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