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