The Indian way

The sovereign wealth fund should comprise investments of retail investors to spread the benefit of foreign inflows

By Mohan Sule

Many bogus reasons have been put forward against India setting up a sovereign wealth fund. These funds, goes one argument, are typical of autocrats such as the UAE and Kuwait. Yes, the US, Australia and Japan do not seem interested but Norway and Singapore, both democracies, though the latter a benign dictatorship, have their own funds. Exporters of natural resources such as Saudi Arabia and Russia, it is pointed out, use sovereign funds to manage their wealth. Yet Venezuela is still to enter the fray. Countries with a current account deficit, where foreign exchange inflows through exports, services and remittances are lower than outflows through imports, should keep away. This has not prevented Brazil from establishing one. May be India can prove to be another successful exception. It is not the government’s job to maximize wealth through portfolio investment, goes another conventional wisdom, nor should it be in the business of acquiring companies. Instead, countries should use their cash surpluses to build social infrastructure or leverage them to cut taxes to boost productivity. The problem is India cannot be conveniently compartmentalized. Similar to developed countries, its economy is manufacturing and knowledge based. At the same time, there is a large public sector, whose objective is to create jobs as well as to ensure equitable distribution of resources at fair or even subsidized prices. Just like other emerging economies, it attracts foreign capital flows but, unlike many of them, is dependent on import of commodities and is not export oriented. Like China, the domestic market is a magnet for overseas investors but, in contrast to the Communist giant, the foreign investment is not sufficient to blunt the energy-import bill. With characteristics of both the developed and emerging markets, India is uniquely placed. Rather than splitting hair over if it should have a sovereign fund, the need is to debate how the fund should function.

China’s plentiful reservoir of foreign exchange eliminates the need for better returns as long as it keeps the yuan undervalued for export competitiveness. More than high prices, it is worried about disruption in supplies of commodities. As a result, its sovereign wealth fund’s overreaching objective seems to be to snap up mines and oilfields for domestic consumption rather than to make profit from them. India, on the other hand, is trying to make its public sector market oriented by divesting government stake and use the proceeds for welfare programs. It is getting out of many core sectors in favor of the private sector, opting for royalty sharing. The country is betting on nuclear energy to reduce dependence on oil for energy needs. As such there is no need for the sovereign fund to buy assets abroad to secure commodity needs, which can be done by private companies or even public sector enterprises like ONGC Videsh. Hence, India’s sovereign fund will need to have a goal that is different from that of other countries. It could be a mix of buying stakes in overseas companies directly or through the stock markets, using the derivatives market to hedge against commodity price fluctuations, or diversifying the country’s asset base by investing in governments bonds and real estate abroad.

In a marked departure, India’s sovereign fund should be based on retail subscription by selling dollar-denominated units. The Indian currency mopped up can be used to sterilize foreign capital, which otherwise the Reserve Bank of India buys to keep the rupee from appreciating, but triggering inflation in the process. The benefits of foreign investment, therefore, would be spread across investors rather than remaining confined to a set of stocks or companies. Like in the primary market, the ceiling for subscription should be Rs 2 lakh to ensure a diversified base. The fund can combine the features of close- and open-ended schemes, with a 10-year lock-in from the date of subscription, which would always be open. The investment mix can comprise local and overseas bonds, equity and other assets. In fact, the sovereign wealth fund could also bid for PSU divestment stake or distressed assets abroad, hold them and dispose them to local investors later. The government may retain the call option to buy back units once the assets have generated returns above inflation or distribute dividends to those who prefer to continue till maturity, when units could be redeemed at net asset value. A sovereign wealth asset management company with professional fund managers would be a better option to the central bank. India, thus, can show the world how to harness its huge human resources and, in the process, spread wealth to investors rather than the government treasury being the sole beneficiary.

Mohan Sule

Towards transparency

To insulate from government interference, chiefs of regulatory bodies need to be confirmed by parliamentary committees

By Mohan Sule

Even as India was riveted by the tug-of-war in the political capital between the government and anticorruption crusaders over creating a watchdog to monitor those in places high and low, another equally riveting drama continued to unfold with its twists and turns in the financial capital. The first act began as the three-year tenure of the then Securities and Exchange Board of India chairman, C B Bhave, was winding up. A whisper campaign referred to his stint at the National Securities Depository, one of the two repositories of investors’ demat shares. Hundreds of fake demat accounts were discovered in June 2005 to overcome the proportionate allotment system: more the number of shares applied for, higher the chances of allotment. Another obstacle for some retail investors was the Rs 1-lakh ceiling, now raised to Rs 2 lakh, on investment in the primary market. Nonetheless, the then finance minister, P Chidamabaram, sought out the NSDL boss to head the capital market regulator early 2008. Bhave went on to lead Sebi for the next three years with aplomb, executing many investor-friendly reforms. A year prior to the expiry of his tenure, the new finance minister, Pranab Mukherjee, even proposed extending his term for another two years in accordance with the new norm of granting a five-year course to chiefs of autonomous bodies. Suddenly, well into his last year, allegations about Bhave’s role, though he had recused himself from the decision, in suppressing a Sebi probe into NSDL sprung up.

In the meantime, the Sebi chief got into a spat with insurance companies for selling unit-linked insurance plans, or Ulips, with characteristics similar to mutual fund products, antagonised the mutual fund industry by banning commission to distributors disguised as entry loads, invited the ire of the ambitious promoters of commodity exchange MCX by exposing their plan to start an equity trading bourse without sticking to ownership parameters, and brought big players such as RIL, the ADAG and the Sahara group under the regulatory scanner. Eventually, the finance minister announced the appointment of a super financial regulator under his chair whose apparent purpose is to coordinate between the various regulators such as the Reserve Bank of India, the Insurance Regulatory Development Authority of India and Sebi to avoid turf wars. Initially, the antipathy towards Bhave did seem a genuine outlet of outrage against the double standards adopted by Sebi in dealing with an entity, which was headed by him earlier, and other market players and issuers. At the same time, events unfolding at UTI, whose boss was the replacement for the departing Bhave at Sebi, necessitated fresh examination of the timing and motivation of the campaign against Bhave. T Rowe Pice, the single largest shareholder of UTI, complained that a finance ministry bureaucrat was holding up the appointment of its nominee to head the mutual fund in favour of a relative. The same official had blithely retorted to the finance minister a year ago that it was too early to consider the proposal to extend Bhave’s term. Subsequently, one of the retiring members of Sebi has accused the finance ministry of interference and harassment through tax evasion investigation.

One of the major acts of the new Sebi boss was to bring back the entry load as a flat fee of Rs 150 for investment above Rs 10000 per scheme. An upfront fee is a better option than charges embedded in the subscription. Yet, it raises questions. Will this amount, constituting 1.5% of the eligible threshold, incentivise distributors to sell products for a lower subscription? The fee will be negligible for higher investments, implying that the structure will benefit high networth investors. The new takeover code too seems to be sensitive to promoters’ concern of lack of bank finances for takeovers by raising the minimum open offer size by a marginal six percentage points rather than addressing the anxiety of the minority shareholders of getting stuck in an illiquid counter. Meanwhile, the banking industry is set to be opened to industry houses despite protest from the RBI governor. At a time when accountability of lawmakers and law dispensers is occupying center stage, it seems appropriate to review the process of selecting heads of regulatory bodies. The government’s appointments need to be ratified by a parliamentary committee through televised hearings to allow the nation to understand their guiding philosophy. This way, they would derive power from the people and do what is right for the people whose interests they are supposed to safeguard. Also, it would avoid energy-sapping controversies like those that dogged Bhave as these could be dealt with during the confirmation hearings so that the incumbent is free to carry out his responsibilities, unburdened by past calls.

Mohan Sule