Short circuit

Rajat Gupta’s shortsightedness and the UPA government’s short-term policies are remarkable for their destructive power

Mohan Sule

The fall of Rajat Gupta in the insider trading scandal in the US can be viewed as a proxy for the India Growth Story: euphoria followed by disappointment. Gupta was the first-generation immigrant who vaulted to the top of Corporate America on merit. This was what the new Shinning India was all about: education and hard work were the capital to invest in the opportunities thrown open as licence raj was dismantled. Instead, the reforms consolidated the position of the entrenched conglomerates as sectors monopolized by the public sector were transferred to the private sector oligarchs with ties to the ruling party or to those entrepreneurs willing to pay a premium. Telecom, aviation and mining, the three showcases of reforms, abound with tales of rules bent to create a distorted playing field. The problem stems from Indian policymakers’ reluctance to let go the barter system and cling to the constituency of a welfare state, sitting at odds with the idea of individual initiative to become wealthy where the field is leveled for all. Despite intellect, and not legacy, being solely responsible for his success, Gupta could not differentiate between gossip and leaking sensitive information to a hedge fund manager. It would be easy to attribute the downward revision in India’s growth to about 7% from 9% for the current fiscal to the euro-zone debt crisis and the slow recovery of the US and Gupta’s woes to a cultural clash in ethics and values. In the end it all boils down to wrong calls of judgment.

Wrong calls on restricting bidders to circles and categorizing them on technology  sowed the seeds to the scandal that saw the corruption of the second round of sale of second-generation telecom spectrum. The underselling exposed the worst-kept secret of policy making in India: the minister-bureaucrat-corporate sector nexus. As a result, first-generation entrepreneurs have to adopt unconventional means to gate-crash into the exclusive group. Top this with inordinate delays in clearing projects such as Vedanata’s acquistion of  UK-based Cairn’s stake in its Indian joint venture to explore oil and gas or South Korean Posco’s desire to mine bauxite in Orissa. Even when bills are introduced to bring clarity to issues such as acquiring land for infrastructure projects or awarding mining rights, the laws are biased against the investors. With elections happening in some corner or the other round the year, most legislations are written either with timidity or brazenly to woo a chunk of the voters. The out-of-control rise in prices is another spoiler. Initially, liquidity caused by foreign portfolio investment was held responsible. There was even talk of imposing capital controls or levying a withholding tax as done by some other emerging economies in South-East Asia and Latin America. Later, the flow of foreign investment into the stock markets slowed down due to the sovereign debt crisis in Europe but headline inflation showed no signs of receding. It was then realized that surging food prices was the primary contributor. An expanding middle class and those lifted above poverty by the rural employment schemes were fuelling consumption of food items and boosting their prices.

A good southwest monsoon was expected to cool down foodgrains on higher output. Instead of a resolution, the problem has got compounded. The minimum support prices were increased recently to insulate farmers from the anticipated downturn in prices. In the meanwhile, the Reserve Bank of India has ramped up interest rates 13 times in 19 months, further hurting manufacturers already battling costly raw materials. The bottom line is prices remain untamed in spite of higher interest rates and slowdown in foreign capital inflow. The spurt in the wholesale price index caused by protein-rich diet and that by dollars chasing assets have to be viewed as separate events requiring different treatment. Yet the central bank has adopted a one-size-fits-all strategy. Making the RBI’s job more difficult is the government’s borrowings to fund social welfare programs on the eve of a clutch of crucial elections. Thus, instead of becoming the center of gravity by leading the recovery of global economy with structural reforms to make investment in infrastructure projects attractive, undertaking prudent fiscal measures to keep inflation under check, and speeding up PSU divestment, policies tailored for a limited purpose — establishing footprints in the Uttar Pradesh election to pave the way for the fourth generation of the Gandhi family to rule India — have short-circuited India’s Growth Story just as Gupta’s alleged desire to gain a quick entry into the millionaires’ club destroyed his reputation built over years of hard work and brilliance.

Mohan Sule

Where does the buck stop?

 

Ask what you can do for Air India and SBI, the government seems to be telling taxpayers

By Mohan Sule 

 

The protesters occupying the streets housing financial institutions and stock exchanges in the US and Europe are united in their disgust at corporate greed but not on how to wean away companies from their gluttony. Their anger seems to be directed at the bailout of too-big-too-fail corporations with taxpayers’ money. Arguments that doing nothing would have had a contagion effect, sweeping away other stakeholders including minority shareholders, clients, suppliers and employees with exposure to the failed institutions, do not appear to have made much of an impression. Many of these once-tottering empires have started making profit and returned government funds but their turnaround has had no impact on job creation. Instead of bringing growth back on track, the chain of events has resulted in economic slowdown. No wonder the rich countries of the euro zone are reluctant to foot the bill of the spendthrift members who have taken on too much debt to make their present comfortable at the expense of their future. The events of the past three years, therefore, have put a question mark over government intervention. A company gets another chance only if the opportunity is used to clean up the balance sheet. This means its shape and size are altered as divisions are hived off and employee strength trimmed. Allowing companies to collapse, viewing their extinction as a natural process of evolution, is a gamble. The hands-off approach to Lehman Brothers resulted in a credit crunch and meltdown of equities around the world.

The bailout of state-owned UTI in 2001 has been a turning point in the Indian government’s approach to sick companies. The quick intervention by pumping liquidity through government bonds prevented the domino effect from spreading to the stock markets. The bull-run that followed helped the mutual fund to repay the government. Since then, the landscape has changed drastically. The government has become proactive. Mergers and acquisitions have been reckoned as an important solution to the problem and not obstructed as happened in 1983, when NRI Swraj Paul tried to take over Escorts, whose assets were not producing the desired returns to the shareholders. A government-appointed committee shepherded Satyam Computer Services, felled by an accounting fraud by the promoters, through the auctioning process. Financial institutions encourage corporate restructuring instead of turning their back on the borrowers. This is in contrast to the pre-reforms era. It was common to stretch the death pangs of sick units by referring them to the Board for Industrial and Financial Reconstruction. Mumbai’s textile mills were allowed to wilt under a prolonged labor agitation. At the other extreme, government took over companies considered vital for the economy or simply because they were found to be profiting from the demand-supply mismatch. Overnight in 1969, 14 privately owned banks were forcibly converted into public sector. Air India, the international airline started by JRD Tata in 1948, was nationalised in 1953.

Now, these two showcases of socialism are in a state of disrepair. Air India is on the verge of bankruptcy. Lack of powers to take market-oriented decisions, dip in passengers following 9/11 in 2001 and meltdown of financial markets in 2008-2009, and rising fuel prices have resulted in losses. The merger with Indian Airlines in March 2007 to create a single entity for operational efficiency has not met with success. It is facing debt of Rs 67000 crore and seeking equity capital of nearly Rs 49000 crore as against Rs 2000 crore pumped in so far. Dithering over an IPO, first planned in 2005, to bring in additional capital has proved costly. A complete sell-off or partial divestment to Indian or foreign investors could give it a chance to recuperate. This looks unlikely considering the paralysis in decision making at the Centre. The condition of SBI is not as serious but the situation is more complex as it is listed. Being majority owned by the government, the bank’s priority is fulfilling social obligations. No wonder, it has to increase its provisioning for bad loans, as per the recent Reserve Bank of India directive. In view of the stock’s plunge to 52-week low, the Rs 23000-crore rights issue to meet its tier I requirement looks remote in the short term. Instead, the government would be infusing around Rs 10000 crore. Unless it pads up its capital, around 7.5% of the assets now, the proxy for the Indian economy won’t be able to grow its loan portfolio. Indeed, a sad commentary on India’s ambition to expand 9% per annum over the next decade. It would be instructive to know what the Wall Street Occupiers would have to say of the government using taxpayers’ money to bail out taxpayer-owned companies mismanaged by it.

Mohan Sule

Primary issue

Institutional and private equity investors should be made to act as filters before IPOs are offloaded to retail investors

By Mohan Sule

Though the market has recovered after dipping below 16,000, the need to revive investors’ confidence in equities has never been more urgent than now. After Lehman Brothers was allowed to collapse, there was unanimity among central banks and governments around the world about the dangers of letting the markets drift to the bottom and then wait till they bounce back on their own. There was no appetite for a repeat of the decade-long Great Depression of the 1930s, or Japan’s lost decade of the 1990s. The composition of the current crisis differs from that in 2008, when a credit-crunch threatened to stall the economy. Central banks had to pump in cash to keep the wheels of industry moving. Second, inflation was low, which allowed leeway for printing more money. This time, emerging economies are concerned about too much of liquidity stoking inflation and are prepared to sacrifice growth to tame price indices. In the US, the Federal Reserve is swapping short-term government bonds with longer dated ones to replace short-term pessimism with optimism about future. The increase in bad assets of banks in China and India, as the downgrading of SBI implies, also discounts loose-money policy. The bottom line is risk aversion rather than access to loans is the issue now.  Fiscal stimulus, initiated soon after the global meltdown three years ago, may compound inflation. Governments, therefore, are looking at other means. For instance, the Indian government has indicated reduction in stock-market transaction levies. The market has welcomed the move.

The finance ministry needs to go one step further and bring down the short-term capital gain (STCG) tax to 10% in the limited window of opportunity available in the run-up to the Direct Taxes Code, with peak STCG tax at 30%, to be implemented from the next fiscal. Besides short-term measures, it should also overhaul the capital-raising framework. Sebi initiated many reforms during the dull phase a decade ago, while preparing the market for better days that followed from 2003. In 1999-2000, procedures for the participation of foreign institutional investors (FIIs) in the primary and secondary markets were eased. By 2003, the number of FIIs exceeded 500, with over 1,500 sub-accounts. Due to FII interest, the Rs 100-billion ONGC IPO in March 2004 was oversubscribed in 10 minutes. T+5 rolling settlement was introduced in 2000 for dematerialised scrips and was expanded to cover more stocks with the facility of automated lending and borrowing mechanism or modified carry-forward system in any stock exchange. Trading in futures contracts based on the BSE’s Sensex and S&PCNX’s Nifty index began in June 2000. Norms for private placement were tightened in 2003 to provide for more disclosures. At the same time, there were missteps. At the height of the dot-com boom in 1999-2000, Sebi allowed tech companies  to offload only 10% post-IPO share capital instead of 25% mandatory for issuers in other sectors in an attempt to revive the primary market. This blatant pandering to the fancy for tech stocks eventually boomeranged with investors getting stuck in illiquid counters as software companies are not capital guzzlers.

Similarly, the response to offer individual investors, who have 5o% quota, shares at a price determined through book building has ranged from lukewarm to overwhelming. The procedure allows issuers and FIIs to create appetite for high-priced offerings. The spinoff is post-listing stampede for exit. At the same time, there is no interest in issues without substantial institutional participation. With the deepening of the investor pool, issuers prefer private placement with institutional investors rather than go through book building to mop up the mandatory retail subscription. The result is the entry of small-sized issues shunned by big investors. The present volatile times, therefore, are appropriate to review the primary market. The initial focus of reforms should be on small and mid caps, which have the maximum scope for appreciation and mischief. These issuers should be made to place their IPO/FPO with domestic and foreign funds, who should offload the capital to retail investors after three years. Only venture capitalists should be allowed to offer for sale shares of startups. By inserting the filter of institutional investors, Sebi would ensure that only equity checked for quality would be available in the market. After obtaining a stock at reasonable pricing, institutional investors would be compelled to monitor the company to create long-term value instead of thinking of making short-term gains. Issuers would be spared of catering to retail investors out of compulsion rather than choice. Thus, issuers as well as institutional and retail investors stand to benefit.

Mohan Sule