The vanishing industry

Foreign interest in local companies could boost valuations of pharmaceutical stocks
Why are Indian pharmaceutical companies selling out to multinational corporations? After Ranbaxy Laboratories promoters divesting their stake and Piramal Healthcare selling its formulation bussiness, the low-profile Paras Pharmaceuticals is the latest to cash out. If this trend continues, there will not be many homegrown Indian companies or brands left. There is nothing surprising about acquisitions in the pharmaceutical space. Indian companies too have swooped on mostly distressed assets abroad to gain access to new markets, technology or products. The restrictive pre-reforms era capped foreign holding in pharmaceutical companies at 49%. This cramped foreign companies’ ability and enthusiasm to grow the market or introduce new products. Second, the stifling Drug Prices Control Order imposed MRP ceiling on drugs categorised as essential, squeezing margin. Foreign companies could do nothing but fret as Indian companies prospered by reverse engineering patented drugs and selling them for a fraction of the price of the original. Not only that, many license holders ‘loaned’ manufacturing to others. Liberalisation enabled many MNCs to convert their Indian affiliates into full-fledged subsidiaries. Being in charge of their operations in India increased their comfort in introducing latest innovations in the Indian market. A large number of patented drugs became ripe for picking, prompting Indian companies to shift focus from the tightly controlled domestic market to overseas potential.

The biggest obstacle for Indian pharmaceutical companies to fully tap the ongoing opportunities is capital, particularly long-gestation funding. Legal challenges from patent holders to generics marketed in the western markets have drained many front-ranking companies. Besides drugs that manage to clear the scrutiny of patent holders and regulatory bodies have only six months to profit before other imitators are let in. Introduction of patented products is lengthy and resource guzzling process without any certainty of success. Many pharmaceutical companies have separated their R&D units as these started proving a drag on their bottom lines. The Indian sector is, thus, facing the twin challenges of penetrating the generics markets in the developed economies and trying to create new products that would earn them fat margin. Both these problems require attaining scale. The regimented market and disregard for process patent till a few years ago meant that most pharmaceutical firms have remained stunted in growth. As a result, the sector is proliferated with small- and medium-scale units. Till recently investors too seemed wary of these stocks. Despite the support from parent that made them attractive, MNC affiliates had limited growth prospects due to their reluctance to introduce blockbuster drugs due to pricing caps and competition from copycat products from Indian manufacturers working on thin margin and opaque functioning.

Much has changed over the last decade. Many drugs have been taken out of pricing control. The opening of the generics export market has unshackled the industry. At the same time, this has exposed its inadequacies: lack of innovations, processing capacity in need of upgradation to become compliant with best global practises, and regulatory pressures at home and abroad. The growth options for the pharmaceutical sector are, therefore, limited. Emulate the tech industry and because a process outsourcing hub and supplier of intermediates or turn attention to over-the-counter products and build them into brands in the local market. Many manufacturers have chosen contract research and manufacturing for third parties. The lure of the unexploited rural market and the booming lifestyle segment have provided an impetus to some others and even attracted fast-moving consumer goods companies to over-the-counter products. It was not only the Indian market that was transforming. Seismic shifts were also taking place in the developed markets. Many global players concentrating on the patented product market were faced with the prospect of drying up of revenue stream. On the other side, there were openings in the generics market. This presented them with two choices: produce the generics themselves or outsource them. Some preferred to buy out generics capacity in emerging markets to service the developed as well as the domestic markets. Snapping up of local OTC brands is but an extension of the MNCs’ strategy to make up for the lost time during the pre-reforms era. A known brand makes the task of establishing footprints in the domestic market so much easier. It can also complement and supplement the existing product basket of the acquirer. Unwittingly, the rich valuation of recent deals could also unleash capital infusion, thereby triggering a re-rating of the sector.
MOHAN SULE

Reality check

Investors may not be forgiving of promoters with questionable track record of doing business

A month ago, the political establishment was basking in the glow of US President Barak Obama’s endorsement in parliament of India’s ambition of a permanent UN Security Council seat. Euphoria has given way to gloom. Leave alone being viewed as a responsible power ready to take its rightful place in global affairs, India is more likely resembling a banana republic, as noted by Ratan Tata. Everything seems to be on sale. One of the visible success stories of reforms is the opening up of the telecoms sector. The monthly increase in subscriptions of telecoms companies has come to symbolize India’s growth story just as the price of a McDonald burger is used to compare purchasing power across nations. It is now becoming clear that Indian taxpayers have paid a steep price to become mobile. Call rates may have dropped to one of the lowest in the world but at the expense of the government treasury. Precious airwaves were sold without calling for bids. Rules were altered to benefit a few. Some of the beneficiaries were investors, subsequently cashing out for huge profit. The revenue lost could have been put to use to reduce fiscal deficit or improving social sectors like education and access to drinking water. There have been two adverse fallouts besides the notional loss: serious long-term players are facing a squeeze due to the crowding of the field. Second, the initial rapid expansion in subscribers attracted fly-by-night operators for the quick gains.

The start of the third-generation telephony services could trigger consolidation, with those failing to win the bids in the auction likely to fall aside. Presence of fewer players could see the return of pricing power to the sector. On the other side, raising capital from the market would become difficult for those suspected of bagging licenses other than on the strength of their financial track record. Along with these stocks, financial services companies and banks whose officials were involved in the bribes-for-loans scandal, too, took a knock. Diversion of client funds to stock markets for proprietary trading and fudging of accounts are recurring frauds. Besides exposing inadequate internal controls, the latest scam also throws light on the opaque system of sanctioning loans, vesting discretionary powers in the hands of a few. Perhaps this again is the result of competition, whose offshoot could be lending rates lower than those publicized to select borrowers, or the tightening of norms to avoid bad assets leading to desperate borrowers resorting to back channels. Also, the biggest client of the financial services companies and banks of late is the real estate sector, which operates in a hazy environment of cronyism. As in the stock markets, the returns can be phenomenal in a short period of time. The entire value chain from borrowing to investing to repaying is subjected to volatility arising from changes in interest rates, developmental rules and environmental clearances. Regulations govern their operations but not the end price, which is supposed to be determined by the demand-supply equilibrium like the telecoms sector.

Initially, costs were high for users of cellular services due to the entry of limited players. Yet demand was strong, attracting more entities. Due to spectrum constraint, there could not be unrestricted access to the market, opening a window of opportunity to profit from hoarding or cornering of airwaves by means fair or foul. The real estate sector, too, is in a similar situation: scarce resources. Hence, covert or overt tie-ups with financial institutions to open the tap on one side and with those who have the power to release land on the other side. The question now is: will India’s growth story suffer due to these eruptions? The latest disclosures could result in much needed cleansing: coalition partners in government may not get away with any outrageous demand. There is recognition of the need for transparency in the real estate sector as it is an important component of economic growth. The trend of auctioning assets and listing of developers are steps in this direction. The Reserve Bank of India, which deserves credit for keeping our banks safe, is no doubt monitoring the financial services sector, increasingly weighed down by bad loans. Capping exposure to the real estate sector, however, is not the solution as it will aggravate the liquidity crisis and bring down the economy. Nonetheless, what has to be understood is that Indian investors may forgive a company becoming a BIFR case due to error of judgment or competition but is unforgiving of stocks whose promoters stand accused of employing questionable practices to be in business.

MOHAN SULE

Divide to rule

To reduce currency risks, companies should separate their facilities catering to domestic and export markets

Many investors have come to grief while timing the market. The market has the capacity to prove even the most conservative projections about its direction wrong. Early this month, the hiking of short-term policy rates by the Reserve Bank of India and the beginning of the second round of injecting liquidity by the US Federal Reserve were expected to increase the inflow of foreign funds. The market even came close to crossing its record high level of 21,000. The central bank was getting restless and was hinting at controls to make managing the currency and inflation easier. But, within days, the tide turned. Lower manufacturing growth in September and fear of the debt crisis spreading to Portugal and Ireland after the European Union bailout of Greece prompted foreign investors to withdraw from the emerging markets. In addition, expectation of China raising interest rates, following some other Asian countries, to cool its economy raised fears that demand for commodities would dip. The 2G telecom scam weighed on market sentiments. The flashpoint in the Korean peninsula shaved off nearly 600 points in intra-day trading. Suddenly, the world looked a much different place than it was a fortnight ago. Possibility of another round of slowdown seems real. After remaining subdued during the book building of the Coal India IPO, the Indian market had bounced back after its closure early November. On 16 November it slipped below 20,000 in intra-day trading and on 24 November was down nearly 1,500 points from its peak.

The volatility in the market reinforces the belief propounded by this column that, for sustainable growth, the world has to become flat once again. The bull-run in 2003 was due to low interest rates throughout the world. Similarly, central banks around the globe coordinated their quantitative easing following the credit crunch triggered by the collapse of Lehman Brothers in September 2008. Subsequently, major economies including the US, China and India announced fiscal stimulus of tax cuts to revive consumption. These measures were expected to pull up global economy. This did not happen. Only the emerging economies spurted as the debt crisis spread in Europe and the US’s slow recovery was not accompanied by growth in employment. The net result has been soaring prices of commodities despite half the world’s economies still in slow motion. This has had the effect of boosting input prices at a time manufacturers in the emerging economies had embarked on ramping up production anticipating rise in usage. The choice was to absorb the cost or pass it to the consumers. Some sectors where consumption exceeded supply did so. Margin of others is under pressure because any sudden price hikes would have had an adverse impact on their share in competitive markets. The domestic market is, thus, mimicking the imbalance in recovery of global economy.

Integration implies that the distortions of the kind seen today are erased. Manufacturers or services providers can achieve economies of scale by viewing the world as their supplier as well as the marketplace. Outsourcing of some back-office functions, production of parts, and assembly of finished products from components sourced from different corners of the world enables companies to make available products and services at the same price across the world. But the global financial crisis has disrupted the rhythm. Companies scaling up to global benchmarks may have to turn inwards to keep their capacities running. All may not be able to do so. The Indian market does not have enough capacity to absorb the IT services currently being exported to the US and Europe and China’s factories need the US market to keep humming. Infrastructure projects are dependent on capital from the developed economies. Instead of spurring local industry, low interest rates in the US have resulted in funds flowing to countries with better yields. Hence, reverse outsourcing is required, with companies in emerging economies using home capacities to service the huge domestic markets and snapping up distressed assets in the west by taking advantage of the cheap money, thereby boosting local jobs and market for their products and also cushioning the home facilities from currency risks. Many Indian manufacturing and services companies including those in the IT sector and Bharti Airtel in the telecom space are embracing this model. The most remarkable has been Tata Motors’ revival of the ailing Jaguar Land Rover company to cater to the western markets instead of trying to build and export luxury cars out of India.
MOHAN SULE

The jugaad laws

Haphazard preparation is not a recipe for failure but promoter-manager face-off can cause disruption

In the run-up to the Commonwealth Games in New Delhi in October 2010, Union Sports Minister M S Gill compared the inadequate planning to a jugaad, or the Big Fat Indian Wedding. The frantic rush to meet deadlines and last-minute emergencies culminates into a dazzling feast. He proved right. The stains of corruption, unhygienic living conditions and shoddy construction were eventually overwhelmed by the spectacular opening show. The Law of Jugaad prevailed. And in keeping with the Indian tradition, the honorable minister may have accidentally given voice to the Principle of Chaos, which could, of course without design, find its way into business-school case studies: Disparate elements dashing about in apparent randomness eventually coalesce to produce results beyond expectation. The corporate world operates on many such time-tested principles yet to be formally acknowledged. Here are some:

The Law of Explosive Density: The power struggle between SKS Microfinance founder Vikram Akula and CEO Suresh Gurumani is clearly not the only one or the last to be seen in businesses. The testy battle between incoming chairman Ratan Tata and Tata Steel CEO Russi Mody had resulted in the latter’s unceremonious sacking. Promoters court professional managers for their skill sets but do not like these executives to create their own constituency, an inevitable outcome of their success. On the flip side, promoters of startups become a burden to bear on listing due to their inability to weigh in on the cost-benefit equation. A prominent example is the sacking of Steve Jobs from the company he founded. Later he had to be reinducted for the same qualities that made Apple stand out from competition: innovation. Does this sound contradictory? Well it is and so is the Principle of Macroegos governing the relationship: The world may be a village, but the boardroom remains a fiefdom.

The Law of Speaking with Silence: The poster-boy for transparency and board member, N R Narayan Murthy, whose venture capital fund invested Rs 28 crore in the pre-IPO placement of SKS Microfinance, spoke only once to founder Akula after the dismissal of Gurumani, urging him to be “open, honest and fair in all matters dealing with every stakeholder”. In the meantime, the market had to contend with speculation and off-the-record insider accounts on the reasons for the CEO’s departure. The company responded to Sebi’s letter for explanation but did not make the reply public. Even a month after the incident, the regulator is “investigating” the reasons, though Gurumani continues be the director and attended the board meeting that approved the September 2010 results. This gives rise to the Principle of Immunity: Continue doing what you want till you tire everyone else.

The Law of Audacity of Hope: Tata Motors’ buying of British brands Jaguar Land Rover appeared far-fetched following the global financial meltdown. Yet, Tata’s gamble looks set to pay off. Similarly, Airtel’s African foray will put pressure on its balance sheet but could power its growth. Nonetheless, the grand vision of the two companies has come at a cost to the present shareholders. The conventional rule is that companies put their excess cash, which drags down valuation, to fund organic or inorganic expansion. But, here, two companies have taken on debt to meet the challenges of growing the market. Yet, the market has not turned its back on the two stocks, viewing their setbacks as temporary and a prelude to greater things. Respect earned can be leveraged and boosted further, as per the Principle of Increasing Returns.

The Law of Return to Roots: Reliance Industries appeared invincible as long as it followed the business-to-business model. Only Vimal, a familiar slogan in the pre-reforms era, is hardly heard. No sooner did it venture into the business-to-consumer model early this decade by dabbling into mobile telephony than the group’s woes started: the brothers split up. Both the groups’ retail ventures are floundering. Reliance Communications and Reliance MediaWorks are deep in debt. Reliance Infrastructure has to contend with pricing and regulatory issues. RIL’s fuel stations did not stand a chance with those of subsidy-receiving oil marketing companies. The food outlets present a mixed bag. Many other companies, too, have got bruised on diversifying from their core competencies. This sort of pattern is what the Principle of Mid-Life Crisis would propound: The downturn in the lifecycle of a maturing company is is often hastened by its youthful subsidiaries.

MOHAN SULE

The more the better

Increased supply of paper to absorb foreign flows will correct secondary market valuations

Money chases a market that is fairly valued even on one-year forward earning for two reasons: dearth of other investment avenues and opportunity for arbitrage. The near zero interest rates in many developing countries point to risk aversion. The absence of instruments to park their funds are prompting institutional investors to look east and south. The flow could accelerate if the US Federal Reserve resorts to another round of injection of liquidity to spur the economy. Not surprisingly, there is once again that familiar sinking feeling after the initial euphoria over the torrent of foreign portfolio investment flowing into the country. Besides heating up the economy, foreign flows also boost the local currency, blunting export earnings. Second, the inflow could turn into outflow on any trigger in the developed economies or if emerging markets impose controls to regulate and even restrict the flow. In 2008, the collapse of the mortgage-based securities market in the US resulted in a credit crunch and withdrawal of funds by investors across the globe. Now, increase in interest rates by central banks of western countries on recovery gaining ground could provide the signal for foreign funds to look at their domestic markets. The Indian market lost 1,500 points in the three days till 19 October 2007, when Sebi proposed phasing out of promissory notes (PNs), through which unregistered foreign institutional investors take exposure to the Indian market, in 18 months. The regulator had to rescind the ban a year later. Brazil’s stock market witnessed withdrawal symptoms on the imposition of 2% tax on overseas investors’ stock purchases late October 2009.

Taxing foreign investment to discourage hot money and imposing lock-in to prevent sudden flight of capital are the two most common barriers erected by many emerging countries to stem the excessive overseas liquidity making its way into local markets. Foreign investors do not like sudden disruptions in policies and tax regime. The remedy, thus, could prove worse than the cause. Fortunately, India was saved from taking any action in 2008 by the collapse of Lehman Brothers and the resultant meltdown in the financial markets later that year. Two years on, India once again has to confront the dilemma if it does not want asset bubbles. Buying dollars by the Reserve Bank of India could fuel inflation on release of rupees in the system. Instead, structural adjustments could be a preferred alternative. One of the immediate steps would be to revist the ban on PNs. Sebi insists on know-your-client norms for Indian investors. So why not for foreign investors? A major factor for stock valuations going for a toss on deluge of dollars is the lack of depth and liquidity of the Indian market. There is just not enough paper to allow the huge pension and sovereign funds to participate in India’s growth. Besides the 50 stocks in the Nifty including those in the Sensex, institutional investors’ universe extends to another 100 or so counters. The remaining stocks have very small public float or have corporate governance issues to contend.

There are two ways of going about to meet the demand: encourage more companies to list and those listed to raise more capital. The viability of this strategy was evident from the way the market took a pause when the Coal India IPO was open for subscription last fortnight. This would allow investors waiting on the sidelines to enter the market. The present time is right for the government to speed up its stake-sale in PSUs as foreign investors are particularly partial to divestment programs. It should also draw up a timetable, as was done when companies were mandated to switch their physical shares into electronic, by categorizing those with low public float as per market cap to ensure orderly supply of paper. More companies will list or raise capital if the market sentiment is friendly. Dilution will not remain a concern if the economy continues with its trail-blazing growth. The market’s response will hinge on the experience of investors with the earlier IPOs/FPOs. Tepid listing or erosion in wealth by even one or two large issues can puncture investors’ enthusiasm. The last time the primary market busted was when the huge Reliance Power issue, the biggest till Coal India IPO came along, that opened mid January 2008 failed to translate its marketing hype into reality by closing 17% below the offer price on listing. The responsibility of ensuring that the foreign fund inflow is sterilized to cap inflation and the rupee is not only with the Indian government and the central bank but also with investment bankers to curb promoters’ and their greed to prevent the economy from stalling.

MOHAN SULE

Shooting the messenger

A stock exchange should instill confidence in companies to list and investors
to trade

To enjoy the freedom of pricing issues, it is clearly understood that issuers have to be upfront about their track record. What if the Securities and Exchange of Board rejects the offer document on the grounds that disclosures are “dishonest”? The issuer has the option to contest the dismissal with the Securities and Appellate Tribunal. Irrespective of the outcome, there will be an intangible consequence: loss of investor confidence. This would be particularly worrisome if the applicant is a stock exchange, where investors expect transparency not only from listed companies but also in trading. One of the reasons for the decline of the Bombay Stock Exchange was interference by promoters, who also happened to be trading members, in its functioning. Subsequently the exchange restructured ownership in the process of becoming a company. The bone of contention now is the indirect shareholding of a stock exchange proposed by MCX, a commodity exchange, and Financial Technologies, a tech firm. Apart from each owning 5% equity as per regulation, promoters hold warrants convertible into equity amounting to 60% of the capital. These shares would carry no voting rights but rank on par with ordinary shares. It is possible that those in possession of the remaining equity could take control or even obstruct management if even half of them vote as a bloc. This would happen if the remaining shares are not allotted to associates and those favorably disposed to the promoters. In fact, Sebi feels all friendly shareholders together should not hold more than 5% equity and has accused the exchange promoters of “withholding material information on arrangements regarding the ownership of shares of its shareholders”.

Very few companies listed on Indian stock exchanges have two classes of shareholders as the market strongly disapproves of promoters’ sly attempts to keep control of their company and at the same time invite investors to share the risk without any say in its affairs. Foreign investors have shown reluctance for this sort of dual structure proposed by the government in the banking sector. In this case, promoters have controlling economic interest rather than voting power. This appears to be an attempt to occupy a seat at the table to enjoy listing gains rather than a safety net to thwart hostile bids. Instead of acting to comply with Sebi’s demands, the promoters have chosen the scorch-earth policy followed by retreating armies. They hint at conflict of interest: C.B. Bhave,the Sebi boss, was earlier the managing director and CEO of National Securities Depository, promoted by rival NSE. This sort of character assassination is a typical strategy employed in corporate warfare. Witness the muck being thrown around in the SSK Microfinance power struggle. It was even insinuated that Henry M Paulson, the US treasury secretary during the financial meltdown, influenced the decision to allow Lehman Brothers to collapse, put pressure on Bank of America to bail out bankrupt Merrill Lynch at a very high price, and assisted J P Morgan Chase to buy Bears Stearns at bargain price due to this ties with Goldman Sachs.

By extension of this logic, all decisions on banks and mutual funds taken by previous Sebi chairman M Damodaran should be reviewed because of his stints with IDBI Bank and UTI. If O P Bhatt, the current chairman of SBI, is selected to succeed Bhave, should he recuse himself from rulings that may impact, say, ICICI Bank? Or, going forward, can a software company allege foul play against disciplinary action for violating the listing agreement with the new exchange whose promoter is in the IT space? In the appointment of Damodaran and Bhave, the government had made a cautious beginning of inducting IAS officers with some market experience to head Sebi. After this episode, do not be surprised if a vanilla bureaucrat is once again selected to head the watchdog. Another crucial question is: do we need a third stock exchange? Competition brings down trading costs and throws up arbitrage opportunities. At the same time, investors prefer a platform that has the weight of volume. For this reason, there has been a wave of consolidation between bourses in Europe and in the US. Online trading has made niche presence to attract regional investors redundant. NSE’s success also hinges on its ability to flag off derivatives trading before BSE could get its act together. This does not mean there is no place for another efficient and transparent bourse that will appeal to foreign investors. To succeed, the exchange should set an example by adhering to not only the letter but also the spirit of the law.
MOHAN SULE

Moody markets

Sustainability of the rally will hinge on the world becoming flat once again

Just like meteorologists, those in the profession of mapping the market mood are becoming predictable. The forecast for the day following a thunderstorm typically is an extension of the previous day. The situation is exactly the opposite for the markets. Red flags are raised about heated markets and overvalued stocks following a few days of aggressive buying, while a declining trend is promptly declared a buying opportunity. During the last bull-run however, money managers had started mimicking weather forecasters and were predicting greater heights for the benchmarks even as they were breaching new records on liquidity flow from foreign funds and low interest rates. During the current recovery, market intermediaries reverted to their cynicism and were cautioning against rich valuations based on trailing earning. In hindsight, both projections were off the mark. Soon after crossing 21,000 in January 2008, the market began sliding on credit crunch in the US. Rather than correcting to the historical median level based on trailing earning growth, stocks sprinted forth in September 2010 even as market watchers debate over the triggers and how far they would head as foreign investors scramble to buy the India story. The act of defiance seems surprising coming so soon after the Reserve Bank of India once again nudged up policy rates to tame inflation as the double-digit annual expansion in the Index of Industrial Production over the month of July signaled the heating up of the economy. The behavior of the market, which is fairy discounting even one-year forward earning, seems to be at odds with traditional economic theories.

Any rise in interest rates is usually followed by fall in stock prices across the board. Higher cost of money not only makes borrowing expensive for investors to buy stocks and for consumers to finance non-durables but also for companies to fund expansion undertaken to meet demand that goes up in a booming economy. The domestic currency appreciates as a result, denting exports. Imports become cheaper, hurting local manufacturers. Hiking of interest rates sets off a chain reaction and has to be undertaken after careful calibration to ensure that growth merely slows down and is not derailed. For this reason perhaps, the RBI has left untouched bank rate since 2002, but has been tinkering with short-term borrowing and lending rates. High long-term interest rates and high growth rates cannot coexist. Foreign investors seem to have recognised the central bank’s caution as temporary. Normal monsoon is expected to cap foodgrain prices as kharif crops start arriving in the market and bolster rural purchasing power, spinning off into higher topline growth for a host of sectors including automobiles, real estate, cement, consumer non-durables, fertilisers, and banks. Despite the hardening, interest rates are still low than the 2007-08 level. More emerging economies like India raise interest rates, more attractive they will become until recovery takes root in the western countries.

The recent rally is at odds with the theory of a flat world, which suggests prosperity will spread from one corner of the globe to the other as trade barriers crumble and funds slush around to find the most lucrative investment opportunities. Also, stocks become cheaper if the currency is weak. Instead, there is unidirectional flow of funds from the US with a weak dollar to the developing economies with stronger currencies. The sustenance of the market surge, thus, will hinge on three factors. First will be the pace of bounceback in the US and Europe. Recession in the US was officially declared to have ended in 2009 though recovery is still weak and another fiscal stimulus package may be required to shake up the economy. This seems unlikely in view of the huge fiscal deficit. Till then, emerging economies will continue to attract hedge funds rather than serious long-term money from pension funds, which would fret about valuations in relation to growth. Once this happens the market will gain at a steady clip rather than at a furious pace like in the last leg of the rally that ended in January 2008. Second will be the signal from commodities. Still subdued despite the spurt in consumption by China and India, oil’s rise on demand from developed economies could slow down the bull-run in emerging economies. On the other side, investors flocking back to the NYSE and Nasdaq could soften gold, currently scaling new peaks. The third, and related, signpost would be the US Federal Reserve resuming raising discount rate. This would strengthen the dollar and free the RBI to aggressively tackle inflation rather than doing this in bits and pieces. Till the time the world returns to becoming flat once again, there will be continued unease over the continuation of the current rally.

MOHAN SULE

Post-Avatar world

Survival of native tribes is as important as capping on carbon emission and protecting small investors

A big corporation wants to mine minerals that threaten the existence of the local habitants. A saviour fights to thwart its designs and save the ecology of the land. Sounds familiar? This could be the story line of James Cameron’s Avatar set on a lush gas moon in the Alpha Centauri star system. The indigenous humanoids escape from extinction due to the timely intervention by a paraplegic marine, who assumes their persona and eventually changes his allegiance from RDA Corporation to the Na’avi tribe. Turn forward the clock from December 2009, when the movie was released worldwide, or backward from 2154, the period depicted in the billion-dollar hit, to Orissa in India in 2010. Substitute the protagonist Jake Scully with scion Rahul Gandhi and the mining conglomerate with Vedanata Resources. By denying permission to the London-based holding company to dig bauxite, the environment minister has opened a Pandora’s box: will India remain a tortoise in the race with China by insisting on all-round inclusion? Can the country hope to generate sufficient jobs to achieve double-digit growth if policies become restrictive and protective, discouraging investment? Or does this smack of hypocrisy as India along with China scuttled the consensus on carbon emission at the Copenhagen conference? And, importantly, is this the continuation of the transformation process marking the change in perception of government from being too big and insensitive to being one that is ready to act to cause minimum loss and disruption in the lives of people?

The trigger for the increasing role of government obviously was the global meltdown caused by the failure of financial institutions in the developed economies, resulting in loss of confidence in markets to correct the inefficiencies. Ironically, the situation came about because the markets were responsible for corporations to pursue the single-point agenda of growth, which could come at a cost to the stakeholders. Unless a company is operating in an emerging market, core operations are unable to fuel the growth machine after a certain point of time, as amplified by the woes of FMCG and telecom companies whose basic revenue growth is stabilizing and profit margin is getting squeezed. The fudging of accounts at Satyam Computer Services typifies the desperate attempt of promoters to remain on top of the quarterly results cycle. To expand their balance sheets, financial institutions in the developed world took on bets on risky derivatives, which also proved to be their downfall as is the case of companies that stray from their knitting. Unlike in the past, when they remained on the sidelines and let market forces dictate the future of a bankrupt company, governments around the word offered safety nets by touting the principle of too-big-to-fail, and actively formulated fiscal stimulus. In the process, they took equity stakes in the failed institutions and imposed restrictions such as caps on CEO pays. To divert attention from the damage to the fiscal deficit as result of the massive liquidity infusion, the private sector was ridiculed and scolded. The humiliation of the top brass of Goldman Sachs is still fresh. The oil spill off the Gulf Coast from a rig owned by British Petroleum reinforced the image of irresponsible companies whose CEOs received fat pay packets without commensurate accountability.

In India, the government took the stand that the government had the right to price natural gas even from wells for which licenses were given to the private sector. This was welcomed in the sense that government was not expected to indulge in profiteering like the private sector, thereby protecting the interest of the end users. The Supreme Court accepted this argument over pricing of gas to be supplied from Reliance Industries to Reliance Natural Resources. The fallout of the government’s overreach is the likely loss in investment and tax revenue were natural gas prices linked to demand. Most democratic governments tend to resort to populism to win votes or sustain power. Fiscal irresponsibility of a few European Union countries to protect the citizens from belt tightening eventually ended with the same results when multilateral agencies imposed austerity measures to bail them out. In India, subsidized fuel has caused havoc with the fiscal deficit. Though petrol has been deregulated, the government is going slow on liberating diesel. This could be the right step for a developing economy like India. By the yardstick of its activism in protection of environment and the poor, the government is also expected to safeguard the interests of other sections of the constituents. Towards this objective, it has set up regulators. But what happens if regulators come under attack for leveling the field for small investors? Who among the political class will don the mantle of Jack Scully to deflect the flak being directed at Sebi chief C B Bhave for taking on mutual funds and powerful companies to bring about transparency in the market? Inspired leaks to media about search for successor appear to be attempts to turn him `accommodative’ rather than farsighted succession planning.
MOHAN SULE

All-weather friends

Many other sectors can turn defensive to give FMCG and pharma company

For the markets, the season changes every quarter. A sector in favour last quarter may not necessarily find takers in the next. Investors find warmth in FMCG and pharmaceuticals stocks during the bear chill but turn cold to them in a bull market. IT stocks fluctuate along with the rupee, a factor of the health of the developed economies: a strong US economy boosts the dollar and makes our exports competitive. The fortunes of the real estate sector wax and wane with rising and softening interest rates, reflecting the state of the domestic economy. Nothing illustrates the volatile taste of the market better than the changing outlook of banks and telecom. After viewing it with trepidation for the rising non-performing assets and lust due to hefty treasury income on low interest rates for a few quarters, the banking sector now seems to be firmly entrenched on investors’ checklist as the best bet to ride on the coming growth wave. A favourite till a few quarters ago for mimicking the growth story of the new liberalized India, telecom has been beaten down after being washed with debt undertaken to bid for 3G and BWA licences and falling margin on intensifying competition. It is not necessary that these two sectors would continue to enjoy their current status a few quarters down. Like shifting sand, their fortunes can take a reverse turn due to global and domestic economic environment or company-specific developments. Rising interest rates are more likely to expose the weak links among banks, taking down the sector. Valuations of telecom stocks are already looking attractive and could further enhance their appeal if there is a major shakeup. Ditto for aviation, another reforms era success story, which spawned competition, cannabilisation and, eventually, consolidation.

It is now pretty evident that every cyclical phase in the market throws up surprises. New sectors emerge and old and mature industries blip out. If the prosperous last decade of the last century closed with the big bang debut of Internet companies, the new century washed ashore with the belly-up corpses of many of these startups. If telecom ruled the waves for a brief period, so did real estate. Even as tech stocks staged a comeback, riding on the success story of Apple’s iPod, iPhone and iPad, the market returned to its manufacturing roots, with crude oil dictating the mood swings as a barrel became worth more than $140 not because of cut in production but from growing demand from China and India. If the allure of gold proved irresistible so did the old world charm of basic metals such as copper, steel and aluminum on the US housing boom and so also basic food items such as sugar, corn and wheat as the emerging economies sought improved lifestyle. As the first decade of the new century drew to a close, the housing boom fuelled on cheap money crashed under its weight, pulling down with it financial institutions. The choking of the credit pipeline and liquidity to the stock markets grounded to a halt the bull-run in commodities. If the dotcom IPO rush characterized the excesses of the previous bull-run, it was the bursting of the real estate bubble that concluded the latest. The collapse of Lehman Brothers, exposing the rot in the financial services, is considered the defining moment for the about-turn of the market. Yet, the fall of Enron or WorldCom or Long-Term Capital did not usher in a bearish phase. Invariably, it is one sector that gathers enough momentum to propel and prick the feel-good sentiment. It is during times of distress that mature industries gain prominence. Some of them continue to do well even in good times but are overwhelmed by the flavours of the season. Perhaps it would be appropriate to call them all-weather friends of investors. Their presence is comforting but never domineering in a market rally like, say, tech or telecom. Just as institutional investors hedge their cash positions in the derivatives market, investors tend to earmark certain share of their portfolio for defensive sectors to ensure stable returns.

Considering the increasing reliance on steady performers to see through volatility, it is surprising the small numbers of these sectors. One reason is that it takes years for an industry to attain maturity. Some promising sectors peter out after a few years, while many older ones suffer from cyclical demand. The trick will be to correctly identify those that have the DNA to survive rough weather and retain sanity during exuberance. If soaps, detergents and medicines are used during boom or doom, so is the people’s need to communicate. Intense competition has battered telecom stocks but this could be the growing up pains as consolidation. The FMCG sector too has and is facing competitive pressure on margin. It is trying to get a handle on the situation by reducing weights and pushing volumes and foraying into food processing and over-the-counter pharmaceuticals. Telecom players are eyeing 3G, BWA and data transmission for growth and may have to foray into content and hardware to offer the entire value chain to subscribers. If pharma can be the perennial consumption theme, so can be hospitals and education, sectors yet to see substantial listings on the stock exchanges. Private equity players are already betting on them as the next growth stories. So far, banks were considered a cyclical play, whose future was tied to interest rates. This perception has changed as the sector is set to enmesh with India’s growth story. Besides, treasury income in a low interest-rate era compensates for fall in fees and lending spreads during a bullish phase. Unfortunately, crude-based raw materials and dependence on cotton crop have robbed textiles, an old and indispensable sector in the economy, from acquiring the defensive tag. The technology upgradation fund is contributing to the industry’s modernization. Infusion of capital to achieve economies of scale can make it a global hub like the automobile sector is poised to become and its dependence on labour turned into an advantage to make it the next defensive candidate. Waiting on the sidelines but never far from the subconscious is the entertainment sector. What better way to cope up with the bear phase than be transported into a fantasy tale of good triumphing over evil or the underdogs taking on the champions?
MOHAN SULE

Second thoughts

To what extent should rules be revised in response to the sentiments of the constituents without diluting the original intention of reforms?

Infosys Technologies boss Narayana Murthy recently bemoaned the lack of governance in India. Bureaucracy, he lamented, was out of touch with the changing landscape, and advocated scrapping of the Indian Administrative Service. Murthy is only half right. Governance, or rather lack of it, is just part of the problem. It would be a full-blown headache if the laws framed by our legislators crumble from any assault on them. The most glaring example is the shape of the budget by the time the Finance Bill is passed in parliament. Two recent instances show that the problem stems at the stage when laws are being drafted. The first example is of the revisions proposed in the Direct Taxes Code. The basic premise for a framework was to simplify rules for easy compliance, leading to better revenue collection. Exemptions were proposed to be scrapped altogether or to be taxed on maturity. This was in exchange for a lower tax rate. The code, thus, looked sensible. No sooner was the draft released, various lobbies jumped in with their objections. Investors in small savings should continue to enjoy a tax-free ride, and long- and short-term capital gain needed to be segregated for stability in the markets. Despite indications of a lower tax regime, the proposal to club capital gain with income was met with resistance. Eventually, a revised paper to the draft was released recently, diluting many of the original suggestions including retaining long- and short-term capital gain. It now remains to see how many of these revised proposals undergo a change before implementation. How did this come about? In retrospect, the failure to sell the original version was the inability of the government to give an assurance on personal tax rates. Instead of promising a moderate and stable tax regime over the next three to five years, the government indicated taxes could be subject to change depending on the demands of the situation. This naturally raised concerns that while the government would retain the flexibility of changing the rate of taxation, elimination of tax exemption would become a permanent feature.
The second draft, too, contains mischievous elements such as calculation of long-term capital gain and retention of securities transaction tax. The entire episode, right from writing the original draft by a committee headed by a retired bureaucrat to the revised proposal, demonstrates the limitation of bureaucracy, which either bows to implement the per projects of the current dispensation or formulates laws that are ideal in a perfect system but difficult to implement in a chaotic system that has be responsive to public opinion. The directive on 25% public shareholding for listed companies, too, reeks of bureaucratic bungling and ineptitude. The objective behind the directive is to make stocks liquid to enable investors to trade without causing price tremors as well as to reduce the scope for price manipulations. Like the DTC proposals, the intention is laudable but impractical. It assumes that low floating stock is a deliberate design by some companies either to keep control or gain from the fund-raising opportunity that listing provides. Allowing companies to list with just 10% public float was initiated by the predecessor, the NDA government. This was to prompt listing even by companies not in need of funds to revive the primary market following the dot-com bust. Lack of paper was responsible for the relaxation then. The situation seems to be in contrast now. Many companies want to tap the markets for funds for their capex to meet demand from the anticipated growth of the Indian economy. They are waiting for a definite turnaround in the secondary market to get richer valuations or to ensure good post listing performance. The experience of those that have issued shares over the past year has not been encouraging. There has been increasing investor indifference, culminating in timid response even to PSU FPOs.
The various reasons attributed for this phenomenon range from volatile markets, high pricing and the Dutch v French method of book building. The flood of paper by companies over the next three years to meet the listing norms would have crowded out issuers with genuine need for funds and sucked out liquidity from the secondary market, thereby affecting even the Rs 40000-crore PSU divestment, which depends on the feel-good factor. Instead of following a timetable that would segregate companies by market cap to dilute promoter stake to below 75%, the government’s solution, which again seems to have the stamp of bureaucracy, is to exempt PSUs from the 25% dilution requirement by permitting them 10% float. In the process, one important lesson seems to have been forgotten. The indifference of both institutional and retail investors to IPOs including PSU FPOs over the past year was not due to supply overhang. It was because of high pricing. Some reasonably prices issues got good response despite volatile market conditions. The second lesson is the difficulty in pricing PSU FPOs. Most listed PSUs are quoting at astronomical valuations not because of their monopolies but because of the illiquid counter. So far short-term gain of rich pricing, the government is sacrificing long-term investor interest of better price discovery on PSU counters. No wonder even foreign investors are turning lukewarm to PSU offerings from their earlier enthusiasm to divestment on the realisation that the entire exercise is similar to raising a bridge loan rather than attempt to make these entities market oriented. Nothing brings out this contradiction starkly than the overwhelming response of foreign investors to the recent US$ 19-billion IPO, the second biggest in the world so far, from Agricultural Bank of China, could make it the largest so far.

MOHAN SULE

Monitoring the regulators

An apex council can bring in much needed coordination between different bodies to smoothen out irritants

Look who is courting controversy! Invariably, it is the Securities and Exchange Board of India that is caught in the line of fire. Its textbook mandate is to fence the ground, level the field, and catch and punish wrong doers. On ground, however, Sebi is expected to ensure there are no bumps in the quest of all the stakeholders to become rich effortlessly. Issuers of capital want low entry barriers and intermediaries hassle-free trading, while subscribers demand cost-effective transactions. In the process, it comes out as unreasonable (ask asset management companies), arbitrary (in taking action against insider trading and price manipulators), harsh (check out investment bankers at the receiving end), and out of touch (poll institutional and retail investors). If there is a regulator who manages to antagonize all the sections of the market that it touches, the honour surely must go to Sebi. Very rarely is the market watchdog lauded for the orderly transition of the capital markets from outcry trading on broker-dominated stock exchanges to seamless and paperless execution of trades. Yet, there is no cause to complain of its recent clampdown on unit linked insurance plans. Where it erred was in allowing these products to be marketed. It was right on insisting that as a portion of the corpus of these products is invested in the equity markets, suspending their sale was within its regulatory ambit. But good intentions rarely make for good policy. The combination of insurance coverage and market-oriented returns was too enticing to be torpedoed. The issue was lobbed into the courts like all other explosive themes that are too hot to handle. But the issue encompassed too many stakeholders—investors, markets, mutual funds and insurance companies---to let it linger and fester. The ball eventually landed in the politicians’ court. The finance minister issued an ordinance to restore custody of the products with the Insurance Regulatory Development Authority (Irda).

Sebi, however, must have enjoyed the last laugh as the Irda amended certain features that loaded the dice in favour of issuers. Overall costs charged by Ulips have been capped on the basis of 10-year tenor and limits imposed on surrender charges, confirming that the capital market watchdog’s objections to these products was not without merit. The spat, nonetheless, hastened the process of appointing a super regulator. Undeterred by the braying to drop the idea of a Financial Stability and Development Council, the government introduced the Securities and Insurance Laws (Amendment) and Validation, Bill 2010, to replace the Ulip Ordinance. The bill, passed in the Lok Sabha last fortnight, seeks to have a joint committee to resolve the differences among financial regulators Securities and Exchange Commission of India, Irda, the Reserve Bank of India and the Provident Fund Regulatory and Development Authority (PFRDA). The finance minister will head the committee. Is Sebi upset with the supposed emasculation of power? By now it must be pretty used to getting its orders reversed by the Securities Appellate Tribunal, approached by subjects aggrieved over the market regulator’s rulings. Surprisingly, the disquiet came from the Reserve Bank of India, so far not used to its decisions being questioned. The government contends such a body is required for coordination between regulators and sort out disputes over turfs. The Sebi-Irda friction was the latest in the long list that included even an RBI-Sebi skirmish over NBFCs in the early days of Sebi’s birth. They had to follow business transaction norms laid down by the RBI and trading criteria prescribed by Sebi. In the same way, the Telecom Regulatory Authority decides on the operational aspects of telecom companies, which have to adhere to disclosure norms laid down by Sebi while tapping the markets for capital. Insurance companies, too, will face similar dual control once they get listed. So a formation of super regulator, with the finance minister in the chair and comprising other regulators, does make sense to ensure that there is no cross-connection.

India is not alone on this page. The US has proposed the Financial Stability Oversight Council to watch Wall Street despite the presence of the Securities and Exchange Commission. The Treasury Department will lead the nine-member council comprising regulators from the Federal Reserve, SEC, Federal Housing Finance Agency, Commodity Futures Trading Commission and other agencies including state securities, insurance and banking regulators and credit unions as non-voting members. The principle behind the UK’s new Council for Financial Stability, which the new government proposes to junk, was straightforward. The heads of the Treasury, Bank and Financial Services Authority will meet, probably quarterly, to analyse the state of the banking system and take action when deemed necessary. The basic difference between the supervisory councils in India and those in the US and UK is the latter’s narrow purview. The US council’s limited objective is to supervise the Wall Street, while that of the UK is to guide the Bank of England. In India, the scope is wide. Therefore, there is fear of the regulators losing their autonomy. There is a crucial difference that needs to be considered. Though the US president appoints regulators, drawing them even from the private sector, they need to be confirmed by the Congress. As their independence is derived from the people, the regulators are free to act on their own without approval or guidance from the government. In India, regulators are invariably selected from the bureaucracy of the public sector. Though autonomous, they often consult with the government. Besides, the boards of the regulators including those of Sebi and the RBI have govrnment nominees. While there should be no interference from the government in their policing work, a super regulator will ensure that they are on the same page. During the later part of the boom of 2003-2007, for instance, finance minister P Chidambaram was at odds with the money tightening policy of the RBI, whose main job is inflation control, while growth is primarily the responsibility of government by introducing appropriate fiscal policies. At a time like this, when developed economies are in recession and emerging markets including India is facing inflation, it is necessary that both the government and the regulators calibrate their policies so as not to hinder growth as well as let inflation go out of control. The RBI and Sebi may, for example, need to coordinate regularly to ease the path of Indian companies in acquiring cheap but strategic targets abroad and raise funds for the acquisitions. Irda and Sebi could require regular dialogue when insurance companies get set to launch their IPOs. A super regulator who would facilitate a structured mechanism for problem solving and policy formation anticipating future changes could be of immense help rather than a hindrance.
MOHAN SULE

Twice shy

Once bitten by the global meltdown, India has to hedge its growth story

Is history repeating? Various multilateral and Indian agencies are once again forecasting mouthwatering economic expansion for the country in the current year. This sounds familiar. Rewind to a couple of years ago, when India was expected to notch above 8% growth for the next few years despite the first signs of credit crisis in the US markets. Then, as now, growth projections were based on domestic consumption. The theory of decoupling was being bandied about. There was buzz about imminent capital controls to slow the foreign exchange inflow to cap inflation and interest rates. A few months down the line, there was a dramatic reversal in the situation. The concern was to insulate the Indian economy from the drying up of liquidity in global markets. The Indian government followed the US and China in announcing a fiscal stimulus package including cut in excise duties to pump up demand. The central bank loosened money supply. This had the desired impact. The markets bottomed out and doubled their value from their lows in the last fiscal as foreign funds started coming back on prospects of India repairing the imbalance in its expenditure and revenue following funds mopped up from the domestic market by a clutch of PSUs, successful auction of third-generation spectrum and broadband and wireless access , and hike in fuel prices. Growth is back on track, particularly since the second half of the previous fiscal. Manufacturing output in the first few month of the current year too is rising. Tax revenue is buoyant, eliminating the need to completely withdraw tax breaks. The markets have broken out from the 17,000 levels. Do these signals signify that the worst is over for India? What has changed that India can afford to ignore the still raging storm in the developed economies?

The IMF has imposed austerity measures in Greece to bail it out of its sovereign debt default crisis. Outlook of the euro zone is still cloudy. Japan’s growth remains flat. The slow recovery in the US is neither accompanied by spurt in jobs nor investment by the corporate sector, raising fear of deflation as the US Federal Reserve has no more scope to lower interest rates. China is under pressure to let its currency appreciate and is putting cap on money supply, which will slow its and, consequently, global growth. If not recession in west, India’s inflation partly contributed by food grain demand-supply imbalance and partly by foreign capital inflow, has the potency to effect a slowdown as the central bank makes credit costly. Yet, there is increasing decibel levels about decoupling on one hand and how global Indian markets are becoming. Cross-border mergers and acquisitions and fund raising imply repercussions on the bottom line of the parent and the home country beyond depreciation in contract value. So will things be different this time? The Indian economy can remain immune from withdrawal of foreign portfolio investors if the global economy once again dips into the last leg of recession if it can ensure that capital expenditure plans including capital market forays of a host of companies in the private and public sectors are not derailed and companies dependent on export revenue are not hurt. This would probably call for another round of fiscal and monetary stimulus and, thus, would be a setback to current efforts of nursing the country’s finances to sound health.

Hopefully lessons have been learnt from dealing with the past crisis. The first is that textbook prescriptions for economic health may not always work. There should be no hurry to rollback the fiscal stimulus neither to tighten money supply till the US and the euro zone economy are decisively out of danger. To have higher interest rates even as other countries are offering money at rock bottom rates will turn India into a speculators’ market. What about inflation? The current spell of inflation is spurred by shortage of food grains and rising consumption. A normal monsoon this season is expected to tame food grain prices. High interest rates will no doubt douse consumption but will also impede efforts to expand capacity to meet demand. Recent resources mopping efforts through PSU divestment and spectrum sell-offs as well as movement towards freeing fuel prices from control should ease government pressure on the bond market, contributing to keeping rates mild. Also, volatile markets should not deter it from going ahead with PSU divestments even if this is at throwaway prices. It could do this in bits, whetting the appetite of investors. This would set the markets on fire, benefiting even the private sector. What the recent global meltdown has done is to recognize the role of governments in making and breaking markets. If there were conventional responses to the past crisis, the future may call for out-of-the-box solutions. For instance, governments using the derivatives market to shape up events to meet ends. It is now recognized that the futures markets contributed to crude oil shooting past the US$ 140 a barrel mark and collapsing to US$ 33 a few months later. During periods of uncertain outlook, stable currency and commodity prices can provide comfort. With commodity prices rising but yet to reach the pre 2008 levels, this is the ripe time to undertake hedges. China is following the tradition route of buying up mines and oil exploration rights. Opec says it is comfortable with the current US $75 a barrel level. So why not tie up supply for the next few years at this level through the commodity futures market? Funds for undertaking this exercise can be raised by floating a sovereign Betting on India’s Growth (BIG) fund (with apologies to Anil Ambani), opened exclusively for foreign institutional investors. If the central bank can intervene through various tools at its disposal to guide the rupee to keep the import bill manageable and at the same time not hurt exporters, surely it is time for the Central government to lead by example by staying on top of the commodity cycle by writing contracts to calibrate prices. The bottom line is to ensure that events do not overwhelm us.

Trust deficit

Front-end loading by mutual funds has come an end. When will front running by brokers?

It is not the best of times for the securities business. On one side is market volatility that is scaring investors and resulting in dwindling volumes. On the other hand is the increasing pressure from regulators for transparency in proprietary trading and thus squeezing margins. Despite evidences of excesses committed by governments, greed, recklessness and questionable operating procedures adopted by those who manage investors’ money are blamed for the current market turmoil. The outburst of Securities and Exchange Board of India chief at a recent conclave of fund managers and the ban on a mid-rung official at HDFC Asset Management Company have brought to the fore the trust deficit between investors and market intermediaries. Dismissing the highly paid fund managers as “aggregators”, C B Bhave, the Sebi boss, bluntly questioned the existence of the highly hyped fund industry. If the ban on front-end loading of expenses has resulted in display of withdrawal symptoms by the mutual fund industry, front running is the recurring theme at brokerages. Efforts to separate and discourage proprietary trading face an uphill task and so also the practice of incorporating various loads by mutual funds. Online trading may have eliminated the price variation between placement and execution of order but not completely neutralized brokers or their employees from taking positions ahead of their clients. Entry loads may have disappeared but not exit loads. Indeed, Sebi seems to have completed a full circle from blaming brokers for most market ills and encouraging investors towards mutual funds in the 1990s to embarking on a do-or-die mission to cleanse the money management industry over the past year. It does imply that the regulator would either prefer investors to undertake direct exposure to the cleaned up secondary market to handing over funds to others or that the practices at asset management companies are no better or worse than those at brokers.

Are the mutual fund industry and the brokers facing flak for systemic flaws? The mutual fund industry was supposed to be a via media for the retail investors to take exposure to the equity and debt markets. Instead, the primary reason for its existence seems to be for the bulk investors, that is companies. This is in spite of capping quid-pro-quo transactions of companies diverting cash to the fund for use to boost their stock prices. There are many reasons for this state of affairs: First is of course the volume game, which fattens fees. Once a fund builds a comfort level with the company, both save on distribution charges. This makes selling to retail investors an expensive proposition. Hence, there is tendency of AMCs to lock in their fees through loads, especially for smaller amounts, rather than fees based on performance Second is the high capital requirement to float an asset management company, which increases reliance on corporate clients and permits entry to companies, banks and financial institutions. It also leads to fluctuation in corpus on large withdrawals. The third is the taxation angle. Dividend from equity mutual funds is tax free, while interest on fixed deposits is not, attracting corporate subscribers. The fourth is the illusion of security-of-a-fixed-deposit-cum-returns-of-the-stock-market combo created by the mutual fund industry by using the personal finance media. Ranking of schemes only reinforces the mirage. Unlike stocks, which discount forward earning, mutual fund investors are lulled into opting for schemes based on track record in spite of the Sebi-inspired disclaimer of past returns being no guide to future performance.

Decimating mutual fund is as impractical and counterproductive as trying to do away with brokers. There is a symbiotic relationship between the two. Brokers need institutional investors to boost volumes. Fund managers rely on brokers to offload or mop up shares in bulk without causing price tremors. At the same time, there is a need for serious introspection by these market intermediaries to find out how they could go about their business without frustrating their clients and the regulator. The mutual fund industry has been a proponent of self-regulation. To aspire for this status, mutual funds must put a cap on large subscriptions, bring down asset management and expense charges, and base fees on returns generated or performance in comparison with benchmarks.. A certain portion of this fee can be shared with distributors. This will ensure there is no mis-selling of schemes based on commission as well as survival of the efficient. Sebi should ease capital requirement norms to reduce AMCs’ dependence on corporate subscriptions. This has facilitated companies and financial institutions rather than experienced money managers to float mutual funds. It is now accepted that smaller corpuses are easy to manage and give better returns. The ceiling on each mutual fund’s holding in the equity capital of a company undermines the necessity of large asset base. Moreover, funds with modest corpuses can focus on mid-caps and bring about welcome changes in their corporate governance, thus increasing market depth. More funds with personalized service would widen the basket for high net-worth investors looking at PMS to cater to their needs. Brokers, too, would be able to spread their risks instead of depending on handful of funds for volume business and to resist the temptation of running ahead of their clients as the mass of orders of a small sized mutual fund may not be adequate to influence the course of the market. Swift punishment such as suspension of registration, which will hurt the broker for lax internal compliance, can do what well intention regulations on inducing transparency in proprietary trading cannot.

Forward view

Stock exchanges can expand the scope of derivatives by launching contracts on unfolding events

Much of the world’s woes over the past two years has been blamed on derivatives. Mortgage lenders in the US lured borrowers with teaser rates and disbursed credit to even those with spotty track record. These loans were spliced and bundled with other mortgages attracting different credit ratings into securities that were in demand from financial institutions to bolster their balance sheets. If derivatives caused grief to many, there was another group of investors who not only used these products to protect from downside risk but also to profit. As the fraud charges filed by the Securities and Exchange Commission against Goldman Sachs shows, the market is always efficient. Contrarians made money betting on crash in real estate. Though the US Congress has passed a bill to restrict the use of derivatives by banks for proprietary trading, the usage is not going dwindle. Financial transactions are becoming complex and contagious as markets are always open in some part of the globe. Tracking the DJIA late into night or the Nikkei early morning is the vanilla way to spot opportunities or eliminate risks. The other option is to use the futures market to take a view. The amazing properties of derivatives have resulted in their popularity extending to markets other than stocks. Forward trading in commodities is as old as that in stocks. Companies with exposure to foreign exchange have discovered the joy of hedging from currency volatility and those affected by monetary policy the comfort of interest-rate derivatives.

Even as investors, institutions and companies are embracing options, it is time to expand the scope to make gains and cushion risk. Why restrict forward view to company guidance, order wins, and industry outlook to predict the course of the stock over one, two or three months in the F&O market? The red herring prospectus contains risk factors to enable investors to take informed decision. If these are found to be inadequate in retrospect, Sebi can impose penalties and stock exchanges can even suspend trading. Commendable no doubt, these actions rarely are adequate to make up the erosion in market cap in the meanwhile. As government, market regulator and bourses wrestle to come up with solutions, the derivatives segment of stock exchange can launch contracts to take into account various out-of-the-box contingencies that may crop up to hurt investors. The freshest example is that of the RIL-RNRL row over gas pricing. If RIL had not backtracked from the agreement signed during the division of the Reliance group, the matter might have not reached the Supreme Court. There was, however, a possibility of intervention by government as natural gas from the same source would be supplied to RNRL and other customers at different pricing. How many investors who bought RNRL shares could have foreseen the reversal? If only the stock exchanges had quickly capitalized on this opportunity by launching contracts to take into account the possibility of the MoU turning junk as the case winded up from the high court to the apex court!

There have been instances of breaking up of partnerships even after commissioning of the joint venture, the most recent being the parting of ways of Renault and Mahindra & Mahindra. The division of assets between the Munjal family recently and the Bajaj family earlier are examples of how investors can shortlist groups that could see splits. What will be the shape of the RIL group and ADAG due to the scrapping of the non-compete agreement? Who will win RCom? MTN, AT&T or Etisalat of the UAE? Can Jeh and Ness Wadia manage the Bombay Dyeing group amicably? Will the Essar conglomerate remain intact between the two Ruai brothers? Mergers and acquisitions is another area. Bank stocks are active after ICICI Bank’s purchase of Bank of Rajasthan. Similarly, after the buyout of Primal Healthcare by Abbot Laboratories of the US, pharmaceutical stocks are in the limelight. Why not allow investors to bet on likely takeover or even bonus candidates? Or write options on the success rate of drug companies filing applications with overseas regulatory bodies? From the very accurate bets on the cricket team likely to win the World Cup to the composition of the government following national polls and listing price of IPOs, it is evident that there is vast market out there, filling a vacuum. It’s time to attract this money and talent into legitimate channels, creating a platform that will be expansive and exciting. As if endorsing this view, the Commodity Futures Trading Commission last fortnight approved trading in F&O contracts tied to the opening weekend box office revenue of the movie, ‘Takers’, a crime-thriller set for release in the US on 20 August 2010.

Off balance

Even careful calibration of issues such as gas pricing and regulating mutual funds can spin out of control

The current market turmoil has turned topsy-turvy rules of investing. Liquid companies with proven financial track record are supposed to be stable in a market downturn. Yet these stocks have not remained immune to recent volatility due to the sizeable presence of foreign institutional investors, who dumped them to meet redemption pressure at home. Dividend paying companies still lure but also invite scrutiny for lack of growth plans to effectively use cash. Sunrise industries are facing intensifying competition and regulatory attention from here and abroad. Market heavyweights are embroiled in their own problems, be it internal issues of control or debts taken for costly acquisitions. Frontline counters’ fortunes are getting linked to the dollar and the euro, whose movements are no longer linked solely to the health of the issuing region. High beta stocks capable of giving sizzling returns start discounting forward earning in a few sessions and become victims of their own success. Corporate governance issues stalk mid- and small-caps, making them unpredictable. Retail investors looking at mutual fund to anchor their savings are finding there is hardly any port to call after Sebi decided to give investors a say in deciding brokerage of distributors. Despite the economy posting strong growth numbers, prospects of fiscal deficit getting bridged due to the successful completion of the 3G auction, and forecast of normal monsoon, the market is stuck in a groove, pinning its hopes on recovery of the US economy and sorting out of the sovereign debt problems facing many euro zone countries for foreign funds to return and pull up the market.

For a brief period, it looked liked that the intervention of the Supreme Court in the dispute on pricing of natural gas from RIL’s Krishna-Godavari block to be supplied to RNRL’s power project in Uttar Pradesh would provide the much needed boost to the market as RIL, an index heavyweight, is now free from uncertainty. The market’s return to range-bound movement subsequently was because the verdict was not merely a judgment on a private memorandum of understanding between two companies. It was a reiteration of government’s role in deciding pricing. Foreign investors in Venezuela and Russia have had unpleasant experiences of the state’s arbitrary interference including expounding of assets. Besides administered pricing of a natural commodity is at odds when downstream products of another natural commodity are proposed to be deregulated. The rise and fall in the market cap of RIL and ADAG stocks following the SC’s say, thus, was as irrational as the bounce-back in ADAG companies after the terse announcement from the Ambani brothers of scrapping the non-compete agreement entered into while carving of group assets between them. The pivot of the ADAG is the power sector. The embargo on Big Brother from making a foray into natural gas-based power generation for another six years till 2022 is huge hedge for not getting natural gas at concession. On the other side, the entry of RIL in the money business — mutual funds, finance or insurance — will not mean much for the Anil Ambani group because it is already operating in a crowded field. Telecom is no longer a lucrative arena, and RCom’s fate is no different from that of other telcos.

Would our markets have fared better if Sebi had not chosen to discipline mutual funds at this juncture? The timing was indeed unfortunate: the market was once again displaying signs of nervousness after springing back into action. This is the period when investors either choose to stay on the sidelines or invest through SIP for the law of averages to work out. Suddenly, asset management companies stopped new launches as entry load, a lucrative avenue to make money, was banned. Following the shifting of onus of commission from AMCs to investors, distributors, too, stopped hawking mutual fund schemes. The diversion of flow to unit-linked insurance plans, which invest part of the corpus in equity markets, was not enough to compensate full-throated investment of equity schemes. The comatose state of the mutual fund industry following recent reforms is one more reminder that regulations that take care of only one section of the stakeholders do not succeed. A middle path could have been linking fees to performance over a period of time or a graded system of penalizing those who seek to redeem their investments before and after one year, making it fruitful for investors as well as AMCs to seek long-term association with the markets. There is a lesson here to be learnt by government, which is introducing the direct tax code, making investment subject to personal tax rate, irrespective of the holding period.

Taking risk

Investors need to be compensated for faulty or misleading information

Equity investment is subject to market risk. This is a common advisory issued to those who want to capitalize on the inflation beating returns of stocks. In the pre-reforms era, the risk was confined to annual results or disappointment over a company’s conservative policy on bonus issues. Investors were satisfied with a modest appreciation. A portfolio made up of scrips like Bajaj Auto, Bombay Dyeing, Tata Steel, HLL, and ACC meant a steady cash flow through dividends. Investors now face far more uncertainty. ACC, now an MNC associate after promoter Tatas divested from the cement business, is a shadow of its former self. Bombay Dyeing is eyeing real estate instead of its traditional textiles business for growth. Tata Steel has a formidable rival in now listed government owned Sail. HLL has transformed into HUL but become a mediocre performer like other FMCG players. And Bajaj Auto is no longer a monopoly as it reinvents to stay in the two-wheeler race. In the meantime, party gatecrashers like Reliance Industries influences market movement, spunky Infosys Technologies determines market sentiment, aggressive Bharti Airtel symbolises the market’s hunger for growth, Dr Reddy’s Laboratories captures the market’s desire for risk taking on a global scale, NTPC epitomises emerging opportunities in the infrastructure space, and SBI offers a ride on the Indian growth story. There are more listed players to pick and choose, more opportunities to see unprecedented gains, but so also more risks to factor in — not only from revision in government policies and regulations but also from global markets including fluctuations in interest rate, currency, fiscal deficit and employment.

The earliest indication of how external factors could impact local markets was the flight of capital from the Far East economies in 1997 after a massive inflow of foreign investment into unproductive assets, particularly real estate, resulted in formation of bubbles and loss of investors’ confidence. The impact on India, in the early stages of opening up, was not as severe as on western economies, which viewed the emerging tigers as cheap sources of labour and lucrative markets. Next came the dotcom rush and bust at the end of last century. The collapse of highly priced IPOs whose valuation was based on eyeballs instead of revenue stream wiped out billions of dollars of market capitalization from the US stock markets and slowed the flow of investment to emerging markets like India. It took nearly three years for global markets to recover. Five years later, US investment bank Lehman Brothers collapsed as mortgage-based securities in its portfolio turned duds following the crash in housing prices. The after-effect was aversion to risk and drying up of credit. The ripples travelled all the way to India and China, whose growth slowed, while Europe went into recession as countries and institutions in the euro zone either had exposure to these toxic assets or had cranked up huge debt during the hey days to finance their expansion.

The recent decision of the Telecom Regulatory Authority of India on pricing of 2G spectrum and the Supreme Court judgement on pricing of natural gas are instances of risks assoicated with sudden changes in the rules of the game. The proposals to charge excess 2G spectrum held by incumbents at the price of the 3G spectrum sold and delink allocation from subscriber base are supposed to make good the loss caused by giving away 2G spectrum on a first-come-first-served basis instead of following the auction route to facilitate entry of new players in the ring. All this comes at the cost of existing services providers with surplus spectrum. It is also a setback to the shareholders who had invested in market leaders in the segment. Similarly, investors had bet on RNRL because the company and its upstream subsidiaries were to benefit from natural gas sourced from RIL at a cheaper rate than available to competitors. The Supreme Court dismissed the private memorandum of understanding between the Ambani brothers on this issue, resulting in value erosion in the ADAG companies. Last year, the government had predicted normal rains. Eventually, the southwest monsoon turned out to be below average, adversely impacting interest-rate sensitive stocks as foodgrain inflation rose and the Reserve Bank of India had to tighten money supply. What can be done to provide a safety net to those who enter stocks based on study of a set of data made available by government and companies? Maybe it is time for public and private sector units to put aside a percentage of their profit to set up a compensatory fund to make good losses suffered by investors acting on information that could prove to be misleading or faulty in retrospect.

The Stockholm Syndrome

Why Goldman Sachs and the IPL’s suspended boss may end up getting sympathy despite their excesses

How the powerful have been humbled! In the US, the top brass of the mighty investment bank, Goldman Sachs, was subjected to intense grilling by a Senate subcommittee in the full glare of TV cameras. In India, the ruling dispensation came down with all its might by leaks to media to force out Indian Premier League commissioner Lalit Modi for taking on a Union minister. Both the episodes had all the ingredients necessary to make for compelling drama: big money, tattered aura of invincibility, hints of fraud, complex transactions, and unrepentant protagonists. The defiant performance of the main players was a chilling reminder that what is good for businesses need not be good for their markets. The investment bank marketed derivates that offered insurance against fall in mortgage-based securities. Cricket’s newest czar invited private ownership of teams by auctioning players to the highest bidders. Profiting from opportunities presented by the market is as legitimate an exercise as is the ego-massaging desire of a group of moneyed individuals to possess a sports team. What is not is when the investment bank allows for contra bets on its own product and the real owners of the franchise are not upfront about their identity. The insatiable appetite of Goldman Sachs and IPL for big money is neither surprising nor shocking. Investment banks in India are bringing out highly priced IPOs to compensate for the finer fees they have to contend with due to rising competition. At the start of the last decade, it was mobile telephony that proved to be a magnet for business houses. Now the latest fad is to own a cricket team for its capacity to generate eyeballs and, hence, revenue.

As has been seen from the IPO boom of the early 90s, the prospect of making a quick buck inevitably attracts hot money, resulting in controversies over allotment, be they bids for 2G spectrum or IPL franchises. What are the lessons learnt from these two blowouts? First, a simple idea can end up causing disservice to the cause. Savvy investors go long and short on a stock or the index to protect from downside risk. Still Goldman Sachs’s double role rankled as it was known to follow high standards of ethical behaviour. The IPL head’s desire to discourage opaque shareholding was selective rather than encompassing: many more teams have tangled equity structure. Second, business should not only operate in a fair manner but appear to be doing so to earn credibility. Goldman Sachs’ defense that what it did was simply a business strategy has failed to arouse sympathy as the slide in US home prices has been blamed for the global financial crisis. Lalit Modi’s tweet about the suspicious composition of the Kochi team would have seemed like a genuine concern were the holding pattern of other teams too was transparent. The third lesson is conflict of interest invariably leads to bust. Goldman Sachs was creating a product that was supposed to insure subscribers against declining mortgage bond prices but benefited others who were bearish on them. Though Modi was IPL’s regulator, he was accused of cronyism. The fourth lesson is that even one indiscretion is enough to unite foes.

Goldman Sachs’ transgression has been the trigger for US lawmakers on both sides of the aisle to pass the financial regulation bill, which will the change the shape of the financial services industry from a risk taker to a money processor. The government’s displeasure at the IPL helmsman taking on a cabinet minister provided ammunition to his detractors outside and inside the IPL. The fifth lesson is that success leads to complacency. Goldman Sachs was among the few investment banks to have withstood the financial market meltdown. The security of its leadership role perhaps led it take on risks that it should not have. The IPL owes its success largely to its organiser’s vision and execution, apparently emboldening him to assume that he is the first among equals. Goldman Sachs and Lalit Modi are not the only losers following the unravelling of their misdeeds. Turning over into a new leaf by investment banks may come at the cost of innovations, depriving investors of opportunities to make profit. The IPL money-making machine is too lucrative to be dismantled. The show will go on but will it get bigger and better? The ringside participants — investors and spectators — may suffer from the Stockholm Syndrome just like kidnapped heiress Patty Hearst, who started identifying with her captors. Fatigued by the recent tales of greed, they may ignore the failure of investment banks in protecting their clients as excesses by governments pull down the markets and conclude that the IPL boss was a victim of a witch- hunt rather than the casuality of a clean-up.

Problem of plenty

As long as institutional investors remain silent, cash-rich companies will continue to give hefty dividends

Even as the Indian economy is poised for an explosive growth, with opportunities beckoning to expand market share, more and more companies are declaring dividends for the year ending March 2010. This follows a difficult financial year 2008-09, when the developed economies faced recession and the emerging markets a slowdown as financial markets melted on credit crunch. In the last decade, HUL and Nestle stood out from the rest for their bumper dividends. Now it is the turn of Hero Honda Motors to distribute surplus cash to the shareholders. The Anglo-Dutch conglomerate issued one bonus debenture of Rs 6 each per Re 1 share in 2002. It also paid a special dividend of Rs 2.76 per Re 1 share. Initially, it was to distribute about Rs 135 crore after the dividend distribution tax, which was abolished in the subsequent budget. As a result, it disbursed Rs 608 crore as special dividend from the profit & loss account. The Swiss food maker declared a second interim dividend of Rs 14.50 per equity share of Rs 10 and approved distribution of special dividend of Rs 7.50 per equity share after paying dividend distribution tax in October 2008. Its dipped into the share premium account to withdraw Rs 43.24 crore and returned Rs 43.08 crore that was transferred to its general reserve between 1981 and 1996, which was in excess of the 10% profit of the company. The world’s largest two-wheeler maker by volumes will pay 4,000% interim dividend of Rs 80 on each share of Rs 2 face value, which is the highest payout in percentage by an Indian company to date. Like HUL, the handout could have been more if there were no dividend distribution tax.

Five things stand out in the rush to distribute dividends over the last decade. The first is the ambivalence of the government on taxing dividends. Earlier, companies paying dividend as well as the shareholders were taxed. Later, on the realisation that levying dividend distribution tax implied double taxation as the amount is distributed from after tax profit, only the shareholders were taxed. Now, it is once again back to the earlier position of taxing the corpus set aside for distribution by companies, with the recipients getting a tax-free ride. The new Direct Tax Code to be implemented next fiscal has proposed taxing all income without differentiating the source and period of holding as per the personal tax rate. This implies reverting back to the double-taxation regime unless the dividend-distribution tax is abolished. The second trend is that large payouts are being resorted to by consumer durables and non-durables companies despite pressure from intensifying competition, HUL, Nestle and Hero Honda are sitting on huge cash. Yet all three cannot afford to remain complacent as rivals get bolder. The third strain is cost control. HUL learnt the lesson the hard way after facing labour problems at its Mumbai plant late 80s. It was among the first Indian companies to geographically spread out its manufacturing facilities so that supplies would not get disrupted due to bottlenecks at one plant. This also cuts down on the expense in transporting raw materials and finished products. Eventually, the fashion of developing dedicated suppliers or outsourcing certain processes gained ground even before the word became a lexicon in the financial markets for cost cutting.

Another common feature is that all the three are have foreign equity, though the Indian promoter and the foreign collaborator hold an equal stake in Hero Honda. Besides, all the three are dominant players in their segments. Most of the times, they enjoyed the first-mover advantage. Being a monopoly till Bajaj Auto revved up and Hero Honda had the pricing advantage as motorcycles gained acceptance with the economy opening up and bringing more people into the job stream, and on improving road infrastructure. A young population also contributed to its success. Yet the company, which symbolizes the aspiration of India’s youth, could not think of any other use of its cash. Hero Honda could very soon find itself in a similar situation that confronts HUL and Nestle: saturation of the urban market and a high volume low margin rural market. HUL and Nestle are wooing this segement by launching low-priced sachets, Hero Honda, in contrast, would have to keep on churning higher-end replacement models to grow. The market’s obsession with dividend yield could be another reason for the race to outdo competitors in making huge payouts. As long as institutional investors prefer to remain silent and do not question companies on deployment of their cash in more productive avenues, the trend to please the market with high dividend will continue. Till that time, investors can make merry as the sun shines.

State of the health

Recession or recovery, drought or normal monsoon, India has to live with inflation

The certificate of health given to the Indian economy by Standard & Poor’s was the trigger the market was waiting for to spring back into action. What were tentative moves, influenced by the woes of the European economy and the still weak US economy, into the trading ring after the presentation of the Union Budget 2010-11 have become bolder forays. The budget represents an opportunity to the government to translate its vision into concrete ground level action. Yet, the scope is restricted, mindful of the fiscal imbalance that could be the spin-off of going overboard: inflation, drying of investment, and decline in revenue. In India, along with the budget, foreign investors also watch policies on foreign direct and portfolio investment. Achieving a semblance of stability in managing conflicting interests is considered a feat that needs to be acknowledged. Political stability, efforts to pull back fiscal deficit, important reforms to be initiated in direct and indirect tax codes, restoration of foreign capital inflow, a range-bound currency, kicking off of PSU divestment and 3G spectrum auction, and hints of opening the financial services sector probably satisfied S&P that India is on the right course of inclusive growth. The market has responded to the rating agency’s approval with vigor, unmindful of the rising inflation and indications that the Reserve Bank of India may have to clamp down on money supply sooner than later. A few days after S&P upgraded India’s rating, the RBI raised the repo and the reverse repo rates at which it lends and borrows short-term funds. The central bank’s hesitant moves arise from the crossroads facing Indian markets.

On one side is the promising growth story set to take the markets to new heights. On the other is the accompanying inflation, fuelled by external and internal factors. Earlier, crude oil was a major contributor. The irony is that despite consumption growing manifold on the expansion of the automobile, aviation and petroleum-based product sectors, rise in prices of oil is being absorbed by the economy much better than when the economy was closed. This is despite the government subsidising the usage of petroleum products by urban and rural poor. The answer lies in the increasing prosperity of rural areas, stemming from the minimum support prices for food grains. It is a vicious circle: government supports prices during scanty rainfall to help farmers and also during bumper crop to put a floor to declining prices. The resultant demand from rural areas spurs companies to compete for capital as well as for commodities and capital goods to undertake expansion. Consequently, India is faced with a perpetual problem of inflation as surplus cash finds its way to automobiles, consumer goods and real estate, while infrastructure sectors have to scramble to raise funds. The spin-off is pressure on interest rates. Higher interest rates strengthen the rupee. The monetary authority, therefore, is always in conflict with market forces to tame money supply without capping growth. The banking sector captures the dilemma of the policy makers of meeting liquidity requirement without creating asset bubbles.

Emerging sectors like telecom and aviation are as likely to ground India’s flight as can credit crunch in the infrastructure sectors. Frequent changes in rules and delays in taking decisions have been a bane of the telecom sector just as restrictive guidelines on foreign investment and volatility in aviation turbine fuel have been for the aviation sector. It is important that the two poster boys of reforms remain in good health. The aviation sector is only now emerging from the cutthroat competition even as the telecom sector is in the midst of a shakeout. Transparent allocation of 3G spectrum is vital for its healthy growth just as easing the crushing taxes on ATF. The government’s procrastination and opaqueness in the initial round of bids when mobile telephony was introduced, stemmed partly from the desperation to bridge fiscal deficit, ballooning from subsidisation of the festiliser and petroleum product sectors. Implementation of the Kirit Parikh Committee report on the deregulation of the petroleum sector will temper the need to take recourse to other channels like telecom auctions with stiffling norms and high-priced divestment to make up for the diversion of resources to socially sensitive sectors. But for these compulsions, there would not have been the need to experiment with the French auction method in the sale of shares of NTPC and REC with unsatisfactory results or stiff rules so as to perpetuate by default the control over the telecom market of the top three to four players by virtue of bagging 3G spectrum for all circles.