1. Preface

1.1 I sincerely thank Bombay Chartered Accountants' Society, President Shri Ashok Dhere and the R.R.C. Committee for giving this opportunity to discuss "Business Economics" with the delegates.

This is for the first time in the history of B.C.A.S. that a paper on Economics is being discussed. But then B.C.A.S. has a history of making history . I fondly hope that the society will produce several economists and strategic consultants.

Most of the promises made in the previous budget have been fulfilled.

1.2 For facilitating group discussions, this paper raises a few issues. It gives all relevant data and asks relevant questions. It is for the groups to discuss the questions.

Economics is a subject where there can be no unanimity. In fact there may not even be a majority view. It is not important to arrive at a majority view. What is important is to discuss the issues and be aware of several aspects of a problem. Everyone is entitled to his own conclusions.

Economics is also a subject where everyone has strong views and can lead to heated discussions. Groups may allocate specific time limits to each issue raised here. Some humble suggestions which may help: (i) Do not discuss the preface. (ii) Do not read the figure works and the detailed problems at the time of group discussion. This is not a paper on arithmetic. After a brief introduction of the issues, straight away discuss the queries raised. The queries are marked with an "*" and are highlighted.

While discussing paragraphs 2 to 4; probably, each para may lead to a similar, pessimistic conclusion. You may take up any one of the three paras and it may be almost as good as considering all the three paras.

Para 5 gives the impact of these conclusions on our personal investments. This may be discussed by all groups.

Paras 6 and 7 are for information.

Paras 8 to 10 project different aspects but all lead to an optimistic potential. The groups may again discuss just any one of the paragraphs. In all, each group may discuss three paragraphs.

Conclusion of course, is strongly optimistic.

Economics is a human problem

1.3 Economics is more of a human problem than an arithmetic or scientific problem. A human problem can be solved in many different manners. Consider an example.

A patient goes to a doctor. His problem : he doesn't feel hungry. He can't eat even the tastiest food. Three doctors give three different solutions :

Scientific Solution - Give medicine. If one medicine doesn't work, give a stronger medicine. Take X-ray. Take several examinations. Operate .......

Human Solution - Patient is advised to go on fast once a week ; to change food habits and go on long walks every day morning. Exercise is advised.

Holistic Solution - Do everything suggested in the "human" solution. Add - "Every day, feed at least one hungry soul. It may be a dog, a pigeon or a beggar."

Different people have faith in different solutions. There is no way one can argue about one's choice.

The point is, Economic problems like privatisation of public sector undertakings can also be approached in a clinical manner, a humane manner or a holistic manner with "Vasudhaiva Kutumbakam" philosophy.

Finance Minister has given a thrust with a "critical mass"

1.4 In a human problem, two plus two need not be four. It can be 22 also. That is what Finance Minister Chidambaram has tried in his budget for the year 1997-98. Let us all wish him a great success in his endeavour.

There is plain logic behind this optimism. Markets work on human sentiment. When the sentiment is bad, no amount of fundamentals or technicals help. The political instability and continuous exposure of a series of scams at highest level had ensured strongly depressed sentiment. We have 9th or 10th year in a row when monsoon has been good. Industrial growth rate is also good. GDP has grown at an average of 7% for last three years. The macro fundamentals are good and had been good for last three years. Still, because the sentiment was bad, share market was bad, public issues flopped and everyone was worried.

Tinkering around with the law and granting small reliefs here or there can not change this sentiment.

Finance Minister has taken bold, large move which has the "critical mass" to change the sentiment. It should help the economy.

Everything is, however, not rosy.

Let us see what is wrong and what corrective actions can be taken.

At the beginning of my career, my senior had told me - "I am not interested in a person who only finds faults and difficulties. Come back with solutions also".

Those who have no solutions to offer, have no rights to criticise anybody. Those who have solutions to offer do not criticise individuals. they only analyse situations and offer solutions.

1.5 We all continue to live in a world of MAYA.

MAYA means illusion. Seeing something where there is nothing.

Let us go through a series of steps and see how this religious statement is true in the world of economics.

Step wise exercise can be - examination of the financial position of :

The Central Government of India;

Public Provident Fund; and

Life Insurance Corporation.

95% of Government revenue is spent on Debt-Servicing

2. What is a Debt Trap ?

"When a person or Government has cash outflows (expenses and debt servicing) in excess of its income so that further borrowing is unavoidable, he or it is in a debt trap."

Consider the cash flows of Central Government of India.

* Is it in a Debt trap ? *

95% of Revenue is spent on Debt servicing. For the regular expenses, Government has to take loans.

Using oil-pool account to cover up deficit is misleading

3. Oil Pool Account

3.1 Government announces a subsidised price for kerosene. Refineries have to sell at the lower price. They cannot absorb the losses. Government has to pay for the subsidies. Oil Pool Account was used to make these payments. Now it simply does not pay. Refineries are in a serious crisis. Rs.18,000/- crores due to them is not paid.

Their cash flows are affected and they cannot print notes. They have no money to buy / import crude. Magnanimous Government gives them freedom to borrow abroad. IOC's ECB limit is raised to $ 3 Billions !

Government has a clear and present liability to play.

It simply does not pay.

Government budget is prepared on "cash" system of accounting. So whatever is not paid, does not come in the budget. The deficit ratio remains within limits.

3.2 Finance Minister has reported budgetary deficit for the year 1996-97

3.3 Finance Minister has reported fiscal deficit Rs. 63,000/- crores @ 5% of GDP. IMF managing director Michel Camdessus has stated that the total deficit considering Central and State Governments and Oil Pool deficit is 10% of GDP.

* Is this a misuse of cash system of Accounting ? If yes, have you ever seen a bigger misuse of the "cash" system of accounting ? *

4. Balance Sheet Analysis

Consider Central Government's balance sheet as on 31st March, 1997 given in the budget 1997. Let us do the Balance Sheet Analysis :

Total Assets Rs. 4,33,000 cr. Total Losses Rs. 5,19,000 cr.

Fx loan understated by Rs. 2,83,000 crores

4.1 Government presents foreign exchange loans taken by it "at cost".

Thus, say, a loan was taken in the year 1981 and an amount of U.S. $ 1,000 is still outstanding and payable. The foreign exchange rates were in the year 1981 - Rs. 8/- = U.S. $ 1 ; in the year 1997 - Rs. 35.5 = U.S. $ 1.

The budget still shows this loan at Rs.8,000/- and not Rs.35,500/-.

As a total, the outstanding loan of about U.S.$ 95 billions is shown at Rs. 55,000/- crores instead of showing Rs. 3,37,000/- crores (95 X 35.5).

* Do any accounting standards justify stating a loan at an amount different from the amount which is actually payable ? *

* Does the Government's understatement of loans and hence the understatement of losses amount to misrepresentation ? *

If Government balance sheet does not give a true and fair view, what is the responsibility of Comptroller and Auditor General for the under statement of Rs.2,83,000 crores (337,000-54,000)?

4.2 Investment in small savings schemes by you, me and all the Indians together amounts to Rs. 1,04,000 crores.

4.3 Government provident funds, public provident funds and the deposits with Government by private provident funds together amount to Rs.1,37,000/- crores.

In other words, direct loans to Government by you and me amount to Rs. 2,41,000/- crores.

4.4 Government has incurred a total loss of Rs.5,19,000/- (236 + 283) crores.

4.5 A loss of almost Rs.5 lakh crores means that all your savings certificates and provident funds (total Rs.2,41,000/- crores) are already lost by Government of India - twice over.

Your savings are lost by Government

A summary of the whole analysis is - you may be fondly hoping that you are saving the money for your old age, that there can be no safer investment than a Government security, so when you grow old, you will live on the loans you have given to the Government. But the Government has already lost your money and many other loans taken from RBI, LIC, GIC, banks, UTI etc. There is no way, the Government can repay your loan.

4.6 Normal conclusion is, that Central Government Securities are the safest.

Can we say that :

Central Government loans are not backed by assets. The securities and P.P.F. pass books simply represent a promise to pay.

Government robs you of your savings by causing inflation. you loose money - whether you invest in Government securities or in private deposits and loans.

4.7 When Government itself is not solvent ; can LIC - which has invested 85% of its funds in Government - be considered solvent? Your life insurance policy is a document - which is supported by (as asset backing) Government securities - which in turn have huge losses as asset backing.

* What is the value of that LIC Policy ? *

5. Our personal Investments - Impact of Inflation.

5.1 Consider a chartered accountant in practice for 15 years. His income is, say, Rs. 2,00,000/- per annum. Maximum marginal rate of tax is applicable and he tries to take maximum advantage of the tax benefits under Chapter VI A.

His savings and investments for the life time comprise of :

Assume average annual inflation of 12% ; Assume that his professional income is above Rs.1,20,000/-. For investment decisions apply marginal tax rate of 40%. Assume shares appreciate @ 15% and immovable property @ 12%.

At the end of one year, what will be his gains or losses is given in the next table.

Notes : For PPF and LIC - only accumulated balances are considered. New deposits during the year are not considered. Hence S.88 relief is not considered here. There can be detailed, involved calculations on these yields. We need not go into these. Attempt here is only to highlight the impact of inflation.

5.2 Impact of tax and inflation on your savings.

Due to inflation, value of all investments is eroded

* What conclusions can you draw from this table ? *

* Can you say that normal calculations of appreciation of Rs.2,70,000/- and cash income of Rs.71,000/- are blown away by inflation ? *

For proper comparison, all figures must be reduced to a common base by Discounted cash flow method

5.3 Compare the following :

The C.A. can invest Rs.20,000 per year for next 25 years. What would be his accumulated amounts at the end ? Consider the following 3 options - P.P.F; LIC and shares. What would be the real values when discounted for inflation @ 12% per year.

Total investment - 20,000 x 25 = Rs.5,00,000.

Present value of investment when discounted @ 12% Rs.1,57,000.

* Consider the cost of life insurance. *

* Consider how inflation can dilute large figures of so called growth investments. *

Government does not repay your loans. And you never realise this

5.4 Government does not repay the money it has borrowed from you. But it is a master in the art of keeping you in a state of happiness.

You invest Rs.20,000 per year in P.P.F. and calculate that on retirement (after 25 years) you will get Rs.26,66,000. However, Government will be repaying, in real present value terms, only Rs.1,57,000.

Past performance is a guarantee by the Government that it will not repay your loans. However, by printing more notes, it will make you feel, you have been repaid the loan.

* How do you come out of this Mayajal ? *

5.5 Instead of considering inflation @ 12%, if we consider @ 7%; all calculations will change significantly.

* After discussing paras 2 to 4, would you consider 7% rate of inflation as sustainable ? *

6. Comparison of Investment in India with Investment Abroad.

6.1 Indian Government is Insolvent.

So what ?

All Governments are insolvent.

The U.S. of A. Government is also insolvent. It runs on Japanese finance and the rest of the world investing in the dollar.

Enjoy the game as long as it lasts.

If the Central Government goes bust, everyone goes bust. When everyone goes bust, no one cries.

A serious investor needs protection of his net worth

6.2 Is this approach correct ?

Russian Government has gone insolvent. The Rouble has crashed from 4 Roubles = One U.S. dollar to 5000 Roubles = One dollar.

99% of the Russians are miserable.

But all those who kept their assets abroad, are the happy lot.

So should you hold your assets abroad ?
(We may discuss the issue academically, keeping the morals aside for the sake of arguments.)

Well, it is a matter of common knowledge that several rich Indians have kept their wealth abroad. Government has not been able to do anything to them - except declaring immunity schemes.

6.3 If you want to invest abroad, in which currency can you keep your savings ?

All governments are insolvent !

If you do not trust any currency, can you invest in Gold ?

Gold neither pays interest nor appreciates in the international market.

6.4 One answer may be, you have to invest in foreign securities - which are denominated in foreign currencies. You earn interest and save yourself from rupee depreciation.

Foreign securities essentially represent foreign industries and should overcome the deficits of gold.

6.5 When you compare industry to industry ; Indian industry should, give a return more than the total of (i) rupee depreciation and (ii) return on foreign securities. That means one should invest within India.

Are we back to square one ? Where to invest ?

There is a concept in religion - "NETI NETI"

Enough chaos. No queries under this para, please.

Indian Government is insolvent

India is rich

7. Reasons to be optimistic :

Budget 97 gives strong signals of happiness and optimism.

The above discussed issues give a pessimistic picture. What is the fact ?

The fact is - India is a rich, strong country endorsed with abundant natural wealth and intelligent population. Do not equate the nation with the Government.

Government of India is insolvent. Because of its past, clouded vision & wrong policies.

Present Government has a clear vision and is liberalising at a rate which none of us anticipated. Future is bright. During the change over process, there is bound to be some pain.

Consider the following :

7.1 India has never seen ten consecutive years of good rainfall. Our agriculture is doing well.

U.S.A. has normal GDP growth rate of 2%. When they have a growth rate of 3% ; they celebrate. We had a growth rate of 7%.

Our growth rate is not as good as China's 12%. But our GDP is not decreasing. It is growing. Let us not be scared.

7.2 All the public interest litigation that we are seeing is an international wave. It is cleaning up the public life. So what is wrong ? One need not be worried about cleaning up.

7.3 Consider what can be the impact of following radical decisions :

7.3.1 Revalue the rupee @ 2% per year for next two years and then take it to Rs.18 per dollar. (This was the rate in June, 1991.)

7.3.2 Restructure Central Government's Finances. Sell PSU shares and repay government loans.

7.3.3 Convert the vicious cycle of excessive controls, low productivity, low taxes, high deficit, high inflation; into a virtuous cycle of :

Less regulation, high competition & efficiency, more FDI, higher GDP, lower tax rates, higher tax revenues, surplus budgets, revaluation of rupee, nil inflation and public prosperity.

* For queries, please see paras 8 and 9. *

Some PSUs have excellent values

8. PSU - SALE

RESTRUCTURING GOVERNMENT OF INDIA BALANCE SHEET

8.1 240 PSUs - Capital employed Rs.1,59,000 crores.

8.2 Book value to market price Ratio of 2 gives total market value of Rs.3 lakh crores.

8.3 Deduct defense and strategic units. Add departments and State Government PSUs.

8.4 Market borrowings, small savings and provident funds add upto more than Rs.5 lakh crores.

8.5 Release Rs. 1,00,000 crores to LIC, GIC, UTI and banks by repayment of market loans.

Release Rs.2,00,000 crores to the public by repayment of savings.

And market the PSU shares at Rs. 3,00,000 crores.

8.6 Exchange of securities may be done through a PSU - Mutual Fund.

Sale proceeds of PSU shares can wipe out budgetary deficits

8.7 CRR & SLR are to manage bank's safety and liquidity; NOT to finance Government of India deficits.

Reduction in accumulated losses of Government of India - Rs.1,41,000/-.

8.10 CENTRAL GOVERNMENT RESTRUCTURED BALANCE SHEET

(AFTER PSU SALES)

There are numerous problems and difficulties in restructuring Government finances. Let us not worry. Life is supposed to be difficult. That is the excitement.

* Query is - Assuming without accepting that such a restructuring is possible, will it benefit India? *

9. Rupee Convertibility

9.1 Finance Minister has declared a clear intention to make rupee fully convertible. However, instead of making haste like Mexico and Russia and throwing the whole economy into chaos, - the Government of India and RBI would like to take cautious, measured steps and achieve the target in good time.

9.2 RBI Governor has stated that full convertibility cannot be brought about until the following conditions are fulfilled :

1. India has comfortable Fx reserves;

2. The rate of inflation in India is comparable to the rate of inflation in major trade partner countries; and

3. Financial sector reforms are completed and Indian real rate of interest compares with the rate prevailing in partner countries.

Convertibility of Rupee can cause flight of capital inwards

9.3 Mr. Michel Camdessus, managing director, IMF has stated that India is ready for capital account convertibility. The necessary requisites exist :

1. Present Fx reserves are comfortable;

2. Banking/financial situation is sound; and

3. Macro fundamentals are strong.

GOI should initiate the action on convertibility.

9.4 Author submits that -

Full convertibility is not an "end."

Consider it as a "means".

It will cause a flight of capital inward.

Which will bring in massive Fx reserves; bring down the interest rates, cause rupee appreciation and if managed properly, reduce inflation.

* Do you believe that -

India has the capability to meet the complex challenges that will be thrown up in the process? *

10. Vicious Cycle

This is past. Pre-liberalisation.

Virtuous Cycle

Query : How many steps in the direction of a Virtuous Cycle are already taken by the Indian Government?

11. Conclusion

There is a tremendous potential in the Indian economy. God has blessed this country with several gifts. If we waste the gifts, we deserve to remain poor. But we can certainly be prosperous and happy. Let us take up the challenge.

Government has already taken enough steps to start a virtuous cycle. In a giant country like India, the Juggernaut takes time before it starts rolling. But it will certainly roll. And when it rolls, we all will benefit.

RASHMIN SANGHVI.