyond the domestic market for earning profits. The system of licensing and controls coupled with high import tariffs assured them a very high rate of return on their investments, compared to the rate of return on equivalent investments in other parts of the world. Hence, it was natural for them to concentrate on the domestic market as it ensured them monopoly profits.

When the economic reforms were introduced and controlled regime gradually dismantled, a section of the business community was apprehensive that it would not be able to face competition from foreign companies and would be marginalized within their own country. They were opposed to economic liberalization. These fears were natural as they had been operating in a protected environment for almost half a century and were not confident enough to face competition.  Now the Corus acquisition should dispel all those fears once for all.

The trend for acquiring foreign firms was in fact started by an Indian pharmaceutical firm when it acquired a small pharmaceutical firm in USA. That was an important achievement for the Indian business in general and the pharmaceutical industry in particular, which had all along been dominated by American and European drug firms.

After this initial success of the pharmaceutical company many other big Indian companies started exploring opportunities outside. The Tatas acquired Tetley Tea and more recently truck manufacturing unit in South Korea. A number of other Indian companies are quietly acquiring businesses outside. One could cite many such instances but these are quite indicative enough to show the change that is occurring in the mindset of business community in India. They are not only venturing into the countries of South East Asia and China but also in the West Asian and European countries. Some of the old business houses which had some presence in Thailand and the Philippines prior to 1990 are also expanding their businesses in these countries.

The only country where Indian business has not yet ventured is Russia. Before disintegration the Soviet Union was the largest trading partner of India. At one point of time Russia was the biggest buyer of Indian tea, today it is Pakistan. But today Indo-Russian trade is very limited. Though there are many investment opportunities in Russia somehow the real investment climate is not conducive.

Apart from corruption, company laws, contract laws and labour laws are weak in Russia. Banking system is still primitive by World standard. The financial business in Russia is dominated by traders and not by industrialists or manufactures. As a result, interest on loans from banks for investment purposes is very high. At one point of time these traders were willing to pay a rate of interest ranging from 75% to 150% to banks for the loans. In such a climate no industrialist would venture to set up its business.

Lately things have been improving and Indian business should be on the lookout for important business and investment opportunities in Russia. The Russian market is very big and the consumers there are familiar with Indian goods. For analytical purposes one can say that there are two markets in Russia; one for the super rich who have lot of money and are willing to pay to buy any product. The top European and American firms are already catering to this market. The second market is the rapidly growing for middle class. Indian business can address the Russian middle class and establish itself in the coming years, provided it makes proper moves.

With the competitiveness of the Indian economy growing many of the multinational corporations are slowly shifting their manufacturing base to India. This is not only bringing in new technology but also a new work culture which is having salutary effect on the economy as a whole. The job opportunities as a result are also growing.

Besides, the Indian small-scale-sector, both in the consumer goods segment and non-consumer goods segment, is changing very fast. It is not only coming out with new products but is also improving its existing products. One reason for this has been that these small-scale units are now in a position to import second-hand machinery at very low rates for the production of their items.

Before the economic reforms they were not in a position to get new machines as they were not manufactured in India or the cost of importing machinery was so high that they could not afford it. It is now a thing of the past.  By importing second-hand machines they have improved their productivity. As a result, there is a sea change in the attitude of the small-scale-sector and many of them are giving good competition to even multinational corporations operating in India especially in the FMCG segment.

In the Tata-Corus deal the only losers have been the Indian banks, both State-owned and private. First, the Indian banking laws do not allow financing of foreign acquisitions and secondly, the Indian banks are not big enough to finance such deals.  This should be one important reason for carrying out financial sector reforms and for encouraging emergence of mega-banks.---INFA

 (Copyright, India News and Feature Alliance)

Economic Highlights

New Delhi, 1 February 2007

Avoid Fiscal Contradictions

Separate Budget from Policy Measures

By Dr. Vinod Mehta

 Just on the eve of the budget, the media is full of speculative news about cut in tax exemptions and subsidies.  Yet when the actual budget comes there is neither reduction in subsidies nor cut in tax exemptions.  The old things continue.

For the last five decades it has been observed that the annual budgets are used to make major policy announcements, which are not conducive to long-term savings and investment decisions. Many a time these policy announcements upset the market expectations and lead  to volatility in the stock market. The time has come to think whether we should continue to make policy announcements during budget presentation or separate policy announcements from budget.

Budgetary exercise is essentially an exercise to balance the revenues and expenditures of the Government and it should be treated as such. It is not the place to make economic policy announcements, which is a much more serious matter than the balancing of receipts and expenditures. Moreover, latching economic policy announcement to budget is leading to contradictions in many areas without in any way providing solutions to serious issues.  

One has been hearing about curtailing tax exemptions and levying taxes on savings at the time of final withdrawal for the past few years.  But when it comes to taking a final decision the Government develops cold feet. So is the case with subsidies.  For the past several years, the nation has been discussing the rationalization of subsidies and every time on the eve of a budget anti-subsidy feelings are taken to new heights to find that the subsidies instead of being cut are in fact raised.

The handling of the question of subsidies and cut in tax exemptions call for a serious holistic approach and cannot be tackled in the annual budgetary exercises.  Admittedly, there are a large number of tax exemptions especially to the corporate sector and that savings are tax free at every stage. For instance, when one puts money in Provident Fund or puts money in specified bonds one gets a rebate up to Rs. one lakh and when the final amount is withdrawn the accumulated interest is also not taxed i.e., the final withdrawal with interest earning is also tax free. So the argument goes why one should get tax exemption twice for the same saving?  Therefore it is argued that at least the accumulated interest on savings be taxed. The Government is convinced of this reasoning but saving public is not pleased.

Again, subsidies are an accepted norm in modern societies and cannot be wished away.  The important thing, however, is for what purpose the subsidies are being given and which group(s) stands to benefit from them and whether there are any bad side effects of these subsidies.  The second aspect of this is that these should be administered in a cost effective manner and that the continuation of a particular subsidy is reviewed periodically.  This is the case in most of the developed countries.  For instance, the public transport system, school level education, primary health care, etc. are subsidized in most of the developed countries and the quantum of subsidy reviewed periodically. 

Therefore, there is nothing wrong in giving subsidies so long as they serve a useful social purpose. Let us take the case of subsidies on fertilizers. This is one single subsidy which everyone knows is only harming the nation, but the vested interests are so strong that  no Finance Minister has been able to garner enough of courage and do away with it in one stroke. 

It is common knowledge that the use of chemical fertilizers beyond a certain point is an environmental hazard.  Its long term-use not only pollutes the soil but also spoils the health of the people who eat the produce of such farms.  By keeping the prices of fertilizers artificially down, we are only encouraging the misuse of fertilizer on a large scale. One fails to understand that in a country of over one billion people and the largest number of cattle in the world can't we have sufficient organic manure to replace the use of fertilizers? 

Since fertilizers have been made so cheap that it is not economically possible to invest funds in improving the quality of organic manure, which is environment friendly as well as health friendly.  Recently the Government approved to clear subsidy on fertilizer to the tune of      Rs. 34,000 crore by March 31 this year.

Stop the subsidy on fertilizer and let the farmer buy it at the market prices.  Its consumption will go down and, importantly the farmer will now make an efficient use of it and many of them would even switch over to organic manure. If the fertilizer companies find it uneconomical to operate without any subsidy then let them close down their shop and invest the money in producing organic manure. 

Therefore, delink the question of subsidy from the budget and let the Government state a policy as to what subsidies will continue and what subsidies will be retained.  It may be better to do away with subsidy on fertilizer in the next few years so that the farmers are mentally prepared to buy their requirement of fertilizer at market prices, have time to switch over to use of organic manure as well as give sufficient time to fertilizer companies to either reduce their production costs or switch over to the production of organic manure or bio-fertilizer.  At the same time the Government should come out with an agricultural policy in its totality including the scientific research so that the country is able to produce more than what it requires in the coming years.

 Similarly, the subsidy on food also needs to be streamlined.  As of today a large part of this subsidy goes to meet the expenditure on FCI.  Firstly, the Government has to borrow heavily from the bank to buy food grain from the farmers to store in FCI godowns.  Secondly, it has to pay the maintenance expenditure to keep these stocks in silos.   On the top of it, it has the whole machinery of rationing staff all over the country to implement this scheme.  If the idea is to provide cheap food grains to the poor then the best way would be to issue them food coupons.  The poor can use these coupons  to buy their food  requirements from the market.  The cost of administration would be much lower than the current food subsidy.

As a principle, the commercial activity should never be subsidized except in exceptional circumstances.  There is no need to subsidize exports. It is high time the Government comes out with a working policy paper on its idea about eliminating/cutting tax exemptions and the extent of desirable subsidies or otherwise for each sector of the economy; let the average citizen and the experts react to it and then the Government should finalize its overall policy towards tax exemptions and subsidies.

With interest rates lower than what they were a few years ago and with the Government pushing the average citizen to equity market/mutual fund the citizen should be able to take right decisions about his savings and investment decisions.  Since these are essentially long term decisions the clear cut policy on tax exemptions will help one to take informed decisions on savings and investments. So is the case with subsidies.  It should come clean on the question of subsidies and end once for all the speculative stories about tax exemptions and subsidies.  It will also end volatility in the capital market, which always follows ad hoc announcements in every budget.

All these are policy issues. They need to be de-linked from the annual budgetary proposals.  There should also be nothing secret about the budgetary proposals.  They should be discussed the whole year round and announced at the appropriate time.  There should be only marginal changes in the tax rates with a view to balancing the receipts and expenditure. ---infa

 (Copyright, India News and Feature Alliance)

Economic Highlights

New Delhi, 27 January 2007

Creating Mega Banks

FINANCE SECTOR NEEDS FASTER PACE

By Dr. Vinod Mehta

The Government is again reported to be mulling over the idea of encouraging Public Sector Banks to take initiative to merge so as to emerge as mega banks of international standard. The Government has been pursuing this idea for the last few years but because of strong opposition from a few political parties and trade unions it has hesitated to move forward. Globalization demands that we should have six to seven strong mega Indian banks which can not only withstand competition from mega international banks but also play a significant role in the international financial markets.

In fact, the Narasimham Committee in its second report on banking sector reforms about a decade ago had set the tone for the creation of mega banks by suggesting many sweeping changes in the banking sector with a view to bringing them on par with the international banks.  It must however be noted that these recommendations had been made even when the recommendations of the first Committee on bank reforms, which was also chaired by him, had not been fully implemented because of the intense opposition from the employees' union.

The Committee covered all the important aspects ranging from bank mergers to the creation of global-sized banks. While making these recommendations, the Committee had kept in view the inevitable capital account convertibility, which is likely to result in large inflows and outflows with the attendant implications for exchange rate management and domestic liquidity which only very large banks are capable of handling. 

Some of its important recommendations are: 1) merger of strong banks only with some of them being accorded an international character; the Committee opposed the merger of strong and weak banks as such a merger would pull down the stronger bank. 2) Concept of narrow banking could be arrived at to rehabilitate weak banks. 3) Small, local banks to be confined to states or cluster of districts in order to serve local trade, small industry and agriculture; such banks will have very low overheads allowing for lower costs of services. 

4) Functions of Boards and Managements to be reviewed so that the Boards remain responsible for enhancing shareholder value through formulation of corporate strategy. 5)  The minimum prescription for capital adequacy norms to be revised upwards as the banks will now exposed to more of balance sheet risks. 6) To speed up computerization of banks and focussing on relationship banking. 7) Review of recruitment procedures, training and regeneration policies in public sector banks.

It has been stated in this column on several occasions that the finance sector, which was to be reformed at a much faster pace is the one which is still lagging behind.  None of the present Indian banks is able to stand internationally or to ward of the threat of take-over by foreign banks on their own.  They are surviving because of the Government backing.  All over the world the strong banks have joined hands or are joining hands to become mega banks so that they can stand the international competition and manage the flow of funds in a better way. 

People would recall that a decade  ago two Japanese banks, namely Bank of Tokyo (which had more international presence) and Mitsubishi Bank (which had more national presence) to become Bank of Tokyo-Mitsubishi; at that time Bank of Tokyo-Mitsubishi with the assets totaling around US $647.781 billion is the largest bank in the world.  The second largest bank in the world in terms of assets is Deutsche Bank followed by Credit Auricle, Sumitomo Bank, Industrial and Commercial Bank of China.  If India's largest bank namely State Bank of India joins hands with its seven associate banks even then it would rank 129^th bank in the world in terms of assets. 

Again if one were to merge Bank of India, Corporation Bank and Oriental Bank of Commerce, the merged entity would perhaps rank 331^st in the world in terms of assets.  All this is to say that we do not have a single bank of international dimension.  It will take perhaps 8 to 10 years from now for a few Indian strong banks to emerge a bank of international dimension provided some of them are merged now.

It is in this context that we have to see the recommendation of the Narasimham Committee. It was against forced mergers between strong and weak banks as it feared the weak bank will pull down the stronger bank as was seen in the merger of New Bank of India with the Punjab National Bank more than a decade ago.  Politically, it may be difficult for the Government to close down the loss making banks but Government will have to take stern measures in this direction. Either the loss making banks accept the rehabilitation package worked out by the Government or else accept their closure.  The Government cannot afford to save them all the time by diverting tax-payers money; had they been in the private sector they would have closed down by now. 

One of the reasons for the rut in the banking sector is the equalization of pay-scales of various levels of bank employees in the nationalized banking sector.  Such an approach does not make any distinction between efficient and inefficient employee.  Therefore, it hardly matters whether the bank is earning profit or making losses since the employees are ensured of their pay in the regular scale. After the submission of the second report the bank employees have again threatened that they will resort to nationwide strikes if any attempt is made by the Government to close down loss making branches of a bank or loss making banks themselves. 

It may be observed that the bank employees are using their monopoly power to hold the nation to ransom by refusing to cooperate with the Government in the implementation of financial sector reforms even when the Government has ensured that none of the existing employee will be forcibly retired.  If still the employees adopt a stubborn attitude and do not cooperate in the implementation of reforms, the Government should take very strong stand and take action against the employees within the legal framework available to it. 

The change in the functioning of banks as well as restructuring is inevitable because of the sweeping technological changes in the banking industry all over the world.  With the advances in information technology, computer technology etc. the concept of bank branch has become totally irrelevant.  Again with the costs of real estate going up everyday maintenance of separate bank branches is eating into the potential profits of the banks.  All over the World Bank branches are giving way to ATMs and personal computers for carrying out a number of banking transactions.  Then there are big financial deals to be arranged and so on.  All these are reasons enough for creation of mega banks.

Some to the private sector banks which came up after 1991 have merged like the Centurian Bank and the Bank of Punjab. But it was a merger of two relatively smaller private banks. We are talking of merger of strong public sector banks to create mega banks. With the economy being sucked into the vortex of globalization many mega international banks are looking for acquisitions in India but before that happens we must facilitate merger of strong public sector banks to enable them to become strong mega banks which can stand up to international banks.---INFA

(Copyright, India News and Feature Alliance)