Soaring Markets & Slowdown Caused by Lingering Confusion in Policy

It’s now time to kill the dissonance and move “one way” on the highway to bold reforms, says Raghav Bahl.

(Photo: The Quint/Shruti Mathur)

Video Editor: Mohd Ibrahim
Video Producer: Anubhav Mishra
Cameraperson: Sumit Badola

Coal output crashes by over 20 percent. Overall, eight core sectors lose a stunning 5.2 percent year-on-year over September 2018, contracting to an 8-year low. GDP hits a 6-year low. And yet, India’s stock markets hit an all-time high!

Why, you ask?

To understand this conundrum, let’s dial back a few months, to May 2019. Everybody thought that a struggling economy would dent Prime Minister Modi’s 2014 mandate. But he shocked the whole world by improving upon his tally, crossing a breath-taking 300 seats in Lok Sabha. The markets broke into a euphoric dance of crazy expectations. Surely, he would use his vastly enhanced political capital to finally essay deep, difficult reforms to unshackle the economy, once and for all, right?

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No, wrong. The second Modi government’s first budget was an unusual tax-and-spend document. Among several excesses, it unwittingly brought foreign investors under a “super rich tax” of nearly 43 percent .

“The fear of flight of FPIs from India is not well founded at all. The increased effective tax rate will affect only high income individuals and it is this government’s policy that these individuals should contribute more towards nation building.”

Nirmala Sitharaman, Finance Minister in Lok Sabha

Following this statement from the finance minister, spurned and panicky foreign investors voted with their feet. The markets tumbled nearly 10 percent, threatening to test much lower bottoms.

That’s when the government learned a fatal lesson – the Modi magic can bewitch an electorate, vow foreign leaders, but simply cannot forestall the market’s fury.

So, even an indomitable prime minister had to roll back. He cut India’s corporate tax rate by an eye-rubbing 10 percentage points in one swish of the axe. For new manufacturing companies, it was slashed to around 17 percent, perhaps the lowest and most competitive rate on earth for an economy of comparable opportunities.

The government also admitted its mistake in levying the “super tax” on foreign investors. The markets abruptly changed course, climbing to record highs within weeks of acknowledging a “turbo charged” government.

Ever since that u-turn, the government has been accelerating in the reverse direction. It is talking about hitherto unthinkable actions. For instance:

• The purported decision to sell BPCL to a private acquirer for close to $10 billion.
• To consider rolling back the egregious taxation of equity capital by killing dividend distribution and long-term capital gains taxes

• To make Air India far more sellable by permitting a 100 percent equity sale, transferring the debilitating debt burden out of the carrier’s balance sheet, allowing it to lay off people, change the brand and get merged with the acquirer. These concessions were once thought to be impossible.

So, has the government given up its obscurantist policies for good? Fully and completely endorsed a competitive and market-friendly policy architecture? Unfortunately, NO. Here are a few examples:

• Just look at the merger of BSNL and MTNL. It is merging two dying public sector companies, giving them an anaesthetic infusion of Rs 70,000 cr, which will eventually create a giant corpse.
• How it is blindly refusing to understand that allowing systemically important finance companies to fail – eg, ILFS last year, perhaps DHFL this year – creates a disorderly trauma for ordinary citizens. But if these very assets are saved, while only errant owners/managers are punished, public welfare is enhanced, not diminished.
• Instead of fixing the deep-rooted malaise of public sector banks, it is creating the illusion of “reform” by changing, chopping, merging bad balance sheets, but that’s only getting the patient off the ventilator and into the ICU.

It’s this lingering dissonance/confusion in the government’s policies – exemplified so graphically by its stance on BPCL versus BSNL/MTNL – that is radiating a larger dissonance through the economy. And that’s why the markets are at a record high, while key sectors are reeling in pessimism. It’s now time to kill the dissonance and move “one way” on the highway to bold reforms.