Influencing
Economic Policy
Using The Stock Market
By C.P. Chandrasekhar
26 May, 2004
The
Frontline
Financial
profiteers are once again seeking to influence economic policy in their
favour. On May 14, the Bombay Stock Exchange Sensex collapsed by 330
points to 5069. The media headlined this development, highlighting its
magnitude by focusing on the fact that it was the biggest single-day
decline in four years. One financial newspaper, the front page of which
is an insult to the intelligence of anyone whose eyes may set on it,
banner-headlined its estimate that the fall had wiped out Rs.1,00,000
crores of paper wealth.
A collapse of the
Sensex per se should bother none. The stock market even in the United
States is neither a significant source of finance for new investment
nor a means of disciplining the managers of firms. It is predominantly
a site for trading risks and is mainly a secondary market for trading
pre-existing stocks or new financial instruments, such as derivatives,
that are based on them. Therefore, if anybody loses from short-term
swings in the market, it is only those who have speculatively invested
their wealth in trading stocks in the hope of quick capital gains.
That such speculators
dominate the market and can indulge in deception to earn their profits
is clear from the multiple instances of accounting fraud and market
manipulation that have recently come to light in instances varying from
Enron to Merrill Lynch. These features are even truer of the Indian
stock market in which few shares are actively traded, few investors
such as the financial institutions, big corporates and foreign institutional
investors (FIIs) dominate, and a small proportion of the stocks of most
companies is available for trading. What is more, nobody has inflicted
on investors the notional loss that has occurred in India's markets
prior to and after the elections. Some market participants have brought
it upon themselves and other investors.
However, market
analysts and the media have gone to town suggesting that the reason
for the May 14 collapse were statements by leaders of the Left parties
that the new government should shut down the separate Ministry for Disinvestment
created by the National Democratic Alliance and revise the policy of
privatising profit-making public sector units. This may well be true.
But it is important to pose the right question. Was the "error"
that triggered the market's fall attributable to the leaders concerned,
who were merely articulating their well-known positions on a controversial
matter like privatisation, or to the knee-jerk reaction of speculative
investors who were hoping to reap huge profits out of further doses
of privatisation at bargain prices?
It is clear that
although dissent over disinvestment was the specific trigger for the
May 14 decline, if the new government is to respect its mandate, there
are a host of policies that it will have to adopt, which could result
in a similar collapse of expectations and the Sensex. Thus, the government
may have to moderate increases or even reduce the administered prices
of a host of direct and indirect inputs such as power, oil and fertilizer,
in order to alleviate the difficulties being faced by the farming community.
The implicit subsidy this involves may have to be financed in the first
instance by an increased resort to deficit financing and in the medium
term through an increase in direct taxes on the higher income groups
and indirect taxes on luxuries.
Such fiscal adjustments
may be necessary also to launch large-scale employment generation programmes
to make up for the slow pace of employment expansion and the consequent
persistence of poverty during the 1990s. Further, similar policies may
be needed to widen the coverage and increase the availability of subsidised
food through the public distribution system. Increased food availability
at subsidised prices is crucial to reversing the decline in per capita
food consumption and in calorific intake reported by the National Sample
Survey in a country where a large proportion of the population is at
the margin of subsistence.
All of this would
be seen as "populist" and "anti-reform", since NDA-style,
International Monetary Fund-inspired reform requires a cut in the fiscal
deficit, a lowering of direct taxes, an increase in administered prices
and a reduction in subsidies. Any attempt to redress the intensely inegalitarian
path of development under the NDA can therefore be identified as damaging
by the "market" and those who advocate its cause. In fact,
sections of the media that had celebrated neoliberal economic reform
under the NDA, have implicitly declared that all of the policies noted
above can be a cause for market distress. The markets are nervous, they
argue, because of uncertainty about the attitude of the new government
regarding the "economic reform" process.
Note the use of
the word uncertainty. The election result, which contrary to all expectations
delivered a massive defeat to the NDA, clearly indicates that certain
aspects of the reform must be reversed. The defeat the Bharatiya Janata
Party (BJP) and its allies suffered in all but three States has been
widely seen as the result of two factors: mass rejection of the communal
policies of the BJP and mass anger with the devastating impact of the
neoliberal economic policies of the NDA government on rural India and
the poor and lower middle classes in urban India.
That anger was all
the greater because of the cynical way in which the NDA was seeking
to win another term by misusing manipulated indices of economic performance
and celebrating the gains that a small upper crust had derived from
the liberalisation process. Given the nature of this mandate, unless
the new government currently being formed refuses to take account of
its full meaning and reneges on its own election promises when formulating
its policies, a substantial dilution and major reversal of certain components
of the NDA government's economic reform are inevitable.
Thus, if few investors
who drive the "markets" are nervous about the nature of economic
policy, the error lies in their expectation that economic policies that
benefit them but adversely affect the majority can be sustained in a
democracy where the poor have a voice, even if only at intervals of
five years. Those expectations were patently wrong and so were the bets
based on them. This is not to say that adopting policies that are less
elitist would not guarantee normal profits for investors. They only
threaten the abnormal speculative profits that policies tailored to
please finance and big business, such as privatisation, were expected
to ensure.
SEEN in this light,
the message that has been delivered by the "markets", and
sensationalised by the media ever since the exit poll results suggested
that an NDA victory is not certain, should be dismissed as undemocratic
and unacceptable. But the matter is not as simple as it may seem. The
real difficulty arises because, enticed by the lavish returns that the
policies of the NDA government promised, FIIs have poured investments
into India and come to occupy an influential presence in the markets.
These investors are known to have brought in over $10 billion into India's
stock market during the last financial year. When they choose to sell
out, convert their rupee gains into dollars and exit from the Indian
market, the demand for foreign exchange tends to increase. In India's
liberalised foreign exchange market this weakens the value of the rupee,
as seen in the significant decline over the first fortnight of May 2004.
Movements of this
kind can trigger a speculative attack on the currency and threaten a
currency collapse. That possibility has substantially increased over
the last one year because, drunk with the hype that India's rising foreign
reserves generated, the NDA government has significantly liberalised
capital account transactions and allowed Indian residents to transfer
legally and otherwise their wealth out of the country. Hence, if a speculative
attack on the rupee results in capital flight, domestic wealth holders
may join the herd and help precipitate a crisis. A currency crisis of
this kind can have damaging consequences for the real economy, necessitating
painful adjustments even in countries where the real economy was initially
doing well.
Thus, it is not
the losses suffered by investors in the market as a result of their
unwarranted expectations that are the problem. It is really the fact
that FIIs whose expectations had fuelled the speculative highs that
the markets had reached can damage the real economy to an extent greater
than what was achieved under the NDA. To boot, it appears that even
a mere restatement of the well-known positions of individual parties
that would be associated in some form with the new government can trigger
a market collapse.
This has some lessons
for policy in the days ahead. The patently irrational behaviour of finance
cannot be allowed to influence policymaking, since that would amount
to allowing the authoritarian "mandate" of a minuscule minority
of speculative wealth-holders to overturn the democratic mandate of
the majority. Since the actions of the minority of wealth-holders threatens
to diminish the manoeuvrability of the new government and undermine
its ability to fulfil the people's mandate, the authoritarian threat
from finance needs to be met.
The response should
not be to dilute the thrust and efficacy of a new economic programme,
but to bolster it with controls on currency and capital movements that
restrict speculative activity and restore power to the levers of economic
policy. There is a large menu of polices to control speculative capital
flows and stall speculative attacks on a currency that is available
in the books. At the time of the Asian financial crisis, President Mahathir
of Malaysia experimented with some of these in a small way with much
effect. There is no reason why the new government cannot use similar
means, with greater vigour, to deliver on the promises that won it a
mandate and demonstrate the vitality of Indian democracy.