The Congress party has seriously underperformed its own and most media predictions in the recently concluded round of state elections. The bulls had predicted that the Congress would get close to 75 seats and become the kingmaker in Uttar Pradesh, thus significantly strengthening its own position at the Centre. Any formal alliance with the Samajwadi Party (SP) in the state and at the Centre would have given the Congress the ability to ignore the Trinamool Congress and move ahead with much-needed economic legislation. We have to, of course, see how events transpire, but it seems that the SP will not need support from the Congress and is, thus, unlikely to formally support the ruling party at the Centre.
Given the election results, there is a growing fear on the part of investors that the Congress will turn even more populist. The country has clearly turned more socialistic in the past seven years and investors are fearful that the environment would turn more hostile. Despite the lessons of the Bihar elections, the Congress chose to focus on quotas and giveaways in its campaign in Uttar Pradesh. A further lurch towards populism may be the final throw of the dice to get re-elected in 2014. Given how spending-oriented the Congress high command seems to be, and the perceived weakness of the economic leadership within the United Progressive Alliance (UPA), who will stand up for economic rationality and discipline? Who will try to prevent another fiscal deterioration of the magnitude we witnessed between 2008 and today (the fiscal deficit surged by over 400 basis points of GDP) from happening again over the coming two years?
The UPA’s instinctive desire of political leadership to move towards big government and big public spending programmes will fully manifest itself. If markets and their unwillingness to fund huge spending plans are going to be the only check on the UPA, the markets will need to riot to prevent a fiscal blow-out — which can hardly be comforting from a short- term perspective. Having markets force fiscal discipline also comes with unintended consequences.
There are already rumours floating in Delhi of plans being hatched to offer another farm loan waiver as a means to woo rural voters. The right to food Bill will obviously be expedited, and we may even see a new and renewed focus on the Mahatma Gandhi National Rural Employment Guarantee Act, with stepped-up outlays. There has been talk of bringing in new schemes to cover all unorganised sector workers, as well as a desire to more than double public healthcare spend. All are very noble and honourable intentions — but how do you fund this step-up in social sector spend? You cannot fund all these new programmes and yet make no cuts whatsoever in existing subsidies.
With the perceived weakness of the ruling coalition, it seems highly unlikely that any cuts in subsidy spend will occur. Will the UPA have the guts to decontrol diesel and raise the prices of kerosene and LPG with the Trinamool Congress breathing down its neck? What chances do we have of raising urea prices meaningfully, or bringing in a nutrient-based subsidy framework for urea? Food subsidies are clearly going up. Both foreign direct investment in retail and the goods and services tax (GST) look stillborn, given the state of relations between the Congress and the Bharatiya Janata Party, as well as between the Centre and states.
Given the constraints on cutting spending, raising taxes may be the solution. However, even here, given coalition compulsions, raising taxes for middle-class India may be difficult. Thus, the obvious source of revenue is higher taxes on corporate India and items of luxury consumption. This cannot be good for corporate profitability. Are we going to go back to a 1980s-style Budget of taxing the rich and their consumption to pay for social schemes? That would surely fit in with the socialist mindset of most of the UPA constituents, but it is a negative from the perspective of equity markets.
The coming Budget will, thus, be watched intensely by investors, to see how the finance minister gets the fiscal situation under control. This will be his penultimate Budget before the general elections, and the last one in which anything meaningful can be done. Will there be a serious attempt to move to cash-based transfers of subsidies linked to Aadhar? Unless we reduce leakages and release resources from current schemes, there is simply not enough money to fulfill the UPA’s social agenda. How do you raise revenues in a slowing economy without vitiating corporate confidence, profitability and investment plans? Can we cobble together a grand compromise on the GST?
There is also growing unease on the part of investors as regards the potential abuse of the public sector to bail out government finances. Life Insurance Corporation of India (LIC) has literally become the investor of last resort and is being used to fulfill government commitments to recapitalise the banking system, and to bail out the government’s disinvestment programme. What will this do to the returns LIC can deliver for its policyholders? Are we fundamentally compromising the competitive position of another public sector leader? The government is also crowding out the private sector for equity capital. For every Rs 10,000 crore of ONGC stock LIC buys, it can invest that much less in the equity of private sector companies, for the equity allocation of LIC is reasonably stable and dependent on the policy mix. The private sector in India is already getting crowded out of debt markets, with the government borrowing over Rs 5 lakh crore; if you crowd them out of the equity capital markets too, where will they raise resources from? Our corporate sector is being made too dependent on inflows from foreign institutional investors (FII) to raise incremental capital.
By pre-empting LIC’s equity resources, we are also weakening the only domestic institution that has the resources to counteract short-term FII flows. The private sector has to drive incremental capital spend in the country, fund 50 per cent of infrastructure and move us back towards eight per cent-plus growth — yet you crowd out the same private sector from both debt and equity markets to fund government consumption.
There does exist a minority view: that these electoral setbacks will embolden the reformers within the UPA to move ahead on their economic agenda. They will emphasise the need to get the economy back on track and will demand greater freedom to do the needful on economic policy. This seems wishful thinking at the moment, but one continues to hope against hope that the Congress’ takeaway from these results is not the need for even more populism.
The author is fund manager and CEO of Amansa Capital.
