Two star economists with a free market bent-Jagdish Bhagwati and Arvind Panagariya-appear to be the intellectual godfathers of the NDA’s forthcoming election manifesto. Both professors have steadfastly supported Narendra Modi in the domestic and international press. Whilst they deny having any official role in the BJP, their press comments suggest that their support has extended to matters beyond economic policy and entered more controversial territory.
The two economists have written and spoken extensively about what they believe the Government should do, namely, amend labour laws, recap the banking sector, restart privatisation, amend the Land Acquisition Act, rollback the UPA’s extensive social welfare programs and scrap the state-level APMC Acts. With specific BJP officials who are known to be close to Narendra Modi now endorsing these economists’ policies, it would appear that India is heading for a major policy reset, one that potentially has negative implications for blue collar wage growth (and hence consumption), positive implications for the investment cycle and for the banking sector.
With the unveiling of the BJP’s manifesto less than a month away, in this piece I will specifically look at what the Bhagwati- Panagariya (B-P) duo may propose to revitalize the bad loan-saddled banking sector. If the BJP is to generate a sustainable economic recovery, it will clearly need to drag the banking sector out of the mire. B-P seem to be pushing for a quick recapitalisation of banks.
By a conservative estimate regarding what percentage of the currently stressed assets of the banking system will have to be written off and if one factors in incremental Basel III capital requirements over and above that, Indian banks need around USD 40 billion to regain balance sheet strength. That amounts to 2% of GDP. Given that in FY16 India will have to cut its budget deficit from 4.7% to 4.1%, it is not clear how this recap will be financed.
One way out of the morass has been hinted at already by BJP leader Piyush Goyal who is suggesting that the PSU banks look to the capital markets for funding: “There are enough and more avenues available to raise capital through dispersed ownership of banks' equity capital. It is not as if we are handing over the banks to some industrialists and there should be any objection. The shareholding is being dispersed to small retail shareholders and millions of Indians are becoming partners in the progress of that bank.”
Secondly, post such a bank recap, B-P are advocating that PSU banks be given more freedom to function (although it is not clear whether this is B-P’s idea for someone else’s in the BJP). The supposition here appears to be that free from political control, the PSUs will stop handing over taxpayers’ money to politically connected promoters. To my mind, there are at least three ways in which a new government could seek to nurse the banking sector back to health. Each of the methods have different implications for the share prices of Indian banks.
Method 1: Create a "bad bank" (like the Americans did with TARP) which will buy stressed assets from banks at a nominal discount to book value. This would, in effect, nationalise the bad assets of the Indian banks and the taxpayer would have to bear the burden of these sub-standard loans. Such a bailout would be explosively positive for the share prices of the banks, especially the public sector banks (followed by Axis Bank and ICICI Bank).Provide some financial jugglery is used, the Government will be able to keep these bad assets off its Balance Sheet and thus prevent the budget deficit from escalating.
Method 2: Allow the PSUs to take haircuts on stressed assets (and thus expedite the sales of these troubled power plants and roads to new owners such as sovereign wealth funds, RIL, TRIL, etc) and then allow the PSUs to raise fresh equity capital through QIPs (as opposed to rights issues which would impose further fiscal strain on the sovereign). The QIPs would almost certainly take the Government’s holding in the big PSU banks below 50% and amount to privatisation by the backdoor. Such a "change in control" for the PSU banks should trigger a re-rating of these banks (but that re-rating comes after a heavily dilutive QIP).
Method 3: Allow the PSUs to take haircuts on stressed assets and then recapitalise them through the age old methods of rights issues where the Government stands it corner. Leaving aside the strain that this impose on the sovereign, such a recap will also be severely dilutive for minority shareholders given that every PSU bank currently trades at a discount to book value.
Clearly, if Method 1 comes to pass, PSU banks are a raging BUY and the opposite holds true if Method 2 comes to pass.Link Money Control
Here's Narendra Modi’s to-do list for sustaining optimism-Hindustan Times
New Delhi, May 19, 2014
Following its staggering landslide victory, Narendra Modi's Bharatiya Janata Party (BJP) has a mandate for real reform. Still, quick successes are needed to sustain political and market momentum. The pro-business former chief minister of Gujarat state should start with infrastructure, tax, and banking.
The central challenge is growth. For the past two years, GDP has expanded by less than 5% annually, down from an average of almost 9% in the five years before 2008.
That means fewer jobs for the millions of young Indians joining the workforce each year. Employment increased by just 2 million each year between 2010 and 2012, down from 8 million annually in the first five years of the millennium.
Some of the blame lies with fiscal indiscipline, runaway inflation, a wobbly rupee, and cagey foreign investors. But a huge culprit is collapsing investment.
India has all but stopped building new factories and machinery. The problem, particularly acute in infrastructure and mining, stems from infighting between Delhi ministries and interminable local approvals.
An understandable backlash against corruption hasn't helped. The outgoing Congress Party's "cabinet committee" has helped dent the backlog. But a lot remains to be done. Modi needs to force through more approvals from central government, insist that departments work together, and browbeat local officials.
TAX BATTLES
Tax is another target. India has taken a tough line with multinationals like Nokia, Shell and Vodafone. The UK mobile phone group won a $2 billion-plus tax case in India's top court, only for New Delhi to retrospectively change the law. The dispute is now headed for international arbitration.
Tax is another target. India has taken a tough line with multinationals like Nokia, Shell and Vodafone. The UK mobile phone group won a $2 billion-plus tax case in India's top court, only for New Delhi to retrospectively change the law. The dispute is now headed for international arbitration.
Global companies are often aggressive with tax. But India's current stance deters foreign investment. The BJP calls this "tax terrorism", which implies it is planning to change tack. Modi's finance minister could use his first budget to send a powerful message to international business that India's tax policy is becoming more predictable.
For domestic companies, too, tax could change. For years, politicians have debated a so-called goods and services tax to replace some of India's many indirect charges. Business lobby groups reckon this could add 1.5 percentage points or more to GDP growth, while slowing inflation.
Pushing the levy through parliament, though, will be a challenge because Modi's party doesn't control the legislature's upper house.
BAD BANKS
The financial system is also due an overhaul. Most lending is still done by badly run, overstaffed, and undercapitalised public-sector banks.
A recent timely report from the Reserve Bank of India lambasted the banks' governance and performance, said the government should give up its majority shareholding in state lenders, and warned the sector may need 2.1 to 5.9 trillion rupees ($36 to $100 billion) of fresh capital by 2018. The central bank's recommendations provide a helpful spur to government action.
Downsizing welfare programmes like India's rural job guarantee and using the savings to recapitalize banks would help to give lending a short-term boost without burdening an overstretched federal budget.
Even outside banking, there is ample scope for privatisation. The state has stakes in everything from miners and airlines to hotels and a major producer of newsprint. Drawing up a privatisation plan would be a bold statement of intent, though it will take at least a year to get the auction going.
The new government can also open the door to overseas investment. Though the BJP has pledged to keep out international supermarket chains, many of the existing limits on foreign direct investment can be eased without legal manoeuvring. Obvious candidates are railways and defence production.
Meanwhile, an immediate increase in government-controlled natural gas prices will boost domestic production and get some idle power plants humming again.
MODI RALLY
This is just a first-year agenda. India sits a miserable 134th in the World Bank's "ease of doing business" rankings: it is an especially bad place to start a business, enforce contracts and obtain building permits. Addressing these gripes would help restore confidence.
Agriculture, too, deserves attention. Far too much food is wasted between farm and plate. For now, though, sustaining the "Modi rally" in the stock market is crucial, as it will give the most indebted Indian groups an opportunity to raise equity.
With the most decisive electoral mandate of any Indian government in three decades, Modi's government can start ticking things off its to-do list at once.
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