The big bang reform

Growth will hinge on the policy to sell natural resources rather than merely opening up the economy to more FDI


By Mohan Sule

Is more foreign direct investment the only solution to place India in the 9% growth orbit? Not only Indian commentators but even US President Barak Obama has weighed in on this subject. Opening the Indian economy further will bring in the much-needed capital and technology required to match the pace of supply with the growing demand, so goes the reasoning. Infrastructure has been replaced with multi-brand retail, banking and insurance as sectors that could trigger an explosive expansion of GDP. Opponents fear that this would hurt the indigenous industry and proponents cite the many benefits including better access to providers of goods and services. Yet looking at the experience of opening of the infrastructure sectors, it is doubtful if mere FDI is going to boost the economy. Telecom and power are two glaring examples that demonstrate that ultimately it is policies and regulations that would determine India’s growth and not only foreign capital. The telecom sector attracted plenty of FDI till the implosion of the second-generation spectrum allotment scam of 2008. Canceling of the licenses by the Supreme Court and a stiff base price prescribed by the goverment for a new auction on fears that anything less rigorous would invite more controversy have scared foreign investors already apprehensive of India’s red tape and endemic corruption. Thus, a sector that was a showcase of India’s growth potential has unwittingly become an example of what is wrong with India’s reform program.

The two-day blackout in the northern and eastern parts of the country has also shone a light on how Indian policy makers’ balancing act of keeping prices of essentials low so as not to affect the poor and at the same time inviting investment to increase output has failed to bridge the demand-supply imbalance. Investors who want to set up power generation plants not only have to grapple with pricing of the end service and recovery of dues but also contend with securing raw material. This strange situation is due to selective opening up of the supply chain to private investors. Production of coal is controlled by a public enterprise monopoly, while the last-mile connectivity is predominantly in the hands of state-owned distributors. India’s first experiment with FDI in the power generation sector, Enron, was grounded before it could start running, as it fought a two-pronged attack from NGOs accusing it of profiteering by pricing power more than the cost of production and also slamming it for likely damage to the environment. Posco could rank next to Enron to illustrate how political compulsions can derail sound policy decisions. Foreign investors can gauge the investment climate in the country when no less than the prime minister-in-waiting Rahul Gandhi descends into Orissa to anoint himself the representative of the ethnic tribes that were to be displaced by the South Korean steel maker. In fact, the inability of the government to pass a balanced land acquisition bill has done more to hurt FDI than its reluctance to open up the services sector.

The most famous battle for putting a price tag on commodities of late is over natural gas, with the government alleging that RIL is keeping output from its Krishna-Godavari block low and the company indicating that further investment at current pricing is unviable. This must indeed sound familiar to foreign investors in the power generation sector facing coal shortage due to Coal India’s inability to undertake more investment because of price control. In the telecom sector, the scenario is reverse. Very high spectrum prices will mean there will be few operators, depriving users the benefit of low prices that arise from competition. As long as the government was controlling the supply chain of essentials, it could afford to regulate pricing, taking the subsidy on its balance sheet. But the listing of some of the public sector suppliers of scarce resources has disrupted the cozy equation, with big investors voicing their frustration at the government’s interference with market forces. Even if the economy is opened further, foreign investors will come in only if they can make profit. This is possible if producers are given operational flexibility. The rush of players in the telecom sector despite competition spawning discount pricing was in anticipation of eventual selloffs to rivals. The banking sector, which is artificially being restrained (by putting a cap on voting rights) from achieving economies of scale, is in need of capital. Removing restrictions on mergers and acquisitions will turn these two sectors engines of growth. Hiking the sectoral FDI cap is not the answer to economic slowdown. For durability, the solution is releasing the entire value chain from pricing controls and allowing industry consolidation.

Mohan Sule

Keeping faith

Despite lack of reforms and looming drought, the market is not ready to write off the India Growth story


By Mohan Sule

  The contrast could not be more striking. Even as China, the euro-zone countries, and the US Federal Reserve are scrambling to get their economies back in shape by cutting interest rates, putting together a bailout package, and easing liquidity, the attention of the UPA-II government is focused on survival by writing off debt of states ruled by its mercurial allies, putting on hold reforms like FDI in multi-brand retail, or dithering over reducing fuel subsidy. So any hopes of restoration of our fiscal health, which would ease pressure on interest rates and spur investment, have been dashed. No wonder the Reserve Bank of India refused to relent last fortnight. In fact, the first thing that our new president did was to order an austerity drive in his mansion. Perhaps locking up the grounds and shifting to a more modest abode would produce better results. The staff could be dispatched to rural regions for 100 days of guaranteed employment. Pranabda’s symbolic act also illustrates that our policy makers have still not shed the mindset of the 60s era, when industries making profit were viewed with suspicion instead of being encouraged due to their potential to create jobs, stringent curbs were placed on foreign exchange usage to conserve reserves instead of boosting exports by providing a nurturing business environment, and crackdown on public distribution outlets was considered necessary to ensure availability instead of removing mandatory quotas. In fact, some of the quick-fix solutions have proved to be counterproductive. Increasing the minimum support prices for agriculturists every year irrespective of surplus or deficit benefits the FMCG and consumer durables players but incorporates inflation in food prices.

The story is similar in other sectors like energy and fuel. In the absence of freedom to price electricity, investment in power generation is not a lucrative proposition, resulting in chronic outages: The national grid in the north tripped for two consecutive days end of last month allegedly due to excess withdrawal by some states. Many industrial users have circumvented the shortages by spending on captive generation, thereby locking up investment in an activity that is not their core business. Private refiners prefer to export rather than sell to the domestic market at administered prices, leaving PSU oil marketing companies to take on the subsidy and thereby making no dent on usage. Policy makers who cut their teeth in the socialist era need to realise that the solution to shortages in not capping demand but permitting producers to sell at competitive prices, which would boost investment and supply. The issue of putting the country’s finances in order is assuming urgency in view of the famine conditions in four states: Maharashtra, Gujarat, Karnataka, and Andhra Pradesh. The chorus for drought relief will widen the fiscal deficit. The surge in prices of cotton, sugar, edible oils, coffee and rice could blunt the positive effect of cooling crude oil due to tapering of global demand. A prominent casualty will be the banking sector. Not only will paucity of kharif crop stem any softening of interest rates and thereby hurt banks’ treasury income, there will be pressure to write off farm loans or make available cheap credit to farmers.

Besides India will be importing inflation if it buys food grains from overseas, whose prices will reflect the fall in the country’s output. To make matters worse, even the US is bracing for drought, which has triggered increase in prices of corn and livestocks. The rising prosperity in the emerging markets as reflected in demand for protein-rich food was the main contributor to the worldwide spurt in food prices last year. Principal adviser to the Planning Commission Pronab Sen has said rate cuts are not the remedy for India’s growth slowdown. Weak confidence in the economy, and not a shortage of credit, is hurting growth. Many Indian companies are sitting on piles of cash. Some are borrowing cheaply from international markets. Right now the government should be facilitating companies to carry on capital expenditure. What is needed is a stable climate with no surprises. The bizarre happening at Suzuki’s Manesar facility in Haryana is a setback. Perhaps this could be the fallout of the current turmoil going on in the country due to slowdown in economy, resulting in dwindling job opportunities and cooling wages on one hand and heating inflation due to inadequate supply of essentials on the other. Social programs of the government have increased demand for goods and services. The silver lining is the market is holding steady. The BSE Sensex is up 12% in the first seven months of 2012. What it is waiting for is decisive action by the government to break out.

Mohan Sule

In a flux

Apart from economic and industry- and company-specific developments, the market is sensitive to policy makers

By Mohan Sule

Never before has the outlook been so uncertain. Integration with the global economy has boosted liquidity and valuations but also made the market vulnerable to volatility not restricted to domestic events. If the low interest rates in the developed world saw unprecedented foreign portfolio investment during the boom period of 2003-09, the global credit crunch, slow recovery of the US economy, and the fluctuations in the future of the euro zone have turned the market range-bound. The variables affecting stock movements have increased. Besides company-specific projections capable of impacting market performance, earning estimates based on economic growth calculations also contribute to the flux. Projection of hardening of interest rates prompt investors to reduce exposure to automobile and consumer durables stocks, while a depreciating rupee spells opportunities in export-related stocks. Capital goods stocks slip with a slowing economy, which proves to be a boon to the FMCG sector. This cycle has predictability in its occurrence and also the response. Heating up of the economy, as indicated by inflation, stock market indices, and commodity prices, is required to be cooled by ramping up the cost of money, tightening money injection, and even imposing some sort of barriers to control the entry of overseas capital.

The market second-guesses how the central bank would act. Yields on government securities goes up in anticipation and valuations of interest-rate sensitive stocks plateau off. Institutional investors hedge their positions by taking contra bets in the derivatives market to cushion any price weakness in the cash segment. Companies implementing capital expenditure plans suffer on signs of recession in the form of four consecutive quarters of falling growth. Increasingly, the role of central banks around the world has assumed critical importance in investors’ decision making. The Federal Reserve’s resolve to keep interest rates near static till 2014 signalled the timeframe for the US economy’s recovery. Recent rate cuts by the European Central Bank and China’s central bank were a reaction to the slowing global economy, evident from the fall in prices of copper and other commodities including crude oil. Another source of stress in India is budget making. Every year the market displays nervousness or excitement in the run-up, depending on its expectation. It is a mystery why the government has to wait for one year to make major policy announcements when the annual exercise should be restricted to recalibrating tax rates. Instead, the presidential speech can spell out the agenda for the ensuing session. Even the tax rate can be kept stable and uniform for a longer period. The Direct Taxes Code, requiring three-fourth votes for any alteration in rates instead of a simple majority necessary to pass the finance bill, and the Good and Services Tax would have achieved this feat.

Not only economic indicators, the market also factors in expected political developments. Investors display withdrawal symptoms if polls suggest election of a populist government. The expected win of a socialist candidate in France’s presidential election and left-of-the-center party in Greece caused a temporary liquidity freeze around the world. As if these routine disturbances do not make the already complex life of an investor more confusing, there is a new kind of uncertainty. It stems from abrupt changes in policies, applying brakes to the reform process, or reversing some of the entrenched decisions. The unexpected springing up of the General Anti-Avoidance Rule in the last budget and retrospective amendment in income tax laws on transfer of foreign companies’ Indian assets, rolling back 51% FDI in multibrand retail, and the Supreme Court’s decision to cancel 2G licences allotted in 2008 and the inability of the government to take a call on the base price for the 2G spectrum auction could be included in this category. Similarly, the eruption of the scandal involving about 20 banks in the US, Europe, Australia and Japan in rigging the London Inter-Bank Offer Rate used to borrow dollars for three months, threatens to shake up the foundation of the financial services industry, which has been recovering from government bailouts after the collapse of Lehman Brothers in September 2008. The most wrenching aspect is the alleged involvement of the British government, which wanted to keep interest rates low, in brining pressure on Bank of England. Increasingly, investors not only would have to be bothered about promoters diluting their stakes or equity but also the shift of ministers in the cabinet as was evident by the market’s spurt after the resignation of presidential candidate Pranab Mukherjee as finance minister.

Mohan Sule