Indian Markets Not BOTTOMED yet - Bigger Troubles Ahead

My today's post is not for traders but merely a fundamental coverage of "current monetary and fiscal drama" played by Indian counterparts of Bush, Bernake, Paulson etc. Led by Mr. Manmohan Singh, who was the one responsible for changing the course of Indian Financial Picture when he was Finance Minister in Rao's govt. He is a person who will remembered in history for his GREAT victory over conservationists in 1990s and equally his worst MISHANDLE of economy in 2008.

The govt announced a "package" to reinvigorate Indian economy and this package contained various different magical elements resembling more like a kaleidoscope that is handed to children to make them forget "real things".

I will come to the various elements of this package and present my arguments in favour / against them.

First, the "package" contains following items:

1. An across-the-board four per cent cut in CENVAT
2. Plan to invest Rs. 20,000 Crore in infrastructure development
3. (Not in strict terms, but more or less so) FORCING nationalized banks to provide cheap loans (paticularly home loans) at below their cost of funds rates.

Well, these things were factored in at least a week earlier by markets and most people on streets looked happy. The rumour was there would be a 7.5% interest home loan on loans upto Rs. 5 Lakhs but yesterday the news came out and it was decided at 8.5%.

Now let me come to my arguments. First of all this Keynisian theory is dangerously flawed and disasterous in the long run that govt should run surpluses in boom times and deficits in sluggish times. I believe in true free markets and govt should only monitor rule of law. Yes I am one of those economist Mr. Hayek's fans. Let me come straight to my arguments regarding "package" contents.

1. The across-the-board cut in CENVAT is good action considering there can not be many who can afford to pay high taxes during slowdown and indirect taxes count a lot when prices are concerned. But, that also means a lesser amount of revenue for govt which leads to increasing deficit. Some will argue that this cut in CENVAT will result in price cuts (in fact there are already price cuts in various goods like cars) which will fill the gap of lower CENVAT amount by increasing volume of sales. This looks good in theory but practically this is very flawed theory. The natural "correction" in prices of commodities that would already result in lower consumer goods prices is now being maintained artificially - which means REINFLATING the obscene commodities bubble. I give an example here - let us say the cars were costlier because of higher input costs resulting from high prices of various raw materials like steel and other metals. The natural deflationary cycle would have dealt with this menace on its own by lowered prices which the car companies would pass on to customers. One more advantage of this would be in environmental terms as lesser number of new vehicles sold would mean at least some relief for some time from greenhouse gases.
2. The next element of the "package" is fiscal stimulous of Rs. 20000 Cr on infrastructure expenses by govt. As I have already said, this is very good thing as India needs a lot of infrastructure development. But, once again the question is where will the money come from? In times of already alarming fiscal dificit it is a real hard question.
   
3. The next thing is "forcing" the nationalized banks to cut interest rates. While this looks good for common man as the policy targets loans upto Rs. 20 Lakhs only, the problem is again the viability of such a move. Why can't govt wait for the course of deflationary cycle and preserve its ammunition for more difficult times? What will happen when they reach a situation of high deflation and no scope for rate cuts? That will be disastrous. The banks are said to be very unhappy at this forced duty and they will ask for govt to subsidize these loans. Once again, where the govt will get this extra money?

As you can see, the main problem I see with the "package" is where the govt is going to get this much of money? Remember Farmer's loan waiver? Remember sixth pay commission burden? The govt is already stretched to its limits in terms of funds availability and yet they are going for such "fiscal stimulus".

Although what Indian govt is doing is not even a drop in ocean if compared to what US govt has already done, the difference has to learnt though. Emerging economies don't have the luxury of running big deficits as they have to also consider their currency degradation and devaluation. India, like other emerging economies, needs to rely more on its forex reserves than on external borrowings. Indian govt bonds will not be bought by one and all like that of US are being bought today. Moreover, a destabilized currency will only inflate prices resulting in very complicated monetary situation where the central bank (RBI) will find itself in very difficult position and even HYPERINFLATION (remember Zimbabve?) is a good possibility.

Based on the above I think Indian markets at least haven't bottomed out yet and a fresh new downward spiral may be just around the corner. Being an Indian I pray for being proved wrong.