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Budget and the rollback mechanism

February 26, 2005

The rollback became an integral part of Budgeting around the turn of the century. In hindsight, rollbacks were politically inevitable, given coalition governments and the secrecy of budgeting. Soon finance ministers built rollbacks into the draft of proposed finance bills.

So, we are used to a version of bazaar-bargaining. In the mandi, a shopkeeper asks for Rs X per kilo expecting customers to respond with offers of Rs X minus Y. Finally the market clears at a satisfactory intermediate price.

Run-up to the Budget 2005-06

Similarly, FMs now ask for A, B, and C in anticipation of some protests. Then they magnanimously rollback C and stick to A and B. This is rich territory for game-theorists and one has every hope that somebody will eventually win a Nobel Prize investigating further developments in the rollback mechanism.

This year, the FM has kicked off the bargaining early by announcing an autonomy package for PSU banks last Tuesday.

The clearances to those PSBs that meet certain norms offers them the freedom to do overseas business, merge unprofitable branches, go through acquisitions without prior permission, implement flexible pay-scales etc.

It has set up a predictable storm of protest from the Left and from bank-unions. It has also triggered selective buying in bank shares. It is only the first salvo in desperately-needed bank reforms.

Broadly, it lays the onus on bank boards to ensure future profitability and it offers flexibility to reward performance and punish incompetence.

The 27 PSBs employ over 85 per cent of India's 800,000-odd bank employees and control around 75 per cent of all assets held by 96 commercial banks. Most PSBs have high NPA levels and all are greatly over-manned despite reasonably successful VRS offers.

Foreign investment is capped at 20 per cent in PSBs and voting rights for foreign investors are capped at 10 per cent regardless of total shareholdings. The raising of sector limits as well as the offering of voting rights at par to holdings is long overdue.

The FM has two possible responses. He can instantly rollback bits of the autonomy package. Or, he can suggest a hike in voting and investment limits in the Budget.

These measures cannot be implemented without amendments to existing banking laws. Such amendments cannot be passed without the Left, which will undoubtedly refuse its support.

So, after the inevitable protests, the FM can withdraw Budget proposals to raise voting/ investment limits. He will then, however, manage to push through the current package.

Most market operators assume something like the brinkmanship outlined above is on the cards. Some optimists hope the FM will manage to shepherd through a hike in PSB foreign investment limits at least.

(Even the manically optimistic doubt voting limits will be hiked.) Pessimists assume provisions already announced will be rolled back.

At worst, status quo will be retained. At best, there will be a massive improvement in PSB operating parameters. It is sensible to assume that something in-between will occur in reality.

The political row centred around this should cause a decline in PSB shareprices. At that stage, SBI, PNB and BoB will all become attractive investments.

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