Oil, Rupee, IL&FS: Why is Modi Not Using Brahmastra?

After four years of a blessed existence, Narendra Modi is facing his first acute economic challenge.

Brahmastra, in the Mahabharata, is a “single projectile that is able to destroy the Universe”. Lord Rama is thought to have used it in his last battle with Ravana. With such divine precedence, you would expect a government of Rama bhakts (devotees) to eagerly use the Brahmastra when confronted with a snowballing economic crisis. Alas, the devotees have let down their God.

Let’s set up the context here. The Lehman bankruptcy and American subprime meltdown had completely dislocated the global economy in 2008. The West collapsed, China braked hard, and oil spiked near $150 per barrel; but India’s UPA government trotted out the Brahmastra of stimulus to keep economic growth humming and healthy. Inevitably, our fiscal deficit almost touched five percent of GDP, inflation breached eight percent, rupee slipped to 62/dollar, and interest rates zoomed to 8 percent; but mercifully, the Indian ship stayed afloat.

After a switch of finance ministers in 2012, we began the arduous process of unwinding the stimulus and rebalancing the macro-economy. Do note that despite the crisis, exports leapt to their highest-ever level of $313 billion in 2013/14; surprisingly, we’re yet to climb above this peak.

Modi: From Lucky General to Fall Guy

Now enter the Modi government in 2014. For the next four years, it enjoyed a charmed existence. Oil prices fell to $30 per barrel, America got grooving at 3 percent annual growth, Europe shrugged off its Armageddon, China turned around – and within such a benign environment, India’s macro-economy repaired itself. The fiscal deficit fell to 3.5 percent, inflation went under 5 percent, American dollars poured in, and the 10-year treasury sank below 7 percent. Modi was Napoleon’s proverbial “lucky general”.

But then, it was President Donald Trump’s turn in 2017/18! He cut taxes, hiked the deficit even as America’s economy turned red hot, choked off Iranian oil supplies, and triggered global trade wars. American interest rates promised/threatened to touch 4 percent. All hell broke loose in emerging economies as billions of dollars flew back home. Today, India is again teetering at the edge of a severe macro-economic imbalance: treasuries have crossed 8 percent, the rupee has plummeted by 15 percent to over 74/dollar, oil is perilously close to three figures, and hundreds of stocks are in a severe bear grip even as market indices have crashed by over 15 percent.

Modi, once Napoleon’s “lucky general”, is in danger of becoming Trump’s “fall guy”. After four years of a blessed existence, Modi is facing his first acute economic challenge. Does he have the gumption to deploy a policy Brahmastra, to kill the crisis before it careens out of control?

Unfortunately, on current evidence, his mandarins are just tinkering around, unable to summon the courage required to “neutralise with a single projectile”. Within just the last month, the Modi government has failed to deal with three crippling economic crises.

Crisis One: Oil, and the Folly of Using Rubber Bullets Instead of the Brahmastra

Oil is the most treacherous fault-line in India’s economy; it’s also the Modi government’s most egregious failure. When he took office, India imported 77 percent of its oil requirement. Today, that’s up by nearly 6 percentage points! Crude oil imports have galloped by a debilitating 56 percent over the previous year. Nearly a fourth of our $400 billion of foreign exchange reserves shall be consumed in importing oil this year. And yet, all that the prime minister could do is plead with the world to help India.

Last week, Modi met several oil titans, including the Saudi minister, to “request for a review of payment terms so as to provide relief to the local currency.” Yes, the mighty Indian prime minister naively believed that he could palm off rupees to cold/tough oligarchs, in exchange for hard currency oil barrels! It was an astonishing, and utterly unrequited/unnecessary, capitulation, exposing our soft underbelly.

We may have commiserated with our prime minister’s plight, but for the tax-and-price gouging his government has inflicted on oil producers. Take the case of Cairn, which produces nearly a quarter of our crude oil, and pays out 85 percent of its revenues to the government. You would expect any sovereign to give a very fair deal to such a critical enterprise, right? Now think again. Our rulers have gouged nearly $2 billion from the company in various punitive taxes, even as their arbitration case in the UK is being argued. Is this taxation? Or extortion? Go figure.

But if you think our government exploits only foreign producers, remember how it denuded ONGC’s balance sheet by $6 billion, forcing it to buy HPCL. Now see how it wiped out the market value of its own oil companies:

• Scared by a public outcry to reduce high petrol/diesel prices, Modi cut central excise by Rs 1.50 per litre, causing a revenue loss of about Rs 10,000 crore over six months
• And then it made a shocking call. It ordered public sector oil companies to reduce prices by Re 1 per litre! Merely to earn an extra Rs 7,000 crore this year, it rolled back the major reform of freely priced fuel, achieved so painstakingly by UPA in 2010 (for petrol) and Modi in 2014 (for diesel)
• The markets reacted furiously to this betrayal/repudiation. Within an hour of trading, public sector oil companies wiped out over Rs 1 lakh crore of investors’ wealth.

Crisis Two: The Rupee Falls Freely, as the Brahmastra Stays Parked in the Hangar

The Indian rupee is joined at the hip to oil prices. The Modi government has spent an eye-watering $40 billion since April in trying to stem its fall. It’s the biggest draw-down of India’s foreign exchange reserves since Modi came to power. Earlier, in 2013, the UPA government had sold $20 billion to stabilise the local currency, but those were crisis-ridden days, with oil at $100 per barrel. Today, what Modi’s government is doing is short-sighted. And ineffective. I cannot, for the life of me, fathom why Modi has not floated $40 billion of NRI Bonds yet. Especially since foreign investors have already yanked out $15 billion in debt/equity sales in the current year. There’s talk of “imminent” action here, but nothing has happened yet, even as the rupee is flirting with 75/dollar.

Here’s yet another Brahmastra which has remained inexplicably parked in the hangar.

Crisis Three: IL&FS Gums Up India’s Credit Economy; the Brahmastra Becomes a Boomerang

Right or wrong, IL&FS is seen to be a quasi-sovereign entity, owned and controlled by a clutch of public sector giants, including SBI and LIC. It has defaulted several times in the last few weeks. It needs to repay Rs 34,000 crore from now until 31 March 2019. Its operating cash flow is negative. Merely replacing its board, as Modi has done, is like firing a few blanks. Unless the beleaguered company is provided the Brahmastra of immediate cash, it shall continue to default.

Already the markets have wiped out Rs 20 lakh crore of investors’ wealth. Worse, the credit economy could gum up completely. Remember, public sector banks are staring at a direct exposure of Rs 40,000 crore in term debt given to IL&FS. Provident and pension/insurance funds have an additional Rs 30,000 crore at risk. NBFCs, mutual funds and others could be forced to write off the balance Rs 20,000 crore.

This could trigger a devastating contagion, portents of which are painfully evident. Forced to write down IL&FS debt to zero, mutual funds have stopped lending to NBFCs, who in turn have switched off credit to housing companies.

So one Supertech defaults, which causes Indiabulls Housing to crash by 15 percent the next day, which lowers the NAV of several funds, who face redemption pressures, forcing them to sell good paper, prices fall further, credit dries up completely, more companies default, more write-downs happen, followed by higher redemptions, more distress sales … until the credit economy grinds to a halt. Since IL&FS’s default, the top 20 NBFCs have obliterated nearly Rs 3 lakh crore of investors’ money. That, in simple, graphic language, is a contagion.

Clearly, this is not the time to argue nuances around moral hazard. The government has got a plethora of options. It could underwrite a superior debt/equity instrument of Rs 30,000 crore (aka Brahmastra) for IL&FS, to be paid off before any other creditor or equity holder. That would secure the taxpayer’s risk. The contagion would abruptly stop. Markets would calm down. And then the new board could oversee an orderly rescue of IL&FS, including asset sales over the next few months.

Unfortunately, Modi’s half-hearted actions have converted the possible Brahmastra into a boomerang of contagion, which can be lethal for a $3 trillion economy, now held to ransom by a few billion dollars of liabilities.

It’s a crying shame, really!