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October 4, 1999


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Devangshu Datta

Impact of this election on the real economy will be minimal

Assuming the opinion and exit polls contain an iota of reality, the next government will be a BJP-led coalition; but even an against-the-odds Congress government wouldn't make the slightest difference to India's economic direction. The Congress and BJP economic agendas could well be cloned from each other. One straw in the wind that indicated this convergence was the passage of the 1999 Finance Bill after the BJP government was already in the ICU.

Perceptions however, can be as important as the reality. A lot of people believe that the establishment of a new government will alter India's economic prospects in some fashion. Most take it as axiomatic that a stable government is necessary for continued reform and growth. Again, I would humbly suggest that the evidence point clearly in another direction.

The two governments that did usher in reforms were both under continuous threat. The Narasimha Rao government survived on sufferance between June 1991, when it released the New Economic Policy, and April 1994, which was when the suborning of the Jharkhand Mukti Morcha and the Ajit Singh Lok Dal guaranteed it two more years in power. The moment the Rao government gained that assurance, it stopped the reform process and settled down to enjoy the privileges of office.

The second set of reforms was implemented by the BJP--but only after it realised how unreliable its allies were. In the first flush of installation, it produced an unmitigated disaster of a Budget. The BJP's reformist zeal was displayed only after it figured it was living on borrowed time. The New Telecom Policy was presented by a caretaker government. The New IT policy, the draft insurance bill, the draft resettlement and rehabilitation bill which is so important for the fast implementation of infrastructure projects--all these were released after the trouble started. The Budget was actually passed by a house that had voted the government out.

Meanwhile, ignorant of the lack of governance, or possibly because of it, the Indian economy seems to be in the early stages of a cyclical revival. Quarter one results indicate that. Growth has improved across every sector except mining. GDP is up 5.5 per cent. Cement production and sales are up, auto sales are up, commercial vehicles and two-wheeler sales are up, so are white goods. Housing finance disbursals surged 40 per cent between April-June. So the real economy and especially the corporate sector should do better this Year, regardless of who presents the millennial Budget.

The next government will however be boxed in by some huge constraints and these will dictate its game plan. It has to control a Fiscal Deficit that has already expanded some 26 percent year on year by end-August. This is especially tough since post-Kargil realpolitik demands thousands of crores in increased defence allocations. It has to find some way of selling off or shutting down unprofitable public sector enterprises. At the same time, it has to encourage private investments in infrastructure to compensate for curtailed state spending and thus ensure that the current cyclical recovery isn't choked by infrastructural bottlenecks. It must further finance-sector reforms and free up insurance to unlock domestic savings for infrastructure financing at cheap long-term rates.

Strong inflows on the Capital Account have ensured that India has a Balance of Payment surplus at the moment. But the trade balance is negative, the rupee is under pressure and there could be a negative portfolio investment flow in November-December because of Y2K-related caution. There will also be a negative impact on Current A/C Invisibles as lucrative Y2K contracts dry up for the Indian IT industry.

There is major pressure now building on the Oil Pool due to a 100 per cent rise in crude prices. An accelerated dismantling of the Administered Pricing Mechanism of diesel, petrol and kerosene could help. The cross-subsidy of diesel and kerosene via petrol must go since it is a primary cause of Oil Pool deficits. Actually the commissioning of the Reliance Petrochem complex at Jamnagar and the anticipated commissioning of the Essar Oil complex will also balance the increased imports of crude by export of value-added products.

Given the compulsions, what choices is their, and what difference does it make who's in charge? But perceptions being perceptions, elections always cause volatility in the financial economy. Post-Kargil, the stock market had been chugging along nicely. It hit a sequence of new highs and trading volumes doubled as the initial opinion polls suggested that the BJP-led NDA would win a clear majority.

Market opinion changed as some opinion polls suggested that the BJP might not come through with a big majority--it certainly won't have enough seats to prevent the same blackmail that destroyed the last government. In the markets' opinion, a worst-case scenario is another hung parliament, which is still a possibility.

The chart "The Election Effect: Aug-Sep 99" shows the bearish impact of the change in perceptions clearly. The market crashed 5.15 percent between opening levels on Monday, August 30, and closing rates on Friday September 3. Trading volumes halved as players settled positions and got out.

This was the start of a one-month long roller-coaster ride with share prices under sporadic and unpredictable pressure. Until counting ends on October 10, volatility will continue. Indeed, an unstable majority, or a hung parliament, will ensure bearish prices for an even longer period. That is standard behaviour if one extrapolates from the last couple of elections. Market behaviour during the Jan-Feb 1998 and June-July 1996 elections was also bearish.

Now, according to my hypothesis, the impact of this election on the real economy will be minimal. We could even make the provocative hypothesis that a fragile, insecure coalition would be the most dynamic force for reforms. And, that is also the situation when prices will fall most drastically in the short run. So, a hung parliament would actually be a wonderful investment opportunity!

A temporary drop in share prices during the elections is ideal for a long-term investor. I don't think picking stocks is a huge problem in the current circumstances. The golden triangle of FMCGs, pharma and IT still looks like a happy hunting ground, assuming a quick dip in prices. There are also plenty of cyclical turnaround stories available in manufacturing companies emerging from recession. New opportunities have been opened up by policy changes in telecom and power, and what about oil and natural gas? Petrochem and refinery stocks are under-valued even if APM stays in force until 2002, and it could well be due for earlier abolition for reasons stated above. Have fun and rework your portfolio on the cheap while the politicians sweat it out.

Devangshu Datta

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