When it comes to faith in Modinomics are we becoming victims of the Karan-Arjun syndrome?

karan arjun Vivek Kaul  
Rakesh Roshan made a fairly trashy but super successful movie called Karan Arjun, which was released in 1995. It was a rare occasion when the Khan superstars, Salman and Shah Rukh, shared screen space (They were also seen together in Karan Johar’s Kuch Kuch Hota Hai and K C Bokadia’s Hum Tumhare Hain Sanam).
Karan Arjun was a story of reincarnation, where the two heroes(played by Shah Rukh and Salman) are killed by the villain. They are reborn and come back to their original village and take revenge. But before they are reborn, their mother(played by Raakhee) keeps telling everyone, “Mere bete aayenge, mere Karan Arjun aayenge … zameen ki chaati phad ke aayenge, aasman ka seena cheer ke aayenge.”
Despite the ridiculousness of the idea, the sons are reborn and they come back and take revenge. Such confidence in something happening is rarely seen in reel or real life for that matter. A similar confidence seems to have taken over stock market investors in India right now. They firmly believe that Narendra Modi will become the next Prime Minister of the country and clear up all the economic ills that have held back economic growth for a while.
Stuck projects will be cleared. Investment will pick up. Consumption will be back. And happy days will be here again. Or so the logic goes.
The BSE Sensex has been rallying on this possibility and between September 2013 and March 20, 2014, it has rallied by 14.4%. The foreign investors seem to be more taken in by the possibility of Narendra Modi coming in as the knight in the shining armour and rescuing the Indian economy.
Goldman Sachs said in a recent report that “the upcoming parliamentary elections could have an important bearing on policy choices and the progress of structural reforms. Adoption of more decisive and/or pro-growth policies could help boost investment activity and provide impetus to the overall growth cycle, in our view.”
The bank had been a little more direct in a November 2013 report where it had said that “Domestic equity investors tend to view the BJP as business-friendly, and the party’s prime ministerial candidate Narendra Modi (the current chief minister of Gujarat) as an agent of change. BJP and Mr. Modi, in particular, have been focussed on infrastructure and capital spending in the past and a BJP-led government may be beneficial for the investment demand pick up, in our view.”
The foreign institutional investors have bet big time on this possibility. Between September 2013 and March 20, 2014, they have invested Rs 62,271.54 crore into the stock market. During the same period the domestic institutional investors have sold out stocks worth Rs 45,034 crore.
And this investment by the foreign investors is clearly because of the Modi factor. As 
Geoff Lewis, Global Markets Strategist, JPMorgan AMC told The Economic Times recently “Well, Modi is obviously a very big influence on the stock markets.”
But even Narendra Modi, despite his best intentions, may not be able to do much, if and when he does take over as the Prime Minister of India. And there are several reasons for the same. Let us look at them one by one.
A big hope from a Modi led government is that he will restart the investment cycle. As Neelkanth Mishra and Ravi Shankar of Credit Suisse write in a report titled 
Elections: Much Ado about Nothing dated March 19, 2014 “Hopes are high among investors that elections can re-start the investment cycle. Even if the electoral verdict is favourable, such misplaced optimism ignores the realities of the business cycle, and overestimates the powers of the central government. Only a fourth of investment projects under implementation are stuck with the central government; the rest are constrained by overcapacity, balance sheets, or state governments.”
They further point out that “two-thirds of the projects awaiting central approval are in Power and Steel sectors, both wracked with massive overcapacity, obviating new investments. True utilisation in thermal power generation is below 60%, near 20-year lows (reported plant load factor is 65%). Of the litany of problems in the sector, two are crucial: SEB[state electricity boards] reforms, and coal availability.”
The reforms for state electricity boards need to happen at the state level. As far as solving the problem of coal availability is concerned that is something that cannot be solved overnight. As 
Swaminathan S Anklesaria Aiyar pointed out in a recent column in The Economic Times “our systems are now clogged with so many laws and regulations at the central and state level that Cabinet clearance is just the first step in a long obstacle race. It takes 10-12 years and over 100 permits to open a coal mine. India, with the world’s third-largest coal reserves, has become a coal importer.”
What about accelerating private coal production in the country? That also is not likely to happen any time soon. As Mishra and Shankar of Credit Suisse point out “Given the controversy around coal block allocations, auctions are the only way forward. These are unlikely till the data on reserves in these mines are updated. The government has been planning to conduct coal block auctions for close to three years now (see link), but despite repeated pronouncements of it being a few weeks/months away, there has been little progress. In our view, the challenge is inadequate prospecting—the ministry may be apprehensive of the winning private bidder in an auction managing to increase reserves estimates within a short time frame. Such a development would create negative press and possibly trigger anti-corruption investigations.”
Hence, coal blocks most likely won’t be auctioned till the reserves have been updated. “Blocks are unlikely to be auctioned till reserves have been updated. This is a time-consuming process, and in our view is unlikely to be completed in less than 1-2 years. From the time the blocks are auctioned to the time coal can start to get mined could be another 3-5 years at least,” write Mishra and Shankar.
What about other infrastructure projects? There are many challenges on this front as well. “Challenges abound elsewhere too: legal challenges are likely to stall the National Highways projects, and matter less for India’s road network; Railways lacks financial muscle, and Private Partnership schemes are yet to take off,” write the Credit Suisse analysts.
What does not help is the fact that the banking sector seems to be headed towards difficult times in the days to come. The stressed asset ratio of the Indian banking sector currently stands at 10.2%. This means that for every Rs 100 of loans given by Indian banks Rs 10.2 worth of loans have either not been repaid or been restructured in some way, where the borrower has been allowed easier terms to repay the loan (which also entails some loss for the bank) by increasing the tenure of the loan or lowering the interest rate on it. Also, nearly 85% of the restructured loans have been restructured over the last two years.
What makes the situation even more dangerous is the fact that the non performing assets are likely to increase in the years to come. The Credit Suisse analysts point out that their banking team has been highlighting that “that there is Rs 8.6 trillion of loans with the top 200 companies with interest cover less than one. Only about 23% or Rs2 trillion has become NPA yet.”
Interest cover is earnings before interest and taxes divided by the total interest expenses of s company. If the interest cover of a company is less than one what it means is that the interest expenses of the company are more than its earnings before interest and taxes. Hence, the company is not in a position to fully repay the interest on the loans that it has taken on. In this situation it has no other option but to default or get the loan restructured. Either ways it means problems for the banking system. Or as John Maynard Keynes once famously said “If you owe your 
bank a hundred pounds, you have a problem. But if you owe a million, it has.”
If the problems in the banking system erupt that would mean that there would be lesser money to lend. Also, the government will have to come to the rescue of the public sector banks, and that would mean greater expenditure for the government, something it can ill-afford to do at this point of time.
And if all this wasn’t enough, the ability of the next government (irrespective of who leads it) to spend its way through trouble is fairly limited. As I had estimated in this piece, nearly Rs 2,00,000 crore of the government expenditure hasn’t been accounted for in the next financial year’s budget.
As Mishra and Shankar point out “The apparent reduction seen in the last three years has been achieved mostly by pushing expenditure into subsequent years: while earlier the month of March used to see 16% of the full-year expenditure, in the last three years, it has come down to 11-12%.”
Obviously, this trick of pushing expenditure into the next year cannot continue forever and needs to stop at some point of time.
To conclude, Modi will have to work in a coalition, which will severely limit his ability to make decisions as quickly as he is used to. Given these reasons, the foreign investors and everyone else who feels that Narendra Modi will turnaround the Indian economy in a jiffy, need to understand that they might be becoming victims of what I would like to call the Karan-Arjun syndrome. Reel life and real life do not always go together.
The article originally appeared on www.FirstBiz.com on March 21, 2014 with a different headline

 (Vivek Kaul is a writer. He tweets @kaul_vivek)