The old mindset

What’s common between the government’s reaction to the bear hammering of PSU stocks and, say, the reduction in excise duties on steel? Or between these and various schemes announced in recent weeks to get banks to lend to certain groups at sub-PLR rates?

Or even the proposal to merge the Infrastructure Development Finance Corporation (IDFC) with the State Bank of India (SBI)? Directed functioning, that’s what.

In a nutshell, whenever the government sees a ‘problem’, like a shortage of finance in one sector, it directs a market player to do something to ‘correct’ it. So, when PSU stocks got hammered, merchant bankers are asked to stop selling PSU shares and government-owned banks/institutions expected to bid for PSU stocks.

SBI is not lending enough for infrastructure, some bright soul in the government probably argued, and IDFC doesn’t have the money to do so, so why not merge the two?

At one level, it can be argued, there’s nothing wrong with this approach of fixing things in a managerial sort of way — after all, the sharp surge in steel prices does affect consumers, and there’s no reason why the government shouldn’t step in with an excise cut. But if you do this often enough, two things result.

One, markets get uncertain and price signals get distorted as various players in different markets think that the problems they face because of market movements will be fixed by government diktat.

Two, you move in small steps from a rule-based system that has an overall policy framework, to an ad hoc, situation-driven set of actions that do not fit into a larger framework.

Distorting the excise structure, where there is a uniform 16 per cent rate, because steel prices have gone up, is therefore precisely the wrong thing to do, whatever the pressure from steel users.

There is a third consequence, which is that such interference costs a lot of money, even if it isn’t immediately visible. In the case of maintaining the rupee-dollar parity by sterilising dollar inflows, for instance, some economists have calculated that the cost of this policy was around 1 per cent of GDP last year!

So it is perhaps time for the government to recognise that India’s trade balance has changed in a systemic way, and allow the rupee to rise if that is what the market flows dictate — exporters are already learning to live with a strengthening currency.

As for decreeing the merger of SBI and IDFC when neither institution has sought it (and IDFC isn’t even a government-owned company!), there isn’t even the pretence of meeting market expectations, and we’ve seen enough forced marriages to know that both sides can end up losers.

Directing banks to lend to small-scale industrial units at below-PLR, similarly, has resulted in banks just not lending since the risk associated with such lending, as compared to a AAA-rated company, is too high to be justified by a lower interest rate.

Which is why, by the way, the Grameen Bank lends at interest rates of around 16 per cent and still wins accolades from small borrowers. ICICI Bank is, in fact, talking to Grameen Bank to float an NBFC to do more microfinancing as this is in fact a profitable area, but at higher interest rates than what the government wants.

In the case of the stock markets there are studies, including by KMV Corporation that Moody’s eventually bought, that show the markets usually read a company’s fundamentals better than what experts might think.

So the old practice of asking government-owned banks and institutions to shore up share prices has usually ended up with the taxpayer picking up the bill — because the government is not the best judge of what share prices should be.

In short, reforms are about creating market structures that prevent manipulation and collusion between big market players. They are not about the government stepping into any market where it thinks there is an aberration and playing the old dirigiste game.