Voting with their feet

Aversion of foreign funds to India’s corruption indicates growth can no longer be the only criterion for stock picking

The market knows best. Does it? Following the meltdown in the developed markets in 2008-09, foreign institutional investors chased Indian paper because of better returns and, in the process, boosted the market near to its 2008 peak of 21,000. Yet, these investors are now withdrawing despite higher yields and prospects of about 8% growth in the medium term. The market has already touched 17,300 and how much lower it can go to hit the floor is still open to debate. In fact, India has emerged as one of the worst performing markets among emerging countries. What has changed? Many foreign funds want to be early birds to catch the recovery in the home markets. This should result in a gradual exit to book profit at higher levels than cause an exodus. Second, foreign investors are distinguishing between ‘good’ inflation and ‘bad’ inflation. A growing economy’s capacity constraints and infusion of investment unleash inflationary pressures. Inflation, however, becomes a source of concern for investors when there is no immediate solution to restore disrupted food supply chains. Subsidies to tackle food inflation, a result of expanding demand and shortages due to droughts and floods, cannot repair the situation immediately. Ramping up interest rates, ironically, can cause more pain than do any good. Third, governance has become a buzzword. Investors have experienced the repercussions of reckless behavior and loose oversights in the financial markets in the developed countries. If inability to be masters of their own destiny is infuriating populations of the Middle East, the price for reforms is disturbing investors in India. The rule of thumb is stifling regulations breed corruption and liberalisation nips it.

The end of licensing in many traditional sectors has eliminated the hidden cost of doing business in India. Instead, the emerging sectors, the showcases of a developing economy, have opened a new window of opportunity. The evolving nature of the industry has presented opportunities to profit not only for investors but also for policy makers and bureaucrats in framing and implementing guidelines and companies willing to bend rules for entry or gain in market shares. The second- generation telecoms spectrum allotment scam is the most striking example. Emerging markets including China have never been the objects of affection for their transperancy. The attraction was their growth potential. What mattered so far was a company’s consistency in churning out profit, cash reserves, accessibility of management, investor-friendly corporate actions, promoter holding and may be the quality of independent directors. Knowing the importance attached by foreign investors to these issues, governments keen on attracting capital hastened to set up strong regulators and revamped trading infrastructure to instill confidence in the sanctity of the markets. Despite all these efforts, if foreign investors so far exclusively focused on internal management — complying with listing agreement, avoiding the regulator’s or the stock exchange’s wrath, and not destroying shareholder wealth by stupid actions like assigning shares to promoters at ridiculously low value or the promoters pledging their shares to raise debt — are also paying attention to external management to base their investment decision, then it is indeed a seismic shift.

Of late, carbon-emission credit has emerged as a big business opportunity as well as a demonstration of the company’s sensitivity to the environment in conducting business. Now, there is one more checklist: corporate social responsibility. The problems faced by Tata Motors in Singur, West Bengal, investors in special economic zones, and Vedanta Industries and Posco of South Korea in acquiring land from local inhabitants in Orissa signalled the need for an equation between the company’s objective of maximising shareholder wealth and responsibility to the society. The government has now mandated mining companies to share 26% of their profit with those displaced by their projects and wants all companies to assign a minimum 2% of their net profit for corporate social responsibility. PSUs are already doing this in varying degrees based on their net profit. Hitherto, political and country risks stemmed from volatility due to change in government or stability of the regime. Going by the sudden reversal of fortunes of the business cronies of the son of Egypt’s former president Hosni Mubarak, investors have to take into account the changing proximity of the promoters with the ruling clique or the likely adverse effect of abrupt change in government or its attitude. For investors, this is one more element to factor in a stock’s price. The bear cartel that Anil Ambani believes had hammered his group’s stocks early February perhaps had discounted this possibility.

Mohan Sule

Hoping for a repeat

Lower fiscal deficit next year hinges on buoyant markets to boost tax receipts as in this year. Will oil and food prices cooperate?

Union Budget 2011-12 had the trappings of a government under siege: crumbs for the section (urban elite) agitated over the various scams and focus on those (urban and rural poor) amenable to be wooed. Sparing cigarettes, automobiles and liquor from additional excise burden is seeped with ambiguity. Was this an oversight or the realisation that any increase would prove counterproductive by puncturing the buoyancy in taxes from these sectors? At the same time, the budget has expanded the service tax list to include restaurants serving liquor and raised it on domestic and international air travel. The flip side of lowering the age to qualify for the senior citizen tag to 60 years is the ramp-up of dividend distribution tax for corporate subscribers of debt mutual funds to 30%, thereby closing an avenue that could provide higher post-tax returns than bank FDs. Similarly, increasing the personal tax exemption limit to Rs 5 lakh for those above 80 years has been balanced by bringing AC hospitals with over 25 beds and pathology labs under the service tax net. The budget has gone all out to court the rural population, which is not bad. Due to the thrust on inclusive growth, the market is now hooked on to the rural story. The effort is to improve lending to farmers and reward those who pay their loans early. Housing finance companies, which will get 1% subsidy for low-cost loans, will be cushioned for mortgage risks. Could this be on fears of an impending sub-prime mortgage crisis? NREGS wages will be linked to the Consumer Price Index. Did not the prime minister days ahead of the budget reject the appeal for minimum wages by Congress president Sonia Gandhi, who also managed to fast-track another of her pet project, food security? The prime minister could perhaps attribute this on the compulsions of being a CEO of a promoter-run company just as he blamed the 2G telecom licensing scam on the compulsions of coalition politics!

Funding warehousing is long-term solutions for availability of food and does not address the current demand-supply imbalance, which could increase in the near term with the blanket of food security: 25 kg of food grains at Rs 3 per kg for every family below poverty line. A taskforce has been formed to determine how to hand cash to the poor to buy kerosene and LPG. This indicates the government may take the fuel subsidy on its balance sheet instead of passing it on to OMCs. The obsession with infrastructure continues: more tax-savings bonds to mop up Rs 30000 crore. The problem here is not of funds but speedy decision-making in awarding contracts. The budget’s solution to overcome this obstacle is public-private partnership. Before becoming too optimistic, it is necessary to audit existing ventures. Banks have got lots of attention: the government wants the Reserve Bank of India to give more licences even as PSU banks are being subjected to a massive infusion aggregating to over Rs 30000 crore. There was public disagreement on new licences between the central bank and the Centre after the presentation of the last budget. The RBI came out with a discussion paper in August 2010, nonetheless. What has been its conclusions based on the feedback?

The knee-jerk market rally in response to, among other things, reduction of corporate surcharge to 5% from 7.5%, and permitting foreign arms of Indian companies to send back money in the form of dividend taxed at 15% rather than income, taxed at 33.33%, petered out even before the market closed for trading, realising that this is not a budget of a confident emerging economy. Increasing the limit on investment by foreign institutional investors (FIIs) in corporate infrastructure bonds is perhaps to stem their flight by luring them with high yields rather than growth in equity returns. There is a hint that FDI in insurance may be relaxed but silence on FDI in retail except for a bland promise to ease procedures for all foreign investors. The budget apparently is relying on consumption to fuel growth than taking care of supply-side worries. The government seems to feel it can do a better job of erasing concerns of foreign individual investors, who would be allowed to invest in equity through mutual funds, about high interest rates and corruption than convincing FIIs. If the reduction in fiscal deficit this year is on the back of 3G auctions, a one-time income, besides higher tax collection arising from a bullish market in 2010, the lower targets for the next two years could be on the assumption that penalty collection from out-of-turn 2G licensees, Rs 50000 crore from PSU divestment and the widened service tax net would supplement the current buoyant tax revenue to meet most of the expenditure. This hinges on the bounce-back of the equity market, which would be sustained if the government keeps its market borrowings under check and tackles inflation. It now remains to be seen if oil and food prices are willing to go along.