The Satyam model

To stem erosion in shareholders’ wealth, the government should sell the FTIL group through the auction route

By Mohan Sule
The explosion of the Rs 5600-crore NSEL scam is a vindication of Sebi’s former chief C B Bhave’s tough stance against promoter Jignesh Shah’s proposal to start an equity exchange after launching a commodity futures bourse. Besides insisting on separating distributors’ commission from investors’ subscription, his crackdown on mutual funds’ unit-linked insurance products had antagonised powerful asset management companies as well as irked the Insurance Regulatory and Development Authority and was the trigger for the setting up of a super regulator by finance minister Pranab Mukherjee, apparently to coordinate between different regulating agencies and avoid a turf war. Denial of extension to him was the collateral damage of the ambition of an aide of the finance minister to see her close relative as the boss of UTI. A vacancy was created at the country’s oldest AMC by shifting the incumbent to the capital market regulator’s office, riding on the campaign launched against Bhave for his inaction in weeding out fake subscribers at subsidiary NSDL, when he was heading the NSE, instead of focusing on the faulty proportionate allotment mechanism applicable for distribution of IPO shares. The plan skidded, when the single largest shareholder of the government-sponsored mutual fund, T Rowe Price of the US, raised objection. The fourth largest mutual funds by assets remained headless for over two years till July this year. The moral of the story is that some of the outrages in the Indian financial world can be traced to political ties. Though MCX-SX got the green light after the promoter agreed to bring down his shareholding to 5% in a predetermined timeframe following a hard-fought legal battle, the truce was facilitated only after there was a change of guard at the finance ministry and Sebi.

The promoter of Saradha chit fund could profit from the pyramid scheme either because of complicity or indifference of local policy makers. The Sahara group promoter has built a diverse empire by offering small savings schemes to the informal sector clueless about the risk and returns correlation and benefiting from a nascent regulatory environment with limited reach and power, confusion between regulators over supervision of overlapping products, and the complex landscape in the politically important home state of Uttar Pradesh. Similary, Ramalinga Raju, the promoter of Satyam Computer Services, had become the face of Andhra Pradesh’s transformation from a agri- and marine-based economy to a hi-tech destination for domestic and foreign investors. His political reach cut across the aisle, enabling him to share a dais with former US president Bill Clinton during the latter’s visit to the state in 2000. While Raju was promptly arrested after his confessional statement to Sebi of having doctored his accounts for many years, Shah has blamed the professional management of the spot commodity exchange. Considering that flagship Financial Technologies India owned nearly the entire NSEL, the inference is that either he was sleeping at the wheel or did not know the difference between a spot and futures market. In fact, Shah’s was a classic derivatives strategy of hedging against both a bull and bear run by running a regulated exchange as an entrepreneurial showpiece and at the same time generating a spurious enterprise for high return.

This brings to the second realisation. The conflict between public interest and making profit is sharper in certain businesses. Stock exchanges, often cited in this context, cannot be run as non-profit organisations if they have to invest in offering seamless services and create a secure environment for trading. Yet, the for-profit objective is leading to consolidation among global exchanges, eliminating price competition. If they cannot be completely eradicated, it is essential to ensure that the damage due to scams is limited. Fast-tracking trial is one of the ways and so also freezing and liquidation of the assets of the manipulator. This may not be fair to the other stakeholders. Therefore, focus on consolidated results is an important lesson for investors. This will prompt closer scrunting of the symbiotic relations between group companies. For instance, flagship FTIL’s profit was being boosted by the illegal gains made by NSEL. To solve the problem of the troubled group, the Satyam rescue could be an ideal template. The government disbanded the board of directors and appointed a 10-member committee of eminent professionals to run the software services producer, hit by a Rs 7000-crore hole in the balance sheet. Later, the IT company was auctioned to the highest bidder. This is what should be done to the FTIL group to prevent further erosion in the wealth of the shareholders and also to discourage the formation of bubbles.



Pain postponed

Whether the continuance of liquidity pumping by the US Fed will boost India’s growth is debatable. But it will intensify inflation

By Mohan Sule

There are four inferences to be drawn from the US Federal Reserve’s decision to extend its bond-buying program by another month or till early next year. One is that the US recovery is fragile as inflation is still below target. Second, the buoyancy on Wall Street cannot be mistaken for bounce-back of the home economy. Third, neither the finance minister nor the Reserve Bank of India can take credit for the return of foreign investors as there has been a worldwide rally. Fourth, the recent low of the rupee (below 68 a US dollar) and stocks (below 18,000) could be taken as the threshold for the market’s plunge when the liquidity tapering is announced as the benchmark indices may have crossed new milestones and the rupee appreciated significantly in the meantime. The central bank might also be in a hurry to wind up its costly subsidization of dollar deposits. The easing of FDI caps in some sensitive sectors, which has the power to lend support to the rupee when the Fed actually starts pulling out from the market, will take more time to percolate. What would see an immediate impact would be withdrawal of power, fertilizer and diesel subsidies. This is unlikely till the general election scheduled early next year. So while Ben Bernanke is hoping for inflation to rise, which would indicate the US economy is sprouting green shoots, Raghuram Rajan wants inflation to be tamed even at the cost of growth. The Fed is continuing with loose money policy, while the Reserve Bank of India is making money costly.

On the positive side, the rupee depreciation has helped narrow trade deficit. On the flip side, wholesale inflation remains high. The joker in the pack is food inflation, which rose near about 19% per annum in the month. Rural welfare schemes and the food security legislation will mean that surplus money will chase food items up the value chain. The paradox is slowing manufacturing but higher prices of foodgrains. The central bank now faces the challenges of moderating food credit and at the same time pushing up non-food credit. Food credit surged from a negative growth in FY 2008 to 18.6% annual increase last fiscal, while non-food credit slumped from 23% year on increase to 14% annual expansion in this period. Any which way, inflation is sure to get a fillip. Besides, compulsive focus on non-food credit could worsen the bad loan situation of banks. Gross non-performing assets have risen by 1.12% points to 3.42 % in the five years to FY 2013. Most of it was contributed by the infrastructure sector. The RBI’s new boss wants to free bank branch expansion from controls. How many banks will bite when treasury income supports profitability and the current trend is to shrink balance sheets after being burnt by aggressive expansion in consumer financing? Spread-out in rural areas has great potential, particularly since the launch of the rural employment guarantee scheme. However, there could be political pressure to waive off loans on eve of elections. The central bank instead should have spelled out a roadmap for mergers and acquisitions in the banking sector, which would have led to consolidation and strengthen the ability to withstand global and local shocks.

esides a surge in inflation due to the continuance of Fed’s loose money policy and other welfare programs of the UPA-2 government, real estate also could see the formation of bubbles. The weak rupee has increased the cost of construction. At the same time property prices have become attractive to overseas buyers. This means increased inflows into luxury projects, which could be in the danger of a bust when the Fed goes back to conventional monetary policy making. Developers were luring domestic buyers hit by inflation with 20% upfront payment and deferring the balance till possession. The clampdown on bank financing to such schemes will squeeze cash-flow. A slump in real estate could be dangerous as seen from the widespread fallout of the crash in the sub-prime category in the US in 2008. A host of ancillary industries will face decline in demand. Banks with exposure to these sectors will see a spurt in delinquencies. This would have a ripple effect on the economy. The tightening of credit against gold jewellery too is mis-timed. Rural and poor urban folks used the scheme for liquidity, particularly during times of distress. The RBI, thus, has limited the flow of these funds into sectors such as housing, education and healthcare. The relaxation in dollar borrowings by corporates and banks is meaningless unless policy paralysis is shaken off. Capital-intensive infra, power and telecom sectors are not seeing capital expenditure due to policy and regulatory issues and not because of lack of demand. The bottom line is three months is a short time for India to get its act together.