`Go back to Friedman and his Golden Straitjacket'

Rasheeda Bhagat

SOME people describe him as the Warren Buffet of India; others call him an ``investment thinker/strategist''. But he describes himself ``an old man, who is very, very pessimistic about the future''. The Mumbai-based 73-year-old Mr Chandrakanth Sampat, who has been in the business of investing in the equity market since the late 1950s, refuses to get photographed. His reason surprises and shocks you. Explaining the reasons for his ``pessimism'', he says that ``the real Taliban is not in Afghanistan...it is sitting here at our doorstep and in New Delhi (the Government).''

In an interview to Business Line, Mr Sampat explained why he has pulled out ``nearly 70-80 per cent'' of his money from the market and is sitting on cash. Luckily for him, he did this much before the Ketan Parekh scam, the UTI imbroglio and the September 11 attacks in the US. He got out of the market ``...well almost...in September 2000'', when he saw a frenzy ``which I could neither understand or explain.''

And, he did not invest a single rupee in technology. ``I do not invest in anything I do not understand,'' he says dryly.

Excerpts from the interview:

In this gloom and doom in the capital market, what is your advice to small and medium investors?

Before answering that question, look at the macro picture and the few things we have to keep in mind. The first is a piece of advice from a renowned economist, Jeffrey Sachs. He says the financial industry should overhaul its training so that the analyst understands the economics of the market in which he operates.

We, including the mutual funds, have become day-traders. What Peter Drucker says is that till now the financial institutions and the banks were traders. Now they have become speculators. History shows that no one who speculates in this manner makes money.

Advice No. 2 from Jeffrey Sachs is that the analyst should be looking at the macro picture and not the daily analysis of numbers. Next, and most important, he says the policy-makers should stop catering to the whims of the short-term investors, and impose regulations that favour long-term investor relationships, rather than volatile short-term capital flows.

People are not following these advices, and therefore, the public or investors will never make money.

So what should they do?

Some more of the macro picture first. Peter Drucker in Managing Turbulent Times says: ``Managing fundamentals includes earning today the cost of staying in business tomorrow. Business that does not earn these costs is bound to fade and disappear. These are not future costs; they are costs incurred now, though not paid out until later. They are accrued or deferred costs. A business that does not earn the accrued cost of staying in business, impoverishes the economy and is untrue to its first social responsibility to maintain wealth producing and employment producing capacity of resources entrusted to the enterprise and its management.''

So, can you give examples of businesses that are following this ideology?

We will come to that. Let us first look at IDBI, ICICI, IFCI and UTI, and the total assistance they give to the various industries. What returns are they earning? One look at the picture tells me they are negative.

How recently did you make this assessment?

A month or two back. Then I safely said, `let us put two per cent on the net worth...' If the PLR rate is 11 per cent, let the difference between their earning and the PLR be taken as the future cost. But nobody is generating the future cost. So this country is totally starved of capital. No capital formation is taking place at all.

No. 2, from whatever incremental deposits we hand over to the banks, 39 per cent goes to finance Mr Sinha's deficit. So, the real Taliban is not there...the real Taliban is in our own country.

Today, the Centre's deficit is running at around 5.5 per cent; the States around 5 per cent. The oil pool deficit is

around one per cent (GDP); so we are at a total deficit of around 11 per cent in this country. This was in spite of the GDP growth running at 6.5 per cent. Now, that this rate has slumped to 4.5 per cent, there is going to be a bigger deficit.

If the deficit is bigger, then you will have to protect your currency.

How do you do that?

Thirteen billion dollars is the flow of the (foreign) funds that have come inside. They came during the IT boom. Now that IT boom is over, there are two possibilities. One, if the deficit expands beyond 12-13 per cent, these funds will leave. If they leave, your foreign exchange will be finished and you will have to raise the interest rates to protect the rupee.

Alternately they can be allowed not to sell.

So what happens?

Yes, so what are the prospects for us? If there are no profits, and there are productivity and innovation, the profits would fall. But if there are profits, and no productivity and innovation, the profits will disappear.

What is happening is that the profits are disappearing. There is no capital formation. Drucker has been repeatedly saying that capital formation is the crux of the matter. Without capital formation or profits, there can be no development.

So look at the capital formation. As I said in the financial institutions and banks, there is no capital formation taking place at all. This means if the PLR is 11 per cent, the assistance given is generating a negative 9-10 per cent capital. So, where is the capital formation?

Look at the banking system. Today, we have three public sector banks that are already termed sick. Three others are about to follow. Of the incremental deposits, 39 per cent goes to finance the Government's deficit. So where is capital formation. Who forms it? Nobody. The saver hands over his savings to the public institutions, but the manner in which the institutions and the Government use these savings is leading us to a disaster.

What kind and scale of disaster?

Let me put it this way. There are a number of requirements apart from the financial requirements that need to be fulfilled if you really want to develop this country. But first, replying to your question, the book, The Lexus and the Olive Tree by Thomas Friedman estimates we need around $500 billion of investment over the next decade in order to remain competitive. China is already getting $50 billion a year. Today we have around $2 billion. I do not know if we have drawn any strategy to make this $500 billion available to us.

We are neither forming our own capital nor getting it from outside...

Yes. So how long can we keep up this pace? What are the conditions necessary to raise the capital in a capital-starved economy that is destroying wealth, as is happening? I have answered some of these questions on my Web site, capitalideasonline.com. Go back to Friedman.

Friedman's book talks about the conditions that attract capital flows. First, we have to use our own resources well. But that is not enough. We need to attract external finances as well. Friedman has laid down certain conditions to attract finances, and I quote from his book: ``We have to fit into the Golden Straightjacket. This is to make the private sector the primary engine of economic growth, maintaining low rate of inflation and price stability, shrinking the size of the state bureaucracy, maintaining as close a balance budget as possible, if not surplus.''

Instead, with the GDP growth being what it is, we will go close to 13 per cent deficit... there is a disaster that is waiting to happen.

In Mexico, in one year, the interest rates went to 40 per cent. in the last two months in Argentina, the Treasury went from 9 per cent to 18 per cent, because of these deficits.

So what do you think will happen here?

I said, the Taliban is sitting in New Delhi and not there. As for what we have to do, we have to go back to Friedman and his Golden Straightjacket: ``We have to eliminate or lower tariffs on imported goods, remove restrictions on foreign investment, get rid of quotas and domestic monopolies, increase exports, privatise state-owned industries, and utilities, deregulate capital markets, make the currency convertible, open up industries and the stock bond market to direct foreign ownership and investment, deregulate the economy to promote as much domestic competition as possible, eliminate government corruption, subsides, kickbacks as much as possible, open our banking and telecommunication systems to private ownership and competition, and allow the citizen to choose from any area of competing pension options and foreign-run pensions and mutual funds. When you stitch all these pieces together, you have a Golden Straightjacket.''

All this, are we anywhere close to it?

Nothing of the sort! We have to take any number of permissions before an FDI is allowed!

Now let me give you the total cotton under production in India; the area is approximately 22 million acres. The average yield is 500 kg per acre. But , take the case of Pakistan _ 850 million acres _ and China _ 1,800 million acres. Now going back to Drucker, ask: Are we productive? Are we using our resources well? How long can we go on like this is today's globalised world the way we are going?

We had an extremely good time with foreign flows coming in, into the market and economy. But please understand that this is what is coming.

The Mckinsey study said the total amount of wheat consumption in the UK is equivalent to the total amount of wheat India loses in transit and storage.

So what is the solution? What should we be doing? All this is mindboggling.

Well, you may call me a pessimistic old man.

How do you feel when you do such an analysis?

I feel terrible. If we want to remain competitive, we have to follow what the Golden Straightjacket talks about. If we do not, we face the kind of chaos we saw in 1995-96 in Mexico or Brazil, or South-East Asia and what we are seeing today in Japan. These countries have refused to change and as such, they have faced economic chaos.

What is the remedy?

It is simple. Open up, and totally. The foreigners who come should share their prosperity with this country. And those companies that come here can hold up to 74 per cent; the balance has to be shared with the public. Those who do that will pay only 30 per cent tax. Those who do not do that will pay 70 per cent tax.

What about the domestic industry?

They will be protected... up to 26 per cent.

Do you think any government will be prepared to do what you suggest?

If they do not, we are finished. Our need is $500 billion (of FDI) in 10 years or $50 billion a year. Where is it going to come from?

(To be concluded)

Would you like to share your experience as an investor? Write to us at bleditor@thehindu.co.in