Animal spirits caged

Small investors denied opportunity to access investment that could outperform the market
By Mohan Sule

The recent decision of the Securities and Exchange Board of India to allow small and medium enterprises to trade on a specialized platform without an IPO is another attempt to open up the capital market to these firms. Initial backers such as financial institutions, banks, private equity investors and venture capitalists will be able to exit with gain for the risk taken. Many SMEs could be with a scalable model in urgent need of funds but unable to fulfill the listing requirement. Listing may be the path to grow big for some of them, which otherwise would languish for want of capital. In a public offering, the market assigns a value based on track record and outlook of the company. Investment bankers fix a price range after taking into account the views of big-ticket investors. The issue either gets an overwhelming response or flops, depending on the subscribers' perception of the valuation. The listing could be at a premium if there is unmet demand or at a discount if the high valuation has drawn lukewarm response. Of late, this process has been corrupted, with some investors using the mechanism to make quick gains by getting out after the shares debut on the bourses. Thereafter, the stock is left languishing, waiting for some trigger from the company. Overpriced offerings to capitalize on the bullish sentiments, too, have spoilt the market with their subsequent dismal performance. Nonetheless, the baptism is essential to test the staying power of companies. By skipping this vetting process of the market and restricting access only to informed investors with minimum investment of Rs 10 lakh, Sebi has made public its lack of confidence in SMEs’ corporate governance practices and in the process denied small investors a chance to partake in the India growth story. For retail investors, these stocks could have been good alternatives to expensive large caps, a chance to diversify their portfolio, and an opportunity to outperform the broad market. In turn, access to the small investors would have unleashed the animal spirits of these firms. Thus, the listing of SMEs in the present format in essence is a private placement.

The other important issue is the quantum of shares available for trading. Without an IPO, the inference is there will be no dilution of equity. Either the promoters will be offering part of their holdings or the lenders and the backers their stake. The small number of shares available might make the stock illiquid, putting off the high networth investors that Sebi hopes will be attracted to these firms. The last time the market regulator tweaked the rules for listing was to allow tech companies to offer only 10% of their equity capital to public. The aim was to ride the popularity of these companies, which had caught the fancy of the developed markets for outsourcing their back-office work to cut on costs, to boost the languishing primary market following the dot-com-bust-induced global recession at the turn of the century. Many startups from the IT sector did list. The unintended fallout was the stampade among several small caps from the old economy to switch to offering software solutions to latch on to the boom. Some others changed their names to appear as tech companies though they had nothing to do with the sector. Besides, the small number of outstanding shares made price discovery difficult. Instead of providing a lifeline to the primary market, the half-baked measure caused immense harm to investors. The sharp spurt in IPOs eventually sputtered out under the weight of dubious offerings. This market revived only after the secondary market kicked back into life mid 2003.

SMEs are an important component of any economy. Due to their low level of automation, they are employment generators, especially in the rural and semi-urban areas. Many of today's success stories, particularly in the tech, pharma and auto ancillary sectors, started small. Investors have seen their wealth multiply manifold as these companies made the transition to large caps. On the other side, SMEs play in a constricted field. Most of them are in sectors where entry barriers are low, with unorganized players snapping at the heel. Very few operate in the infra sector, an emerging area. Those that do are able to do so because of political ties. Some others are contend to be captive suppliers to original equipment manufacturers and are often funded by the latter. Thus, their fortunes rise and fall with those of the user-industries. Promoter-driven, they may lose their sense of purpose as more decision makers nominated by large investors or institutions join the board with the infusion of capital. The resultant power tussles could be upsetting, the most recent example being that of SKS Microfinance. But by allowing big investors the first right of refusal, Sebi may have unwittingly laid the stage for pricey offerings from these firms later on.

Ring out the old

Investors want to turn their back on half-hearted reforms that retain the power of veto and protect vested interests

By Mohan Sule


More than the covert liquidity injection spree by the new governor of the Reserve Bank of India, the belief that bond-buying by the US Federal Reserve will continue till its new boss settles early next year has triggered a relief rally in the market. The soft credit line extended to banks to enable them to lower interest rates on home and consumer loans is the RBI’s idea of a Diwali fix for an economy low on growth and high on inflation. Whether the fireworks crackle or turn out to be damp squibs will depend if the consumers squeezed by rising foodgrain prices and shrinking disposable income bite the bait. Nonetheless, foreign institutional investors have returned with a gusto, propping up equities and the rupee. Hopefully, this allows domestic investors — floating in an economy adrift in space due to the policy paralysis resulting from the many corruption scandals, battered by stocks and bonds waxing and waning to the sightings of the minutes of the Fed’s policy meets, baffled over gold’s status as a dinosaur or a new-age currency, and bruised by the Indian rupee sinking faster than the force of gravity — to look ahead with optimism, particularly with the opportunity round the corner to ring out the old and ring in the new. Adding to the chaos is the cross-connection between the government’s desire of a high-growth, plentiful-liquidity economy and the central bank’s goal of tight-money, low-inflation financial landscape. No wonder, investors want policy makers to shrug off their fears to approve legislations that allow industry to escape the Hindu growth rate faster than the velocity of Jupiter.

Clarity on the goal of reforms will sweep away much of the cobwebs of historical baggage. Foreign direct investment, for instance, is assumed to be one face of liberalisation, the other being foreign investment in the capital market. Right now both are viewed as means to accumulate foreign exchange reserves to finance imports, primarily energy. The objective was justifiable during the first phase of the opening up of the economy, when the country had to mortgage its gold as our dollar stockpile had dwindled to finance 15 days of imports. Understandably, a cap was imposed on FDI in some sectors, while a few were kept totally out of bounds. The second phase saw the ceiling abolished completely in many industries and lifted some more in certain others, while a few remained untouchable. In the third phase undertaken in the second half of this year following the free fall of the rupee on the flight of FIIs after the Fed dropped hints of winding up of its pump-priming program, 100% foreign owned companies were allowed to operate telecom services and make defence equipment and the level of FDI increased in insurance and aviation and to controlling stake in multi-brand retail. Yet, these steps did not generate the desired response due to the fine print imposing many restrictions. Reforms that go the entire last mile, particularly in sectors such as power and transport, without the ifs and buts that render the excercise pointless is what investors would like to see.

The experience so far is that the conditions attached are to serve two purposes. One is the desire of the policy makers and bureaucrats to continue to hold the veto. The stringent rules governing paybacks that foreign companies, particularly from the US, have to adhere while investing abroad blunt the diabolic charm of quid pro quo. The telecom and aviation sectors are apt reminders of how an uncertain policy environment can put off rather than attract investors. Second is to protect vested interests. Hence, the resistance to free completely fuel and power from pricing control. PSU insurers are used to bail out sick units and nationalised banks to waive off loans on election-eve. Safeguards and permissions at various stages have translated the land acquistion law as unworkable or at best a time-consuming process. Yet, where entry has been freed, consumers and investors have benefited from increase in transparency and quality of delivery. An effective regulator can ensure a level-playing field. In some markets, foreign brands have ceded to Indian makers, enjoying the edge of cost-efficiency. Of late, Indian entrepreneurs are acquiring assets abroad to diversify as well as to import these brands to take on foreign competition on home turf. Allowing businesses to decide investment based on demand outlook rather than on obstructionist regulations is what is needed in the coming year. Otherwise, India would be a barren land, with neither Indian nor global investors. If not for the reverse book-building escape plug, most of the listed MNCs would have exited by now. This regulation, formulated apparently to protect minority investors, has had the opposite effect of scaring potential foreign investors and is symptomatic of India’s obsession of safeguarding one constituency at the expense of the other.