Former Reserve Bank of India governor Bimal Jalan, who is now a member of the Rajya Sabha, the upper house of Parliament, and is also a member of the parliamentary consultative committee of the ministry of finance, has long been apprehensive of the bull run on the Indian stock market led by external funds. In fact, he preferred to call it a “bubble”. A day after the meltdown, he spoke to Mint on a range of issues, including the macroeconomic fallout of a US credit market crisis, and argued for a level playing field between domestic and foreign institutional investors. Edited excerpts:
How do you expect the US credit market crisis, which is now manifest in the stock market slump here, to pan out?
This (the stock market drop) is a purely financial phenomenon. It was expected because it is a bubble. It would have been better if it had happened slowly, but this won’t affect any real activity in the economy, unless there’s a crash.
Won’t it affect the money market?
Liquidity is sufficient, that’s not a problem. Bubbles like these, financial bubbles in particular, suffer from what Keynes called the casino effect: People just continue to pour in money, even by borrowing. At the moment, this cycle is correcting itself. Anything which goes up, at current prices, by 40% is a financial bubble. That’s what has been happening in the stock market, you had 30-60% returns on average. Look at the Reliance Power IPO. Thousands and thousands of crores being bid, even without (the company generating)a single unit of power. All this, even as the market was going to fall. So there could be a shock effect, but not much on the real economy.
Economic confidence: Bimal Jalan does not think a recession in the US would affect India much. (Photo: Ramesh Pathania/Mint)
The second thing is the US impact. The most interesting thing about market economics is that whatever happens, the market will find a reason to explain that. Just three months ago, we heard that Asia—namely India and China—had decoupled (from the US economy), they are the primary sources of growth for the global economy. Now, suddenly, we are coupled. So, one is the impact on the financial economy. One doesn’t yet know the full impact, and how deep the recession might be. But if there is a recession, FIIs will start withdrawing money, (so would) even banks which have been hit. The second is the contagion effect. This may start affecting other countries. Europe is already badly affected. But looking at overall trends so far, I don’t see that affecting us much.
Also, inflation is under control, so the liquidity problem becomes that much more easy to handle.
But there is a considerable inflation at the retail level.? Also, global commodity prices are very high.
The primary mover of monetary policy is the wholesale price index. That is down now, less than 3.7%. Inflation is always a concern in India, because of monsoon failure, oil prices, food supply problems. Our inflation is primarily monsoon-driven, though the links have become weaker. There is a paradoxical situation here. If there is a recession, then the global commodity prices should come down.
In the event of a US recession, what kind of policy measures are likely at home?
The greatest strength of India is that most of our savings and investment is domestic. That is reflected in our current account deficit. Over 34% savings and investment rates, and all of it generated at home. During a recession, we don’t have a pump-priming mechanism anymore; our fiscal deficit is what it is. But domestic demand is high. The other thing about India is that middle-class incomes are rising by 20-25%. It’s a significant achi-evement, that the incomes of 200 million people are not rising by just 10-12%, but 20%. So, if our growth rate comes down, the simple solution will be investment. With much greater concentration on infrastructure projects.
So you don’t expect industry’s capacity to invest getting affected?
Corporate profitability is 35%. If you have such high growth year after year, some slowdown in profitability, in terms of business cycles, is to be expected and factored in. That’s precisely why companies have reserves. In India, resources are not a problem anymore. I mean there is no reason why companies should not invest. On the contrary, there seems to be a tremendous euphoria about everything in India.
Are you hinting at the over-optimism in the stock market?
The bubble shouldn’t have taken place to begin with. Part of it is our own creation. I have said this at length before—that this amount of money is coming in only for the stock markets, through the FIIs who can turn around anytime. That you have to create a level playing field in terms of taxation; you have to do something about capital flows. If we can’t use them, we have to do something about them. You can’t sometimes appreciate, sometimes depreciate, sometimes hang in there. And in how many scrips (were these investments being made)? 20, 25? This was unsustainable. But this is only the financial side. The real economy is very sustainable. There is an entrepreneurial regeneration definitely. The acquisitions abroad, what we are doing at home in steel and engineering...clearly there is great resurgence in the economy.
Is that why policymakers are telling investors to keep investing and not panic? Will prices go back up?
The question to ask is has it over-corrected itself. If it has corrected, the prices shouldn’t be going up too much. Most of the money, domestic as well as foreign, including that of the mutual funds, are coming in to a market with too few scrips. Part of the reason is that interest earnings are taxed, but dividends are not, capital gains are not; foreign money is not taxed. So a lot of Indian firms are being set up in Mauritius.
There was nothing wrong with this system when India was not growing, when India was not the big story that it is now. Convertibility is not the issue, but there is no reason why anybody can keep earning 45% returns in terms of dollars. If your earnings from the stock market are growing more than double the rate of average income growth, it is likely to be unsustainable.
Do you expect money to be flowing out? Or inside the country, into avenues other than stocks?
It is yet to be seen if the money is going back or not. But it is already moving out, partly into commodities. But not to banks, the post-tax rate of return in banks is very little.
Do you expect an easing of monetary policy due to this?
There is no reason for RBI to raise interest rates now. There is nothing in the system that warrants it, especially in view of the US recession. Also, the world has changed. You can’t handle such severe capital flows by cash-reserve ratios.
There seems to be a consensus that RBI will practise hands-off this time when it meets on 29 January.
I doubt there is a consensus.
So what can be done to discourage money flow to the stock market?
This requires very deft handling. All financial savings and returns should be taxed in the same way and rate, especially in the case of shares and stocks. Collection of tax is much easier through the corporates, we don’t have to touch them. But in the case of individual earners, they can be taxed at 12.5%. Even here, the question is of approach.
Some 90% of the shareholders earn Rs2-3 lakh a year. The idea is to catch the 10%. Give a standard deduction as in TDS (tax deducted at source), but tax the remainder. In the present circumstance when the market is falling, this needs to be handled very smoothly.
You can set an exemption of Rs5 lakh, say, if you want, but the tax should be there. If people are making 40% on stock markets, tax-free, it doesn’t make sense.
What kind of outlook do you see for the rupee? Will we be better off with a Chinese-type exchange rate management system?
I think it (the rupee) should be stable.
Exporters are already hit by the rupee’s rise. Would a US recession now affect trade, too?
Definitely. If US and Europe are affected, China would be hit much more than India. So, product demand will be affected. And China now accounts for a good share of our trade.