Collateral damage

The drive to make the investment space safe has come at a price: marginalisation of retail investors by the issuers


By Mohan Sule

For all the hype about India’s growing middle class being the size of the entire population of the US, the Indian retail market is increasingly looking like a Rubik’s Cube: a tough nut to crack or easy to solve. Even as foreign multi-brand retailers, banks and insurers are lobbying hard to gain access, some of those who have set up shop are looking to exit. Take two recent examples. The Indian arm of Fidelity, US’s second largest mutual fund by assets, is scouting for buyers. Australian group ANZ, which quit India in 2000, reestablished a branch last year but British bank Barclays is pulling out of retail business to concentrate on corporate banking. Yet fast-food chains like McDonalds and Domino’s Pizza are rapidly gaining market share. All these investors are looking at the same middle-class market. Why is that some have been able to tap it while others have flopped? Two reasons are bandied about for this state of affairs. First is India’s boom is fuelled by consumption, at 58% of GDP compared with China’s 48%, rather than government and private sector investment. Demand for automobiles, food, education and travel are the manifestations. This is perplexing considering the domestic savings rate is about 25%, next only to that of China, which is being advised to boost consumption to level the lopsided growth fuelled by state investment and exports. This leads to the second proposition. Compared with real estate, gold or consumer goods, the financial services market is tightly regulated. Sebi’s preference is to create a secure environment even if it comes at the cost of risk-taking.

Ironically, capital market regulations were evolved to attract foreign investors, who wanted a transparent field. It is now becoming clear that the stricter rules have taken care of demand-side issues but not the concerns of suppliers. Compliance is increasing the expenses of intermediaries and issuers. Fidelity has reportedly complained of low entry load and asset management fees, an indictment of Sebi’s reintroduction of entry load as a flat upfront levy, discontinuing the earlier practice of embedding it as a proportion of the subscription amount. Similarly, foreign banks are hobbled by priority sector lending quotas and caps on branches. The Reserve Bank of India came out with a discussion paper on the roadmap for foreign banks early last year in view of India’s commitment to the World Trade Organisation to open up the sector. The recommendations are yet to be translated into policy. The recent freeing of savings rates means costlier retail deposits, the cheapest source of liquidity for banks. Disposing low margin business of retail lending makes sense for foreign banks cleaning their balance sheets and facing higher requirement of risk capital in their home countries following the collapse of Lehman Brothers in September 2008.

The Indian government does not seem to be perturbed by the sparse presence of foreign players in the retail financial services space. This could be for two reasons. First is the skepticism that foreign players share its goal of making banking accessible to all segments. Individual investors would be better off tapping the government’s high-cost borrowings served with the icing of tax deduction. Second could be the desire to ring-fence the small saver from any overseas contagion as well takeovers in the sector. The repercussion of this strategy is marginalisation of retail investors. Issuers are going overseas to raise resources not only for the depth of the subscription pool but also for cost-efficiency. Sebi recently permitted equity dilution through the wholesale route on the bourses to meet the minimum 25% public float requirement, eliminating lock-in of private placement and preferential allotments — a tacit admission that the retail base of investors is inadequate or dispensable. Diminishing chances of allotment in IPOs, increasingly dependent on applying at higher cutoffs and at maximum permissible limit, are also crowding out retail investors. The zero long-term capital gain tax has not emboldened small investors to build up an equity portfolio. Instead there is spurt in day trading as the investment outlook has shortened, with the markets plugged into global bourses. International events rather that domestic happenings influence the benchmark indices. The tortuous euro-zone bailout negotiations have the capability of shaping sentiments. The Supreme Court’s decision to cancel 122 2G telecom licences issued during the second round of spectrum sale had no impact on market movements. Inflows hinge on arbitrage opportunities created by volatility in local currency or interest rates rather than the long-term view of the economy.

Mohan Sule