One of the corner-stones of accounting is "mark-to-market". Meaning, a company must tell its shareholders the value its financial assets would fetch in the open-market. When these prices fall, the real worth of the company takes a hit, which must be reflected in its quarterly accounting.
When the crisis hit Western banks last decade, sharp losses in the value of financial instruments set off a chain reaction — huge book profits turned to losses; to cover these losses, banks sold assets; the selling pressure forced market prices down; this required banks to sell more assets, etc. To prevent a total melt-down, governments stepped in with emergency loans, which created some breathing room.
However, this borrowed cash did not make the assets —especially derivatives - any more saleable or valuable. To allow banks to repair their balance sheets, a magic wand was required. Governments, acting through financial regulatory boards, wished away Mark to Market (MTM) accounting. Abracadabra! Banks could now value financial assets by their own models. Overnight, they turned solvent. Never mind that similar financial models had prompted banks to invest in such assets in the first place. When reality hit, as it has a way of doing, bank balance sheets proved worthless. Now that MTM is no longer required, reality has been banished. Wow! Which is why some economists call the current practice "Mark to Make Believe".
Make Believe is a defining feature of much policy in our country. Make Believe that an educational cess will be spent on more schools. Then, make believe that children will enrol in those schools. Be naïve enough, further, to believe that teachers will arrive to teach at these schools; and that they will deliver learning. Define the learning by an out-moded curriculum, and Make Believe that this will help young people find jobs. When, reality bites, by way of disastrous learning outcomes, Make Believe that more regulation of private schools will deliver quality universal education. Make Believe that commandeering 25% of entry-level seats in private schools will do more than nibble at the problem.
One of my ways of looking at business is as a series of hypotheses. Assume that there is a demand for a bottled nimbu-paani. Develop a product, and check it out with your target group. Based on feedback, reject the concept, or refine it. If it emerges that your product requires raw materials with different specifications, go about finding, or creating new sources. In one case, of French fries, this step alone took several years. From raw materials through production, to marketing and distribution, a business - especially a new business - hypothesises, validates or rejects, and refines. Even so, it may fail in the biggest reality check of all, the market place.
Much of government policy is based on an ideological rejection of the validity of the market place. This allows it to refuse reality checks, or even ask hard questions, such as the price you would put on a national flag carrier. In 2005, when private airlines had decimated Air India's market share, the Cabinet signed off on a 111 air-plane for it, Making Believe that the airline would deliver the customer satisfaction of a private airline, and its main problem was one of capacity. Now that the carrier has accumulated losses of 13,000 crores, we can all Make Believe that the lure of fat commissions had nothing to do with the Cabinet's purchase decision.
In the convenience of Make Believe, politicians can allocate higher budgets for rural health centers, as if they will result in better infant mortality. To question the cost implications is to be asked how you can put a price to human life. Meanwhile, we can all Make Believe that diverted medical supplies are not part of the incentive to hike budgets.
Make Believe has allowed us to assume that kerosene is being used for rural lighting, rather than to adulterate diesel; for 60 years, it has allowed us to assume that PDS wheat is feeding the poor, rather than feather the nests of those sell it to flour-mills; or to set up power plants based on the fiction that Coal India will supply raw material.
The combination of Make Belief, holier-than-thou ideology and the financial incentives of corruption have distorted our economy and our polity. Mercifully, the government spends only 20% of our GDP. This is the one saving grace that will prevent our economy from disintegrating when the odious excreta of reality terminally hits the balance sheets of Western banks and their governments.
Mohit Satyanand is an entrepreneur and portfolio investor.