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