2014 provided clues if India should cling to the time-tested model of state benevolence or look forward to uncertainty
By Mohan Sule
It is not only investors who face the classic dilemma of choosing between a glorious past and a hazy outlook while zeroing in on a stock In the fading year, even the Grand Old Party had to confront this existential dilemma. Nothing brought the turmoil in sharp focus than the celebration of the 125th birth anniversary of our first prime minister. The giveaway was the jaded overseas dignitaries gracing the occasion as the great man’s great grandson without an iota of charisma of his illustrious lineage gave an angry speech about the angry new rulers of India that was becoming not recognizable day by day from the era of royals dipping into the public coffers to write off loans, subsidize essential items and distribute freebies. In return they got unquestioned loyalty from the common man, believing that remaining poor and deprived was an un-escapable fate, brushing aside any doubts of a cynical ploy to nurture vote bank politics. It was left to the worldwide web to chip at this wall of resistance, tweet by tweet. Acerbic and irreverent, Indians at last found a platform to listen to others’ opinionated voices and give vent to the innermost and often seditious thoughts about the serial scandals of the UPA government. So there was a strange spectacle of the silent troika of mother-son-and-loyal retainer being downgraded to ordinary politicians from their sanctimonious pedestal by a raucous citizenry discovering its new power to effect change. And India took a U turn.
No one understood the power of communication better than the vendor selling hot brew on a railway platform in Gujarat. If an ordinary commodity like tea could be packaged and marketed with the promise of a shakeout from the slumber of pessimism, then surely the country was ready to buy a dream of electricity on tap, smooth roads, low-cost houses and jobs aplenty. The capitalization of the demographic dividend paid off in May, at least for the investors. After the scare of food inflation going out of hand due to below-normal southwest monsoon, the market surged on expectation of bumper earning going forward. Steps to open up to more FDI were seen as transformational, never mind the small issue of retail. The surest sign of a bull market is when tech company incubators switch to dishing out stock tips guised as investor services startups offering clarity on macro mumbo jumbo. Like the mesmerizing babas, some of them now ensconced behind bars after revelation of their human foibles, how many corpses are littered behind the barricade of pay walls built by these Internet investment gurus, with their attention spanning intra-day, will be known only after a Sebi crackdown. Serendipitously, oil prices nearly halved from the peak and the wholesale price index growth dropped to zero by mid December. The taunts of missing-in-action acche din by the opposition soon lost resonance as bond buyers made merry at the expense of a stubborn central bank. Instead the attention of the nation was riveted by celebrities taking the broom for a Swachh Bharat. The Digital India, smart cities and Make-in-India campaigns reverberated around the globe despite no breakthrough on land acquisitions, environmental clearances and labor laws. Yet, the social inclusion program of Jan Dhan Yojana, without a rupee of giveaway, proved to be a smashing success, shutting up the nitpickers, and throwing up the nation’s first Teflon head of the government and second only to the US president of the Good-Morning-America fame.
But every dream has to end. Even after six months of an energized establishment, Corporate India is still awaiting a trickle, leave alone the anticipated gush, of infra orders. The market that seemed unconcerned about the US central bank raising interest rates next year and the resultant slowing of foreign inflows into emerging economies, got panicky on Chinese blues and Russia’s rouble rout and skidded along with the currency. Eruptions in the euro region fuelled anxiety about how oil exporting countries would cope as their revenues shrink. A low-cost airline appeared to be grounded soon after the aborted takeoff a high-cost one. Hardly had one PSU sale flagged off than the market looked poised to upend, raising worries about fiscal deficit, on the mend due to the commodity price crash, if the divestment target is not met and if the exercise is jinxed. Once coveted, then becoming a laughing stock, the global turbulence hinted of a comeback of gold as a safe haven just as the dollar was post-2008 credit crunch. Why stocks are tumbling despite low inflation and loss-making digital businesses getting cash infusion, while offline entities are not sure if the primary market will be enticed by historical performance, perhaps answers the question nagging investors whether to cling to the past or look forward to an uncertain future.
Tuesday, December 30, 2014
Tuesday, December 2, 2014
Botched up
Regulators, companies and investment bankers have to share the blame for the crumbling of M&A deals
By Mohan Sule
Besides injecting life into the primary market, a bull market triggers mergers and acquisitions. After a demand slump, companies dust off plans to expand to capture the buoyant economic mood. Most primary market offerings are to raise funds for organic growth. Friendly and hostile takeovers cut short the incubation period of a grassroots venture. For investors, both routes offer exciting opportunities for wealth creation. A reasonably valued public offering gives ample scope for appreciation on listing as well as a few years later. The inorganic route provides an exit window for the shareholders of a weak prey or an entry into a strong company. The market is happy that cash is being utilized by the predator-company to grow its share, helping improve the return ratios. Yet there is a downside, too. There could be a sudden change in the business environment and delays in execution. A target that seemed apt could prove to be a cumbersome burden due to difficulties in enmeshing different work cultures. Depletion of reserves would mean insufficient spare change to exploit new trends. In addition to all these obstacles, some new problems have cropped up going by a few recent cases. Take the unraveling of the Rs 700-crore Bharti Airtel-Loop deal. Bharti would have consolidated its leadership position in the telecom space, with the Mumbai-based services provider’s three-crore subscriber base. Users of the struggling Loop would have got better services. Despite the obvious advantages, the agreement failed to get regulatory approval. The hitch? Loss of revenue to the Department of Telecommunications as Loop subscribers would be ported to Airtel numbers without paying the mandatory Rs 19 fee.
During the wait, Loop’s subscribers dwindled to 1.2 lakh. Bharti’s stock ended the day of the announcement with a loss of nearly 3%. Loop’s licence is set to expire end November and DoT might not get the Rs 800 crore that the services provider owes it. This is not the first time that Bharti’s shareholders have seen a botched up acquisition. India’s largest telecom company by subscribers gave up the idea of taking over MTN in September 2009 as the South African government wanted India to permit dual listing. This would have allowed sharing of revenue and profit by the two. The cash-cum-stock deal gave Bharti a 49% stake in MTN in return for the latter getting a 36% economic interest in the Indian carrier. However, the Reserve Bank of India refused to concede as the arrangement implied capital account convertibility. So the US$24-billion alliance that would have created the world’s fourth largest telcom services provider covering 24 countries with 200 million subscribers crumbled after eight months of complex negotiations. Trading in the MTN stock had to be suspended for the day by the Johannesburg Stock Exchange after slumping more than 5% on hearing the news. These two cases do not show regulators in a positive light. Many times, the market throws up new situations. Regulators have to act speedily and find a via media till the guidelines are amended to reflect reality.
DoT and the RBI could have shown some flexibility. Bharti could have been told to deposit the portability charges with the regulator till the resolution of the issue and the RBI could have asked Bharti to invest the profit share of MTN in India for the time being. Apart from the regulators, the eagerness of companies to grab opportunities to expand market share without reading the fine print is disturbing. Apollo Tyres’s $2.5-billion (Rs14400-crore) deal to acquire Cooper Tire was called off after the US tyre maker sought judicial intervention to expeditiously close the merger. The Indian company termed Cooper’s decision as “inexplicable” and “a diversionary smokescreen, an unfortunate acknowledgement” of the inability to meet the obligations necessary to complete the transaction. These instances of ambition and impatience overtaking prudence demostrate sloppy due-diligence by investment bankers. The Sahara-Jet Airways acrimony over the deal price after the merger took effect and the bitter experience of Daiichi Sankyo following the takeover of Ranbaxy illustrate that inorganic growth is much as a risk factor as a wealth multiplier. The shareholders of Apollo were saved from a bigger disaster had the Cooper acquisition gone through. Ranbaxy shareholders were bought out at a hefty premium by the Japanese drug maker. Those that remained found a new parent in Sun Pharma. Not everyone is so fortunate. May be the regulator should insist that acquirers contribute a certain percentage of the deal amount to an escrow account with a three-year lock-in to compensate for the loss in market value due to costly missteps.
By Mohan Sule
Besides injecting life into the primary market, a bull market triggers mergers and acquisitions. After a demand slump, companies dust off plans to expand to capture the buoyant economic mood. Most primary market offerings are to raise funds for organic growth. Friendly and hostile takeovers cut short the incubation period of a grassroots venture. For investors, both routes offer exciting opportunities for wealth creation. A reasonably valued public offering gives ample scope for appreciation on listing as well as a few years later. The inorganic route provides an exit window for the shareholders of a weak prey or an entry into a strong company. The market is happy that cash is being utilized by the predator-company to grow its share, helping improve the return ratios. Yet there is a downside, too. There could be a sudden change in the business environment and delays in execution. A target that seemed apt could prove to be a cumbersome burden due to difficulties in enmeshing different work cultures. Depletion of reserves would mean insufficient spare change to exploit new trends. In addition to all these obstacles, some new problems have cropped up going by a few recent cases. Take the unraveling of the Rs 700-crore Bharti Airtel-Loop deal. Bharti would have consolidated its leadership position in the telecom space, with the Mumbai-based services provider’s three-crore subscriber base. Users of the struggling Loop would have got better services. Despite the obvious advantages, the agreement failed to get regulatory approval. The hitch? Loss of revenue to the Department of Telecommunications as Loop subscribers would be ported to Airtel numbers without paying the mandatory Rs 19 fee.
During the wait, Loop’s subscribers dwindled to 1.2 lakh. Bharti’s stock ended the day of the announcement with a loss of nearly 3%. Loop’s licence is set to expire end November and DoT might not get the Rs 800 crore that the services provider owes it. This is not the first time that Bharti’s shareholders have seen a botched up acquisition. India’s largest telecom company by subscribers gave up the idea of taking over MTN in September 2009 as the South African government wanted India to permit dual listing. This would have allowed sharing of revenue and profit by the two. The cash-cum-stock deal gave Bharti a 49% stake in MTN in return for the latter getting a 36% economic interest in the Indian carrier. However, the Reserve Bank of India refused to concede as the arrangement implied capital account convertibility. So the US$24-billion alliance that would have created the world’s fourth largest telcom services provider covering 24 countries with 200 million subscribers crumbled after eight months of complex negotiations. Trading in the MTN stock had to be suspended for the day by the Johannesburg Stock Exchange after slumping more than 5% on hearing the news. These two cases do not show regulators in a positive light. Many times, the market throws up new situations. Regulators have to act speedily and find a via media till the guidelines are amended to reflect reality.
DoT and the RBI could have shown some flexibility. Bharti could have been told to deposit the portability charges with the regulator till the resolution of the issue and the RBI could have asked Bharti to invest the profit share of MTN in India for the time being. Apart from the regulators, the eagerness of companies to grab opportunities to expand market share without reading the fine print is disturbing. Apollo Tyres’s $2.5-billion (Rs14400-crore) deal to acquire Cooper Tire was called off after the US tyre maker sought judicial intervention to expeditiously close the merger. The Indian company termed Cooper’s decision as “inexplicable” and “a diversionary smokescreen, an unfortunate acknowledgement” of the inability to meet the obligations necessary to complete the transaction. These instances of ambition and impatience overtaking prudence demostrate sloppy due-diligence by investment bankers. The Sahara-Jet Airways acrimony over the deal price after the merger took effect and the bitter experience of Daiichi Sankyo following the takeover of Ranbaxy illustrate that inorganic growth is much as a risk factor as a wealth multiplier. The shareholders of Apollo were saved from a bigger disaster had the Cooper acquisition gone through. Ranbaxy shareholders were bought out at a hefty premium by the Japanese drug maker. Those that remained found a new parent in Sun Pharma. Not everyone is so fortunate. May be the regulator should insist that acquirers contribute a certain percentage of the deal amount to an escrow account with a three-year lock-in to compensate for the loss in market value due to costly missteps.
Wednesday, November 19, 2014
Mixed signals
The NDA government is caught between the need for market- oriented reforms and desire to fulfill social obligations
By Mohan Sule
There is growing impatience among foreign investors at the slow pace of reforms in India. Many assumed that Prime Minister Narendra Modi would undertake some radical steps to attract investments after assuming charge end May 2014. Perhaps they had not listened carefully. In his address to the new MPs of his party, he had wondered: If the government does not take care of the poor, who will? In the euphoria of the defeat of the corrupt UPA II government, the market chose to be selective in its understanding about the flexibility of the government in carrying out reforms. The issue is if reforms should be in one sweep or in installments. Diesel pricing has been deregulated but not LPG. The Big Bang reforms of Margaret Thatcher in 1986 transformed London into a global financial hub but also triggered criticism in the aftermath of the collapse of Lehman Brothers in September 2008 that banks embarked on risks not proportionate to their capital adequacy. The P V Narasimha Rao regime in India launched the most comprehensive restructuring exercise India had ever seen. The impact on the economy was equivalent to nationalization of banks and abolition of privy purses. In the era of coalition politics that followed, there was lack of consensus on how much to open up but not on the reforms process. Instability at the Centre, with successive governments lasting for a few months and even days, the foreign exchange crisis that tamed the SouthEast AsiaTigers, and the dotcom bust at the turn of the century ensured that policy makers did not have to do much to discourage foreign inflows. The 2012 verdict of the Supreme Court calling the January 2008 distribution of 122 licences for 2G spectrum on the basis of the first to comply with the conditions as “arbitrary” and “unconstitutional” and the recent cancellation of all coal blocks save four allocated since 1993 was a wakeup call.
The adverse fallout of the telecom scam was the policy paralysis for the remaining two years of the UPA II government. The positive outcome is that the activism of the apex court has given rise to the debate on the best possible way to dispose of natural resources. So far, the rulers had used their discretionary powers to reward cronies. There is a welcome realization that this method discourages entrepreneurship, thereby blocking the creation of jobs as well as innovation, so necessary for growth. At the same time, there is acknowledgement that auctioning, though transparent and fair, does not benefit the end users as the government tries to keep the base price high so as not be criticized later for selling the family silver cheaply. Winners try to recoup their investment through high pricing. Also, it fosters status quo. Only those with established deep pockets are in a position to tap the emerging opportunities. The 3G spectrum auction in 2010 saw participation of only seven private bidders. There were a mere five players bidding for just 102 of the 140 blocks in the GSM band in 2013. In fact, the presence of a large number of players in the 2G space earlier had resulted in fierce competition, leading to low voice usage rates. The outcome was deeper penetration of mobile services. After the shakeout, tariffs are once again on the rise. Service providers are happy but not consumers, who are facing less choice.
The decision to keep prices of coal controlled and Coal India intact, while auctioning the cancelled blocks for captive consumption, too, signals a cautious appoach. This could perhaps be to avoid trouble from trade unions on the eve of elections in Jharkand, which has the highest coals reserves in the country. The message is the government views PSUs as a vehicle to ensure cheap goods and services to poor. This is contradiction to Modi’s declaration in the US that the government has no business to be in business. The power generation sector is an example of half-baked reforms. Generators can produce power but pricing is subject to the regulator’s approval. Yet, they have to import coal at market-oriented rates as CIL is unable to meet demand. The government intends to lower its stake in PSU banks to 51% but wants them to be at the forefront of social programmes such as Jan Dhan Yojana, which is a high-cost operation due to the zero-balance requirement. This social outreach will make borrowers happy but not their shareholders just like those of CIL. Should investors stay with PSUs? With the example of the benign neglect of Air India following the entry of private operators and rising NPAs of PSUs even as private banks are proving to be nimble, investors would not be wrong to fear erosion in the value of their holding as the sectors in which state-owned enterprises are monopolies are thrown open to competition.
By Mohan Sule
There is growing impatience among foreign investors at the slow pace of reforms in India. Many assumed that Prime Minister Narendra Modi would undertake some radical steps to attract investments after assuming charge end May 2014. Perhaps they had not listened carefully. In his address to the new MPs of his party, he had wondered: If the government does not take care of the poor, who will? In the euphoria of the defeat of the corrupt UPA II government, the market chose to be selective in its understanding about the flexibility of the government in carrying out reforms. The issue is if reforms should be in one sweep or in installments. Diesel pricing has been deregulated but not LPG. The Big Bang reforms of Margaret Thatcher in 1986 transformed London into a global financial hub but also triggered criticism in the aftermath of the collapse of Lehman Brothers in September 2008 that banks embarked on risks not proportionate to their capital adequacy. The P V Narasimha Rao regime in India launched the most comprehensive restructuring exercise India had ever seen. The impact on the economy was equivalent to nationalization of banks and abolition of privy purses. In the era of coalition politics that followed, there was lack of consensus on how much to open up but not on the reforms process. Instability at the Centre, with successive governments lasting for a few months and even days, the foreign exchange crisis that tamed the SouthEast AsiaTigers, and the dotcom bust at the turn of the century ensured that policy makers did not have to do much to discourage foreign inflows. The 2012 verdict of the Supreme Court calling the January 2008 distribution of 122 licences for 2G spectrum on the basis of the first to comply with the conditions as “arbitrary” and “unconstitutional” and the recent cancellation of all coal blocks save four allocated since 1993 was a wakeup call.
The adverse fallout of the telecom scam was the policy paralysis for the remaining two years of the UPA II government. The positive outcome is that the activism of the apex court has given rise to the debate on the best possible way to dispose of natural resources. So far, the rulers had used their discretionary powers to reward cronies. There is a welcome realization that this method discourages entrepreneurship, thereby blocking the creation of jobs as well as innovation, so necessary for growth. At the same time, there is acknowledgement that auctioning, though transparent and fair, does not benefit the end users as the government tries to keep the base price high so as not be criticized later for selling the family silver cheaply. Winners try to recoup their investment through high pricing. Also, it fosters status quo. Only those with established deep pockets are in a position to tap the emerging opportunities. The 3G spectrum auction in 2010 saw participation of only seven private bidders. There were a mere five players bidding for just 102 of the 140 blocks in the GSM band in 2013. In fact, the presence of a large number of players in the 2G space earlier had resulted in fierce competition, leading to low voice usage rates. The outcome was deeper penetration of mobile services. After the shakeout, tariffs are once again on the rise. Service providers are happy but not consumers, who are facing less choice.
The decision to keep prices of coal controlled and Coal India intact, while auctioning the cancelled blocks for captive consumption, too, signals a cautious appoach. This could perhaps be to avoid trouble from trade unions on the eve of elections in Jharkand, which has the highest coals reserves in the country. The message is the government views PSUs as a vehicle to ensure cheap goods and services to poor. This is contradiction to Modi’s declaration in the US that the government has no business to be in business. The power generation sector is an example of half-baked reforms. Generators can produce power but pricing is subject to the regulator’s approval. Yet, they have to import coal at market-oriented rates as CIL is unable to meet demand. The government intends to lower its stake in PSU banks to 51% but wants them to be at the forefront of social programmes such as Jan Dhan Yojana, which is a high-cost operation due to the zero-balance requirement. This social outreach will make borrowers happy but not their shareholders just like those of CIL. Should investors stay with PSUs? With the example of the benign neglect of Air India following the entry of private operators and rising NPAs of PSUs even as private banks are proving to be nimble, investors would not be wrong to fear erosion in the value of their holding as the sectors in which state-owned enterprises are monopolies are thrown open to competition.
Thursday, November 6, 2014
Big deals
Strategies adopted by issuers of capital and e-commerce sites
to attract buyers have many similarities
By Mohan Sule
Very few companies can claim to earn US$100 million (Rs 600 crore) in 10 hours. The success becomes even more noteworthy if the entity has been in existence for slightly more than a half-a-dozen years. There have been instances of trailblazing companies burning out later, particular in the telecom, aviation and consumer durables space. The reasons include inability to manage the sudden growth, going off the course with wrong calls or the consumers losing attention and latching on to the next promising idea. Therefore, the latest phenomenon of user-visits bringing an e-commerce site to a standstill due to the inability to cope up with the rush, not surprisingly, has triggered opposing views. On one side are those who feel vindicated that India is taking to e-ecommerce rapidly, with falling prices of smart phones and charges for data downloading fueling the habit. The other argument is that the novelty factor of online shopping could wear out soon. Technical glitches and complaints about pricing are signs of buyers’ disappointment and disillusionment. Both opinions, nonetheless, signal that there is much in common in the way companies woo consumers and investors. The first is that it is not necessary to think out of the box to set the cash register ringing. The practice of offering hefty discounts is not new. Several business-to-consumer companies do it all the time. Law enforcing agencies have had to be called to control crowds at huge sales organised on national holidays. In the US, buyers queue up in freezing winter to rush in at midnight to grab goods of throwaway prices on Black Friday, which flags off the Christmas shopping season. What is required is packaging and marketing. The surest way for issuers of capital to create a buzz is by placement of shares with qualified institutional investors on the eve of primary-market debut. Presence of big-ticket investors is taken as a confirmation that the company is on the right track.
The second similarity is the value-for-money offers. Many offline outlets have protested that often items are sold online at less than the landed cost of imports. Pricing becomes a deciding factor during a slowdown. Reasonably priced IPOs have succeeded even in a dull market. Getting the pricing correct means issuers do not have to depend schemes such as safety nets and market making to pull in subscribers. It is important for digital malls to stay away from tricks such as bumping up prices and undertake a token gesture of slashing them later. A distinguishing feature between two companies in an industry is the degree of confidence that they can instill in the stakeholders. Consumers come to equate quality and after-sales service with the brand. Those with transparent corporate governance practices will find it easy to raise funds at attractive valuations in the market. At the same time, adventurism can prove fatal. E-supermarkets in the US are accused of deploying algorithms to alter prices depending on the visitor’s shopping history, which reflects their purchasing power. Indian companies diversifying into unrelated areas such as aviation and telecom have had to suffer massive erosion in value. Window-dressing of accounts, changing accounting policy and reluctance to share setbacks with investors have also cost companies dearly.
Earmarking special days is also an exercise in brand building. This is observed in the capital market, too. Stocks tend to go up on the eve of board meetings called to mull corporate actions. Listed companies have to utilise cash prudently, either capitalising it through a bonus issue or funneling it for capex, to communicate to the market that the company is in good health. Discounting also reveals if a company is relying on volumes to gain share. Many of them have to turn to debt or dilute capital to crank up production without any buffer for a slowdown. The market rewards those with a good operating profit margin. Companies have to streamline processes to make and sell products with a minimal mark-up or convince investors that the premium justifies the outlook. The success of big-deal days also implies that sellers have to create opportunities. Commodity producers, in particular, have to protect from cyclical downturns by widening the customer base. Asset-light stocks are preferred during slowdowns. Another important inference is that there can be different classes of consumers for the same product. Small investors are in for the long haul and are concerned about dividend payout, while institutional investors would look for capital appreciation. Balancing the different pulls of the market is indeed a tough call for companies looking for buyers of goods and equity.
to attract buyers have many similarities
By Mohan Sule
Very few companies can claim to earn US$100 million (Rs 600 crore) in 10 hours. The success becomes even more noteworthy if the entity has been in existence for slightly more than a half-a-dozen years. There have been instances of trailblazing companies burning out later, particular in the telecom, aviation and consumer durables space. The reasons include inability to manage the sudden growth, going off the course with wrong calls or the consumers losing attention and latching on to the next promising idea. Therefore, the latest phenomenon of user-visits bringing an e-commerce site to a standstill due to the inability to cope up with the rush, not surprisingly, has triggered opposing views. On one side are those who feel vindicated that India is taking to e-ecommerce rapidly, with falling prices of smart phones and charges for data downloading fueling the habit. The other argument is that the novelty factor of online shopping could wear out soon. Technical glitches and complaints about pricing are signs of buyers’ disappointment and disillusionment. Both opinions, nonetheless, signal that there is much in common in the way companies woo consumers and investors. The first is that it is not necessary to think out of the box to set the cash register ringing. The practice of offering hefty discounts is not new. Several business-to-consumer companies do it all the time. Law enforcing agencies have had to be called to control crowds at huge sales organised on national holidays. In the US, buyers queue up in freezing winter to rush in at midnight to grab goods of throwaway prices on Black Friday, which flags off the Christmas shopping season. What is required is packaging and marketing. The surest way for issuers of capital to create a buzz is by placement of shares with qualified institutional investors on the eve of primary-market debut. Presence of big-ticket investors is taken as a confirmation that the company is on the right track.
The second similarity is the value-for-money offers. Many offline outlets have protested that often items are sold online at less than the landed cost of imports. Pricing becomes a deciding factor during a slowdown. Reasonably priced IPOs have succeeded even in a dull market. Getting the pricing correct means issuers do not have to depend schemes such as safety nets and market making to pull in subscribers. It is important for digital malls to stay away from tricks such as bumping up prices and undertake a token gesture of slashing them later. A distinguishing feature between two companies in an industry is the degree of confidence that they can instill in the stakeholders. Consumers come to equate quality and after-sales service with the brand. Those with transparent corporate governance practices will find it easy to raise funds at attractive valuations in the market. At the same time, adventurism can prove fatal. E-supermarkets in the US are accused of deploying algorithms to alter prices depending on the visitor’s shopping history, which reflects their purchasing power. Indian companies diversifying into unrelated areas such as aviation and telecom have had to suffer massive erosion in value. Window-dressing of accounts, changing accounting policy and reluctance to share setbacks with investors have also cost companies dearly.
Earmarking special days is also an exercise in brand building. This is observed in the capital market, too. Stocks tend to go up on the eve of board meetings called to mull corporate actions. Listed companies have to utilise cash prudently, either capitalising it through a bonus issue or funneling it for capex, to communicate to the market that the company is in good health. Discounting also reveals if a company is relying on volumes to gain share. Many of them have to turn to debt or dilute capital to crank up production without any buffer for a slowdown. The market rewards those with a good operating profit margin. Companies have to streamline processes to make and sell products with a minimal mark-up or convince investors that the premium justifies the outlook. The success of big-deal days also implies that sellers have to create opportunities. Commodity producers, in particular, have to protect from cyclical downturns by widening the customer base. Asset-light stocks are preferred during slowdowns. Another important inference is that there can be different classes of consumers for the same product. Small investors are in for the long haul and are concerned about dividend payout, while institutional investors would look for capital appreciation. Balancing the different pulls of the market is indeed a tough call for companies looking for buyers of goods and equity.
Monday, October 27, 2014
Building confidence
Eliminating the trust deficit between government and industry and companies and investors cannot be selective
By Mohan Sule
While flagging off the Make-in-India curtain raiser, Prime Minister Narendra Modi rightly said there is a trust deficit in the country. For the common man, the government is a pervasive and obstructive force, with rules and regulations. For the government, there is a radical lurking round the corner, trying to circumvent authority. The various regulatory bodies empowered with oversight powers would become redundant if companies were to become transparent. Users would not face quality issues or deficient services. Consumers of injectibles and capsules would not be puzzled over the silence of the domestic watchdog even as some of our topnotch pharmaceutical companies are targeted by the US Food and Drug Administration. Investors would not become agitated over commodity producers diverting a hefty amount as royalty to the holding company or MNC associates to their parents irrespective of the bottom line and asset management companies charging a fixed fee without any link to performance. Indian shareholders would not view with scepticism PSU banks for whom social obligations override business sense, with loan writeoffs encompassing the small borrower to the mighty industrialist having the right connections. Imagine how easy life would be if everyone filed correct returns. An entire industry devoted to monitoring tax payers would be rendered jobless.
Modi needs to be credited for not singling out any section of the society for the state of affairs unlike the previous socialist regimes, which blamed the business community for profiteering and keeping the country in a perpetual state of poverty. Yet the remark threw up four ironies. The first was unsaid but understood. The prominent casualty of the lack of confidence between industry and government is manufacturing. The problem of joblessness cannot be solved by software companies alone. No wonder, the prime minister’s preferred composition of growth is equitable contribution of the three segments of the economy: agriculture, manufacturing and services. This is at odds with the traditional understanding that, as the country develops, the share of services overtakes farm and brick-and-mortar output. The second takeout is that investors have to be wooed with the attraction of quick clearance and stable taxation in spite of the advantages of democracy, demographic dividend and demand. Crony capitalism, unfortunately, has not only drained the country’s resources but also clogged the investment pipeline. The Supreme Court’s judgment cancelling all but four coal blocks allotted since 1993 is an opportunity to clear the cobwebs of entrenched interests. Clear-cut policies on awarding contracts, straightening of ambiguous tax laws that are open to interpretation, ensuring an import taxation structure that is fair to producers of raw materials, intermediates as well as end products, and eliminating the role of middlemen by switching over to e-commerce could perhaps encourage fair business practices.
The third contradiction became apparent during Modi’s US tour. Apart from the issue of liability of nuclear plants, the other thorny issue was protection of intellectual property rights. Besides the tech and entertainment industries, global drug producers face billions of dollars of lost revenue due to copy cats in India. The government’s crackdown on spurious products or even infringement of patents in the local market has been half-hearted so far due to the desire to keep medicine prices low. A sign of the changing times is the stripping of the National Pharmaceutical Pricing Authority from capping prices of non-essentials on the eve of the prime minister’s departure to the US. The fourth dissonance cropped up during Modi’s speech to the United Nations General Assembly, when he exhorted members not to distinguish between good and bad terrorism, not realizing that he had laid himself open to similar criticism by branding FDI in retail as inimical to the country’s mom-and-pop shops while welcoming it in Railways and defence. Protecting one segment of the business comes at the expense of another: farmers, who would get better pricing and a captive market. Better storage and distribution would contribute to lowering of food inflation. The consumer durables industry is an examples of Indian players being swamped by foreign competition yet receiving hardly any sympathy from the policy makers. If employment creation is the focus, it would be better achieved by large malls rather than family-run holes in the wall. Similarly, issuers are able to raise funds quickly by providing privileged access to institutional investors. However, by ignoring the small investors, these companies are blocking the exit routes of these big-ticket investors.
By Mohan Sule
While flagging off the Make-in-India curtain raiser, Prime Minister Narendra Modi rightly said there is a trust deficit in the country. For the common man, the government is a pervasive and obstructive force, with rules and regulations. For the government, there is a radical lurking round the corner, trying to circumvent authority. The various regulatory bodies empowered with oversight powers would become redundant if companies were to become transparent. Users would not face quality issues or deficient services. Consumers of injectibles and capsules would not be puzzled over the silence of the domestic watchdog even as some of our topnotch pharmaceutical companies are targeted by the US Food and Drug Administration. Investors would not become agitated over commodity producers diverting a hefty amount as royalty to the holding company or MNC associates to their parents irrespective of the bottom line and asset management companies charging a fixed fee without any link to performance. Indian shareholders would not view with scepticism PSU banks for whom social obligations override business sense, with loan writeoffs encompassing the small borrower to the mighty industrialist having the right connections. Imagine how easy life would be if everyone filed correct returns. An entire industry devoted to monitoring tax payers would be rendered jobless.
Modi needs to be credited for not singling out any section of the society for the state of affairs unlike the previous socialist regimes, which blamed the business community for profiteering and keeping the country in a perpetual state of poverty. Yet the remark threw up four ironies. The first was unsaid but understood. The prominent casualty of the lack of confidence between industry and government is manufacturing. The problem of joblessness cannot be solved by software companies alone. No wonder, the prime minister’s preferred composition of growth is equitable contribution of the three segments of the economy: agriculture, manufacturing and services. This is at odds with the traditional understanding that, as the country develops, the share of services overtakes farm and brick-and-mortar output. The second takeout is that investors have to be wooed with the attraction of quick clearance and stable taxation in spite of the advantages of democracy, demographic dividend and demand. Crony capitalism, unfortunately, has not only drained the country’s resources but also clogged the investment pipeline. The Supreme Court’s judgment cancelling all but four coal blocks allotted since 1993 is an opportunity to clear the cobwebs of entrenched interests. Clear-cut policies on awarding contracts, straightening of ambiguous tax laws that are open to interpretation, ensuring an import taxation structure that is fair to producers of raw materials, intermediates as well as end products, and eliminating the role of middlemen by switching over to e-commerce could perhaps encourage fair business practices.
The third contradiction became apparent during Modi’s US tour. Apart from the issue of liability of nuclear plants, the other thorny issue was protection of intellectual property rights. Besides the tech and entertainment industries, global drug producers face billions of dollars of lost revenue due to copy cats in India. The government’s crackdown on spurious products or even infringement of patents in the local market has been half-hearted so far due to the desire to keep medicine prices low. A sign of the changing times is the stripping of the National Pharmaceutical Pricing Authority from capping prices of non-essentials on the eve of the prime minister’s departure to the US. The fourth dissonance cropped up during Modi’s speech to the United Nations General Assembly, when he exhorted members not to distinguish between good and bad terrorism, not realizing that he had laid himself open to similar criticism by branding FDI in retail as inimical to the country’s mom-and-pop shops while welcoming it in Railways and defence. Protecting one segment of the business comes at the expense of another: farmers, who would get better pricing and a captive market. Better storage and distribution would contribute to lowering of food inflation. The consumer durables industry is an examples of Indian players being swamped by foreign competition yet receiving hardly any sympathy from the policy makers. If employment creation is the focus, it would be better achieved by large malls rather than family-run holes in the wall. Similarly, issuers are able to raise funds quickly by providing privileged access to institutional investors. However, by ignoring the small investors, these companies are blocking the exit routes of these big-ticket investors.
Wednesday, October 8, 2014
The chaos theory
The safe-haven status of the dollar and food inflation in India have disrupted linkages between stocks and currency
By Mohan Sule
Once upon a time not far ago, there was a perfect world. The prosperity at the beginning of this century did not come out of the blue but was the result of different stages of evolution. Opportunity for a better life mutated into greed and transcended into lust. A dot transformed into a decimal, bloating into a balloon. Eventually, there was a bust. It took a few years for rays of hope to pierce the gloom that enveloped the globe, which had become closely entwined. Parts of a machine were produced in different corners and assembled in another location and sold someplace else. There was no false sense of nationalism. Instead the race was to build on the core strengths of demography, technology and market. For instance, an exporter of back-office services could be a voracious consumer of fast foods and luxury labels. A nuts-and-bolts hub of the world could have insatiable appetite for commodities. Money was cheap and plenty and sloshed around wherever it was needed. It looked like good times were here forever. Alas, it was not to be. Once again, living beyond means got the better of a prudent lifestyle. Money ran out even as debt piled up. The monetary earthquake shook the foundations of blue-chipped institutions. Some crumbled into dust. September 2008 was the turning point for the financial history of the world just as BC and AD are pegs to chart the age of the globe. A pre-Lehman Brothers has become a lexicon to conjure images of debauchery. It has become a marker for future generations to know that the world would never be the same again.
Going by textbooks, low interest rates encourage risk-taking. The US stock market is hitting record highs on near-bottom interest rates. But instead of plummeting because the US Federal Reserve still doubts the strength of the economic recovery and refuses to raise interest rates, the Dow Jones continues to surge. The picture in India is the reverse. Stocks are sprinting despite high cost of money. Reserve Bank of India Governor Raghuram Rajan has warned of outflow from India on a US bounce-back. The question that will arise on this possibility is: will the S&P 500 benchmark retreat because of competition from debt? And, in such a situation, will the RBI remain on course of lowering interest rates once food inflation falls? The interesting takeout is that India’s central bank will have to second-guess the Fed rather than follow a course dictated by India’s economic indicators. So there could be a strange paradox of the US playing by the rule book of keeping interest rates down to trigger growth and India’s central bank refraining from lowering interest rates on fear of exit of foreign money. The burden of preventing a major disruption in the market will be on the Indian government by ensuring that foreign investors earn return in excess of that back home. Take the comeback of bank stocks despite high non-performing loans. The market is re-rating them in the belief credit offtake will increase as thrust sectors such as infrastructure will have to rely on debt to fund capital expenditure. On the other side, a bubbly stock market is enabling highly-leveraged companies to become light by raising equity to retire debt.
Another lesson that has turned topsy-turvy is that the strength of the currency reflects the economy. Despite near-recessionary condition, the US dollar continues to rule. The acquisition of a safe-haven status means a bear attack drives investors to hoard the greenback and so also a bull-run. The Indian currency, confirming to textbook behavior, turned weak during the slump. Yet it also exhibits a contrary trend. High interest rates should bolster the rupee. Instead, a strong dollar is keeping it suppressed as also RBI’s mop-up from the market to fend of repercussions of any stampede. Now the question is will the rupee depreciate further if interest rates are pared? The Indian currency should gain due to the resultant acceleration in foreign investment on growth prospects getting a boost. If this does not fox traditionalists, then the recent phenomenon of narrowing trade deficit should. Growing imports signal industrial acitivity. A soft rupee, therefore, should widen the gap as India’s imports, particularly those of energy (US$ 450 million in FY 2014), exceed exports (US$ 312 million). Ironically, the chasm is shrinking because of squeeze in gold imports and cooling of oil prices despite tensions in the Middle East. The cause is the slowdown in China, whose FDI hit a four-year low in August. In fact, China, a major exporter of cheap goods, should be cranking up its wheels with consumption in the US poised to look up. Meanwhile, rising food intake, rather than the growing hunger for oil, on the back of economic expansion is keeping consumer inflation afloat in India. Indeed these crosscurrents are the new challenges for central banks and governments as age-old equations are giving way to a new chaotic order.
By Mohan Sule
Once upon a time not far ago, there was a perfect world. The prosperity at the beginning of this century did not come out of the blue but was the result of different stages of evolution. Opportunity for a better life mutated into greed and transcended into lust. A dot transformed into a decimal, bloating into a balloon. Eventually, there was a bust. It took a few years for rays of hope to pierce the gloom that enveloped the globe, which had become closely entwined. Parts of a machine were produced in different corners and assembled in another location and sold someplace else. There was no false sense of nationalism. Instead the race was to build on the core strengths of demography, technology and market. For instance, an exporter of back-office services could be a voracious consumer of fast foods and luxury labels. A nuts-and-bolts hub of the world could have insatiable appetite for commodities. Money was cheap and plenty and sloshed around wherever it was needed. It looked like good times were here forever. Alas, it was not to be. Once again, living beyond means got the better of a prudent lifestyle. Money ran out even as debt piled up. The monetary earthquake shook the foundations of blue-chipped institutions. Some crumbled into dust. September 2008 was the turning point for the financial history of the world just as BC and AD are pegs to chart the age of the globe. A pre-Lehman Brothers has become a lexicon to conjure images of debauchery. It has become a marker for future generations to know that the world would never be the same again.
Going by textbooks, low interest rates encourage risk-taking. The US stock market is hitting record highs on near-bottom interest rates. But instead of plummeting because the US Federal Reserve still doubts the strength of the economic recovery and refuses to raise interest rates, the Dow Jones continues to surge. The picture in India is the reverse. Stocks are sprinting despite high cost of money. Reserve Bank of India Governor Raghuram Rajan has warned of outflow from India on a US bounce-back. The question that will arise on this possibility is: will the S&P 500 benchmark retreat because of competition from debt? And, in such a situation, will the RBI remain on course of lowering interest rates once food inflation falls? The interesting takeout is that India’s central bank will have to second-guess the Fed rather than follow a course dictated by India’s economic indicators. So there could be a strange paradox of the US playing by the rule book of keeping interest rates down to trigger growth and India’s central bank refraining from lowering interest rates on fear of exit of foreign money. The burden of preventing a major disruption in the market will be on the Indian government by ensuring that foreign investors earn return in excess of that back home. Take the comeback of bank stocks despite high non-performing loans. The market is re-rating them in the belief credit offtake will increase as thrust sectors such as infrastructure will have to rely on debt to fund capital expenditure. On the other side, a bubbly stock market is enabling highly-leveraged companies to become light by raising equity to retire debt.
Another lesson that has turned topsy-turvy is that the strength of the currency reflects the economy. Despite near-recessionary condition, the US dollar continues to rule. The acquisition of a safe-haven status means a bear attack drives investors to hoard the greenback and so also a bull-run. The Indian currency, confirming to textbook behavior, turned weak during the slump. Yet it also exhibits a contrary trend. High interest rates should bolster the rupee. Instead, a strong dollar is keeping it suppressed as also RBI’s mop-up from the market to fend of repercussions of any stampede. Now the question is will the rupee depreciate further if interest rates are pared? The Indian currency should gain due to the resultant acceleration in foreign investment on growth prospects getting a boost. If this does not fox traditionalists, then the recent phenomenon of narrowing trade deficit should. Growing imports signal industrial acitivity. A soft rupee, therefore, should widen the gap as India’s imports, particularly those of energy (US$ 450 million in FY 2014), exceed exports (US$ 312 million). Ironically, the chasm is shrinking because of squeeze in gold imports and cooling of oil prices despite tensions in the Middle East. The cause is the slowdown in China, whose FDI hit a four-year low in August. In fact, China, a major exporter of cheap goods, should be cranking up its wheels with consumption in the US poised to look up. Meanwhile, rising food intake, rather than the growing hunger for oil, on the back of economic expansion is keeping consumer inflation afloat in India. Indeed these crosscurrents are the new challenges for central banks and governments as age-old equations are giving way to a new chaotic order.
Conflict of interest
Government as a regulator, producer and user benefits neither the shareholders of the seller nor those of the consumer
By Mohan Sule
The countdown has begun for a decision on pricing of natural gas. The UPA II government had almost doubled the price to US$ 8 per million British thermal unit effective April. The Lok Sabha election in May delayed the implementation. The NDA government end June decided to put off the matter by three months. The outcome will affect the shareholders of Reliance Industries, ONGC and Cairn India as well as those of user industries including power generators, fertilizer producers and refiners making cooking gas. An upward revision could fuel a rally in RIL and, effectively, light up the equity market as the heavyweight has been a laggard compared with other constituents of the benchmark. In the three months to 5 September 2014, the broad market gained nearly 8% compared with RIL’s loss of more than 5%. Importantly, the government is readying to issue shares of ONGC. A favourable verdict can fetch attractive valuation for the PSU. The picture will be opposite for end users. Increase in prices will drive up costs. Inflation is an overriding theme for the electorate, which has generally been satisfied with the performance of the Narendra Modi government after 100 days in office. Yet any reluctance to bump up prices could restrict supplies and slow down GDP growth. No wonder there is anxiety on how the drama unfolds in the next few days. There is certainty that prices will be hiked. The question is by how much and what will be the formula for future.
Pricing of natural gas is one of the many instances that have brought to the fore the divergence of interest of the sellers and the buyers. The coal-scam drama, which refuses to fade out, is a prominent case of cross-connection. The government is the largest producer (Coal India) and also a major consumer (NTPC and Sail, for instance) of coal. It could afford to keep prices low as long as CIL was not listed. The largest foreign portfolio investor resorted to legal action against the government for not allowing prices to reflect demand. Revision in power tariff due to increase in prices of coal is resisted by bankrupt state-owned discoms. The entry of private sector to boost supply has created more problems than being a solution due to the arbitrary allocation of coal blocks. The ensuing fallout was policy paralysis, affecting the producers as well as the users. The result is that neither CIL nor power generators are getting the discounting that companies in an industry with vast untapped potential should be attracting. Sugar is another example. The minimum support prices to sugarcane farmers, a crucial segment of the electorate, is relentlessly increased despite protests from sugar producers, who have to sell a portion of the output at controlled prices. Moreover, exports are controlled. On the other side, government-owned banks routinely complain about piling debts of sugar mills. As a via media, mixing of ethanol, a byproduct of sugar, in petrol has been encouraged to ease the cash-flow problem of sugar producers and reduce the influence of crude oil on fuel prices. This arrangement will ease some of the pain of sugar manufacturers but is not a substitute for withdrawal of government presence from the sector. As such, sugar stocks languish on the trading floor despite India being one of the largest consumers.
The norm is for interested parties to recuse from situations involving conflict of interest. For example, the Telecom Regulatory Authority of India, an autonomous body, oversees the industry, despite having two PSU operators, with the entry of private services providers. Similarly, the Central Electricity Regulatory Commission regulates power tariff. However, going by the valuation of BSNL and MTNL, loosening of control by the government does not necessarily benefit the shareholders of PSUs that had been monopolies when they were listed. Smaller private banks by assets enjoy better discounting than some of the biggest PSU banks due to more flexibility. In that sense, the government failed to mention reforms as a risk factor. Perhaps the belief was that the private sector would remain fringe players in view of the depth of coverage of the government-owned entities. Later events have shown that the margin counts more than volumes. The need for a third-party arbitrator, therefore, is to ensure the economy grows not due to higher pricing but because of consumption, which calls for cost-effective operations, thereby, benefiting the shareholders of both the producer and the users. Institutional investors have to become active to nudge the government to stop disturbing the pricing equilibrium. Otherwise, there will be only IPOs and FPOs from e-malls, food chains, theme parks and multiplexes.
By Mohan Sule
The countdown has begun for a decision on pricing of natural gas. The UPA II government had almost doubled the price to US$ 8 per million British thermal unit effective April. The Lok Sabha election in May delayed the implementation. The NDA government end June decided to put off the matter by three months. The outcome will affect the shareholders of Reliance Industries, ONGC and Cairn India as well as those of user industries including power generators, fertilizer producers and refiners making cooking gas. An upward revision could fuel a rally in RIL and, effectively, light up the equity market as the heavyweight has been a laggard compared with other constituents of the benchmark. In the three months to 5 September 2014, the broad market gained nearly 8% compared with RIL’s loss of more than 5%. Importantly, the government is readying to issue shares of ONGC. A favourable verdict can fetch attractive valuation for the PSU. The picture will be opposite for end users. Increase in prices will drive up costs. Inflation is an overriding theme for the electorate, which has generally been satisfied with the performance of the Narendra Modi government after 100 days in office. Yet any reluctance to bump up prices could restrict supplies and slow down GDP growth. No wonder there is anxiety on how the drama unfolds in the next few days. There is certainty that prices will be hiked. The question is by how much and what will be the formula for future.
Pricing of natural gas is one of the many instances that have brought to the fore the divergence of interest of the sellers and the buyers. The coal-scam drama, which refuses to fade out, is a prominent case of cross-connection. The government is the largest producer (Coal India) and also a major consumer (NTPC and Sail, for instance) of coal. It could afford to keep prices low as long as CIL was not listed. The largest foreign portfolio investor resorted to legal action against the government for not allowing prices to reflect demand. Revision in power tariff due to increase in prices of coal is resisted by bankrupt state-owned discoms. The entry of private sector to boost supply has created more problems than being a solution due to the arbitrary allocation of coal blocks. The ensuing fallout was policy paralysis, affecting the producers as well as the users. The result is that neither CIL nor power generators are getting the discounting that companies in an industry with vast untapped potential should be attracting. Sugar is another example. The minimum support prices to sugarcane farmers, a crucial segment of the electorate, is relentlessly increased despite protests from sugar producers, who have to sell a portion of the output at controlled prices. Moreover, exports are controlled. On the other side, government-owned banks routinely complain about piling debts of sugar mills. As a via media, mixing of ethanol, a byproduct of sugar, in petrol has been encouraged to ease the cash-flow problem of sugar producers and reduce the influence of crude oil on fuel prices. This arrangement will ease some of the pain of sugar manufacturers but is not a substitute for withdrawal of government presence from the sector. As such, sugar stocks languish on the trading floor despite India being one of the largest consumers.
The norm is for interested parties to recuse from situations involving conflict of interest. For example, the Telecom Regulatory Authority of India, an autonomous body, oversees the industry, despite having two PSU operators, with the entry of private services providers. Similarly, the Central Electricity Regulatory Commission regulates power tariff. However, going by the valuation of BSNL and MTNL, loosening of control by the government does not necessarily benefit the shareholders of PSUs that had been monopolies when they were listed. Smaller private banks by assets enjoy better discounting than some of the biggest PSU banks due to more flexibility. In that sense, the government failed to mention reforms as a risk factor. Perhaps the belief was that the private sector would remain fringe players in view of the depth of coverage of the government-owned entities. Later events have shown that the margin counts more than volumes. The need for a third-party arbitrator, therefore, is to ensure the economy grows not due to higher pricing but because of consumption, which calls for cost-effective operations, thereby, benefiting the shareholders of both the producer and the users. Institutional investors have to become active to nudge the government to stop disturbing the pricing equilibrium. Otherwise, there will be only IPOs and FPOs from e-malls, food chains, theme parks and multiplexes.
Sunday, September 7, 2014
The comeback
Retail investors will return to the market not because of any regulations but due to confidence in the economy
By Mohan Sule
Now that the secondary market has heated sufficiently, the focus has shifted to the primary market. Several government-owned and private units are preparing to enter the ring. Some PSUs would be offloading shares to reach 25% public holding, while many others to meet the ambitious Rs 50000-crore disinvestment target for the fiscal. Promoter-driven companies could be issuing equity to lighten debt, fund stalled expansion or build a chest for organic or inorganic growth. It is understandable that the private sector would wait for a frothy secondary market to get rich valuations. But for the government to strike when the mood is bullish suggests lack of confidence in the operational performance of the PSUs, many of whom are monopolies and should be able to draw investors’ attention without difficulty. The idea of enlarging the ownership to ordinary investors can be best achieved when the market is depressed and shares can be sold at attractive prices instead of offering a nominal discount to inflated P/E. Second, most issues would be of modest size. Subscription targets can be met with the participation of domestic and foreign institutional investors. Private sector companies have been placing shares with these investors even during the low phase. So do issuers need retail investors?
The marginalisation of retail investors, ironically, began as reforms gathered pace and gave rise to sunrise sectors such as tech, telecom, education, media and logistics. Many of the players in the old industries have become large caps due to the licence raj, which raised barriers for new entrants without the right connection. In contrast, the need for capital of the new sectors is modest compared with producers of, say, steel and capital goods. As such the emerging industries’ reliance on retail investors is far less than that of old economy companies. For instance, e-commerce businesses have no problem raising capital in the incubating stages. Yet many of these ventures are bigger by value than decades-old manufacturers as return from nascent industries has the capability to outstrip that from mature industries. During the dot-com bubble at the turn of this century, traditional earning matrix such as cash flows was junked in favour of esoteric parameters such as eyeballs. The valuations assigned made no sense to retail investors trying to comprehend their potential without any previous markers. The ensuring crash confirmed their fears. The changing investment landscape, however, has brought into focus the indispensability of retail investors. Venture capitalists and private equity managers pump in funds in the hope of exiting at bumper profit on listing. Angel investors reap the initial growth benefits. By the time they begin trading, these enterprises have achieved critical mass and future growth may not be at the same pace as in the past. Retail investors enter at a high point, with the promoters pricing shares exorbitantly based on past performance (minimum three years of profit to list). This is another reason for them to shy way from the primary market.
The role of Sebi, too, needs to be scrutinized. On the eve of the government preparing to flag off its big-ticket divestment program, the regulator goes through the now-familiar exercise of tightening investor protection rules and adding more features such as expanding the retail quota, introduction of marketing-making and safety net, stipulating discount to the offer price, and increasing the maximum investment limit. At the same time, it eases the cost and time required by issuers to raise money through the wholesale route. For instance, placements with qualified institutional investors do not have a lock-in as in preferential issues. If anything, book-building has created confusion rather than succeeding in coaxing retail investors. Most issues are bid at the higher range for fear of being left out, particularly from desirable offerings. Importantly, the price band is determined based on the response of institutional investors. Proportionate allotment has given rise to multiple applications from the same household, pushing aside the small investor. So there is a strange picture of wary retail investors caught between a confused regulator and expedient issuers. As the mood of the sulking market has undergone a change post May 2014, issuers are once again readying to target retail investors despite no fresh carrot dangled by the regulator to protect capital and enable them to earn higher return than fixed-income products. The lesson is that no amount of tweaking of rules will bring back retail investors as would the confidence that the economy is going to be in a better shape tomorrow than it is now.
By Mohan Sule
Now that the secondary market has heated sufficiently, the focus has shifted to the primary market. Several government-owned and private units are preparing to enter the ring. Some PSUs would be offloading shares to reach 25% public holding, while many others to meet the ambitious Rs 50000-crore disinvestment target for the fiscal. Promoter-driven companies could be issuing equity to lighten debt, fund stalled expansion or build a chest for organic or inorganic growth. It is understandable that the private sector would wait for a frothy secondary market to get rich valuations. But for the government to strike when the mood is bullish suggests lack of confidence in the operational performance of the PSUs, many of whom are monopolies and should be able to draw investors’ attention without difficulty. The idea of enlarging the ownership to ordinary investors can be best achieved when the market is depressed and shares can be sold at attractive prices instead of offering a nominal discount to inflated P/E. Second, most issues would be of modest size. Subscription targets can be met with the participation of domestic and foreign institutional investors. Private sector companies have been placing shares with these investors even during the low phase. So do issuers need retail investors?
The marginalisation of retail investors, ironically, began as reforms gathered pace and gave rise to sunrise sectors such as tech, telecom, education, media and logistics. Many of the players in the old industries have become large caps due to the licence raj, which raised barriers for new entrants without the right connection. In contrast, the need for capital of the new sectors is modest compared with producers of, say, steel and capital goods. As such the emerging industries’ reliance on retail investors is far less than that of old economy companies. For instance, e-commerce businesses have no problem raising capital in the incubating stages. Yet many of these ventures are bigger by value than decades-old manufacturers as return from nascent industries has the capability to outstrip that from mature industries. During the dot-com bubble at the turn of this century, traditional earning matrix such as cash flows was junked in favour of esoteric parameters such as eyeballs. The valuations assigned made no sense to retail investors trying to comprehend their potential without any previous markers. The ensuring crash confirmed their fears. The changing investment landscape, however, has brought into focus the indispensability of retail investors. Venture capitalists and private equity managers pump in funds in the hope of exiting at bumper profit on listing. Angel investors reap the initial growth benefits. By the time they begin trading, these enterprises have achieved critical mass and future growth may not be at the same pace as in the past. Retail investors enter at a high point, with the promoters pricing shares exorbitantly based on past performance (minimum three years of profit to list). This is another reason for them to shy way from the primary market.
The role of Sebi, too, needs to be scrutinized. On the eve of the government preparing to flag off its big-ticket divestment program, the regulator goes through the now-familiar exercise of tightening investor protection rules and adding more features such as expanding the retail quota, introduction of marketing-making and safety net, stipulating discount to the offer price, and increasing the maximum investment limit. At the same time, it eases the cost and time required by issuers to raise money through the wholesale route. For instance, placements with qualified institutional investors do not have a lock-in as in preferential issues. If anything, book-building has created confusion rather than succeeding in coaxing retail investors. Most issues are bid at the higher range for fear of being left out, particularly from desirable offerings. Importantly, the price band is determined based on the response of institutional investors. Proportionate allotment has given rise to multiple applications from the same household, pushing aside the small investor. So there is a strange picture of wary retail investors caught between a confused regulator and expedient issuers. As the mood of the sulking market has undergone a change post May 2014, issuers are once again readying to target retail investors despite no fresh carrot dangled by the regulator to protect capital and enable them to earn higher return than fixed-income products. The lesson is that no amount of tweaking of rules will bring back retail investors as would the confidence that the economy is going to be in a better shape tomorrow than it is now.
Thursday, August 21, 2014
A game-changer
Financial inclusion will plug leakages from economic recovery into informal savings outfits
By Mohan Sule
Even as there is a sense of optimism, if not euphoria, over the incremental steps being taken by the Narendra Modi government to put the economy back on track, Reserve Bank of India’s Raghuram Rajan has introduced a note of caution. He feels there is a danger of foreign investors, emboldened by the loose money policy being followed by their central banks to kick-start the stalled growth, pulling out of emerging economies if the recovery in the US acquires momentum. Such a development will prompt the country’s Federal Reserve to depart from its guidance of holding interest rates near bottom this year. This raises the possibility of a repeat of what happened early calendar year 2009, when the Indian stock market melted on outflow of foreign capital despite the economy projected to expand 8-8.5% in the fiscal ended March 2009. However, a run on Portugal’s biggest bank in July shows that the mature economies have a long way to go before they can be said to be in the safe zone. Also, there is a certain comfort in knowing that central banks and governments are better equipped to deal with such kind of crises. Western nations have identified banks that are too big to fail because of the likely impact on the domestic and global markets. The Portuguese government’s bailout, for instance, contained the fallout from spreading to rest of Europe. Liquidity pumping could resume to prevent another Great Depression of the 1930s, when supply of money was restricted.
Notwithstanding his bearish stance, the RBI governor deserves gratitude for building up forex reserves to defend a run on the currency in anticipation of such a scenario. The cautiousness, which keeps the rupee depreciated and widens trade deficit, is necessary till the investment climate for foreign investors improves. If not, the Indian currency could plummet even below the current 61 a US dollar, triggering the moderating inflation to flare up. Despite hiccups such as ambiquity on retro taxation and lack of clarity on General Anti Avoidance Rules, which give the taxman arbitrary powers to initiate recovery proceedings, sentiments have improved markedly since the last week of May when the National Democratic Alliance won a decisive mandate. The market has come off from its lifetime high not because of any doubts about the prime minister’s commitment to reform but due to the uncertainty created by the US decision to undertake air-strikes in Iraq and the resultant rise in crude prices. The threat of drought is receding. Hopefully, food inflation will cool down. Though big-bang reforms may have to wait, the budget initiatives to boost infrastructure have raised hopes of higher growth. One of the most important thrusts, which could be Modi’s flagship policy just as the rural employment guarantee scheme was Sonia Gandhi’s, is financial inclusion. Connecting poor villagers with the banking network could be the most ambitious economic program to be launched in India. With memories of Indira Gandhi’s loan melas and Sonia Gandhi’s farm-loan waivers, the plan as expected has met with resistance from those who prefer the present-day banking set-up, which keeps away even the urban poor. Despite a robust credit appraisal system in place, banks are struggling with bad loans. The bribery scandal at Syndicate Bank is a confirmation of the government-owned banks’ role in fostering crony capitalism.
Nothing has illustrated the failure of traditional banking more starkly than the success of Sahara, which has been told by the Supreme Court to refund Rs 20000 crore to small depositors, mainly from semi-urban areas. If the rural guarantee scheme can hand out 100 days of wages a year to qualifying recipients without any work to show, the overdraft facility proposed as an incentive can be considered seed money to bring the non-banked into the system. The benefits of the project will be immense even if half the participants imbibe good banking habits. Future loan write-offs will be nipped. The overdraft can be viewed as a fiscal stimulus to revive the economy just as linking guaranteed wages of rural folks to productivity activities. There will be a record of delinquent accounts, which will enable the government to precisely focus fiscal policies to address the dark areas of the economy. The Modi government’s refusal to cap farm subsidies, and thereby scuttling the WTO accord, too, had received lots of flak initially. Now there seems to be a consensus emerging that the position to protect Indian farmers is justifiable. Apart from providing a powerful boost to the economy, financial inclusion will prepare the poor to participate in the imminent recovery. Besides accelerating urbanisation, wages from job opportunities will not find their way to Ponzi schemes run by scamsters.
By Mohan Sule
Even as there is a sense of optimism, if not euphoria, over the incremental steps being taken by the Narendra Modi government to put the economy back on track, Reserve Bank of India’s Raghuram Rajan has introduced a note of caution. He feels there is a danger of foreign investors, emboldened by the loose money policy being followed by their central banks to kick-start the stalled growth, pulling out of emerging economies if the recovery in the US acquires momentum. Such a development will prompt the country’s Federal Reserve to depart from its guidance of holding interest rates near bottom this year. This raises the possibility of a repeat of what happened early calendar year 2009, when the Indian stock market melted on outflow of foreign capital despite the economy projected to expand 8-8.5% in the fiscal ended March 2009. However, a run on Portugal’s biggest bank in July shows that the mature economies have a long way to go before they can be said to be in the safe zone. Also, there is a certain comfort in knowing that central banks and governments are better equipped to deal with such kind of crises. Western nations have identified banks that are too big to fail because of the likely impact on the domestic and global markets. The Portuguese government’s bailout, for instance, contained the fallout from spreading to rest of Europe. Liquidity pumping could resume to prevent another Great Depression of the 1930s, when supply of money was restricted.
Notwithstanding his bearish stance, the RBI governor deserves gratitude for building up forex reserves to defend a run on the currency in anticipation of such a scenario. The cautiousness, which keeps the rupee depreciated and widens trade deficit, is necessary till the investment climate for foreign investors improves. If not, the Indian currency could plummet even below the current 61 a US dollar, triggering the moderating inflation to flare up. Despite hiccups such as ambiquity on retro taxation and lack of clarity on General Anti Avoidance Rules, which give the taxman arbitrary powers to initiate recovery proceedings, sentiments have improved markedly since the last week of May when the National Democratic Alliance won a decisive mandate. The market has come off from its lifetime high not because of any doubts about the prime minister’s commitment to reform but due to the uncertainty created by the US decision to undertake air-strikes in Iraq and the resultant rise in crude prices. The threat of drought is receding. Hopefully, food inflation will cool down. Though big-bang reforms may have to wait, the budget initiatives to boost infrastructure have raised hopes of higher growth. One of the most important thrusts, which could be Modi’s flagship policy just as the rural employment guarantee scheme was Sonia Gandhi’s, is financial inclusion. Connecting poor villagers with the banking network could be the most ambitious economic program to be launched in India. With memories of Indira Gandhi’s loan melas and Sonia Gandhi’s farm-loan waivers, the plan as expected has met with resistance from those who prefer the present-day banking set-up, which keeps away even the urban poor. Despite a robust credit appraisal system in place, banks are struggling with bad loans. The bribery scandal at Syndicate Bank is a confirmation of the government-owned banks’ role in fostering crony capitalism.
Nothing has illustrated the failure of traditional banking more starkly than the success of Sahara, which has been told by the Supreme Court to refund Rs 20000 crore to small depositors, mainly from semi-urban areas. If the rural guarantee scheme can hand out 100 days of wages a year to qualifying recipients without any work to show, the overdraft facility proposed as an incentive can be considered seed money to bring the non-banked into the system. The benefits of the project will be immense even if half the participants imbibe good banking habits. Future loan write-offs will be nipped. The overdraft can be viewed as a fiscal stimulus to revive the economy just as linking guaranteed wages of rural folks to productivity activities. There will be a record of delinquent accounts, which will enable the government to precisely focus fiscal policies to address the dark areas of the economy. The Modi government’s refusal to cap farm subsidies, and thereby scuttling the WTO accord, too, had received lots of flak initially. Now there seems to be a consensus emerging that the position to protect Indian farmers is justifiable. Apart from providing a powerful boost to the economy, financial inclusion will prepare the poor to participate in the imminent recovery. Besides accelerating urbanisation, wages from job opportunities will not find their way to Ponzi schemes run by scamsters.
Wednesday, August 6, 2014
At cross-purpose
Sebi’s mandate is to protect investors, while the finance minister’s objective is to maximise revenue
By Mohan Sule
The Union Budget 2014-15 proved to be disappointing for the opposition. There was not a single issue to whip the Narendra Modi government with despite it stealthily pulling the plug on Sonia Gandhi’s flagship rural employment guarantee scheme by linking wages to productive activities, which will ensure its slow death going forward. (Hint: FMCG companies are once again turning their focus on urban areas, with the looming drought being one of the factors.) The moaning on the absence of big-bang reforms could have turned into a weapon of torment had the government announced elimination of fuel and fertilizer subsidies or decided to get out of PSUs save for some minority stake. The uproar over the ensuing price rise and selling of the family jewels would have stalled parliament for the remaining budget session. No wonder neutral observers look to the stock market to gauge the impact of the exercise as equities, it is believed, discount all available information. On that count, leaving aside the temporary scare of the return of the debt crisis in the euro zone, the budget has scored spectacularly, with the benchmarks touching new highs some days later. Yet, it is not without blemishes. There are three sore points for investors, which were at odds with the finance minister’s stated intention of easing the tax regime. The first is the ambiguity on retrospective taxation. Despite assurance that his government would not backdate taxes, Arun Jaitley’s assertion that resorting to retrospection taxation remains the right of a sovereign government caused alarm. This implies that any Vodafone-like transaction, conducted to escape Indian taxes, could see a repeat of then Finance Minister Pranab Mukherjee’s amendment in Union Budget 2012-13.
The second is the lack off clarity on the implementation of the General Anti-Avoidance Rules. Mukherjee, who had introduced this provision, had suspended its execution for three years after the market slumped on withdrawal of foreign investors, who feared the discretion given to tax officers to initiate proceedings against anyone suspected of evading taxes. The third are two measures to reduce tax arbitrage by companies. The first is the application of dividend distribution tax on the gross amount and not on net basis. The second is the doubling of the long-term capital gain tax on debt mutual funds and extending the period to qualify for the income to three years from one year. Even investors who had bought the units earlier for their tax-efficiency compared with other fixed-income products will be subjected to the new rules. As such the budget gets low marks for providing tax stability and eliminating tax terrorism, which are essential to attract long-term capital into India. The silver linings are the imminent implementation of the Direct Taxes Code, which will enable assessees to take a long-term view on the tax rate as any changes will require an amendment, calling for three-fourths of the vote, and the proposed Goods and Service Tax reform merging all the Central and state levies into one. However, indirect taxes will be subject to changes annually like they are at present. This leads to the question if it is possible to have a consistent tax regime over a three- or five-year period.\
For this to happen, it will be necessary to change the way India looks at budget presentation. Shorn of hype, it should be reduced to tabling the country’s balance sheet rather than an opportunity to introduce reforms. For many years now, the government has been raising fares ahead of the Railway budget. Even customs and excise duties have been hiked or lowered mid way to dovetail with any import glut or slump in manufacturing. Nomenclatures such as countervailing duty, special additional duty or anti-dumping duty are used to tweak existing rates without disturbing the basic structure, which may be the result of multi-lateral trade agreements. Instead of being a yearly ritual, a taxation package can be presented to parliament with sunset clauses. This means specific revisions will be scrutinized in greater detail instead of passing the Finance Bill in totality or rolling back certain provisions under pressure. The finance ministry can also take a leaf from capital market watchdog Sebi, which frequently revises guidelines to weed out outdated practices. These updations factor in past experiences but are never applied retrospectively. But the objectives of the government and the regulator differ. While Sebi’s charter is protection of investors, the finance minister’s mandate is to maximize tax revenue and minimize expenditure. It will be historic if the finance ministry,too, changes its slogan to minimum taxes, maximum compliance.
By Mohan Sule
The Union Budget 2014-15 proved to be disappointing for the opposition. There was not a single issue to whip the Narendra Modi government with despite it stealthily pulling the plug on Sonia Gandhi’s flagship rural employment guarantee scheme by linking wages to productive activities, which will ensure its slow death going forward. (Hint: FMCG companies are once again turning their focus on urban areas, with the looming drought being one of the factors.) The moaning on the absence of big-bang reforms could have turned into a weapon of torment had the government announced elimination of fuel and fertilizer subsidies or decided to get out of PSUs save for some minority stake. The uproar over the ensuing price rise and selling of the family jewels would have stalled parliament for the remaining budget session. No wonder neutral observers look to the stock market to gauge the impact of the exercise as equities, it is believed, discount all available information. On that count, leaving aside the temporary scare of the return of the debt crisis in the euro zone, the budget has scored spectacularly, with the benchmarks touching new highs some days later. Yet, it is not without blemishes. There are three sore points for investors, which were at odds with the finance minister’s stated intention of easing the tax regime. The first is the ambiguity on retrospective taxation. Despite assurance that his government would not backdate taxes, Arun Jaitley’s assertion that resorting to retrospection taxation remains the right of a sovereign government caused alarm. This implies that any Vodafone-like transaction, conducted to escape Indian taxes, could see a repeat of then Finance Minister Pranab Mukherjee’s amendment in Union Budget 2012-13.
The second is the lack off clarity on the implementation of the General Anti-Avoidance Rules. Mukherjee, who had introduced this provision, had suspended its execution for three years after the market slumped on withdrawal of foreign investors, who feared the discretion given to tax officers to initiate proceedings against anyone suspected of evading taxes. The third are two measures to reduce tax arbitrage by companies. The first is the application of dividend distribution tax on the gross amount and not on net basis. The second is the doubling of the long-term capital gain tax on debt mutual funds and extending the period to qualify for the income to three years from one year. Even investors who had bought the units earlier for their tax-efficiency compared with other fixed-income products will be subjected to the new rules. As such the budget gets low marks for providing tax stability and eliminating tax terrorism, which are essential to attract long-term capital into India. The silver linings are the imminent implementation of the Direct Taxes Code, which will enable assessees to take a long-term view on the tax rate as any changes will require an amendment, calling for three-fourths of the vote, and the proposed Goods and Service Tax reform merging all the Central and state levies into one. However, indirect taxes will be subject to changes annually like they are at present. This leads to the question if it is possible to have a consistent tax regime over a three- or five-year period.\
For this to happen, it will be necessary to change the way India looks at budget presentation. Shorn of hype, it should be reduced to tabling the country’s balance sheet rather than an opportunity to introduce reforms. For many years now, the government has been raising fares ahead of the Railway budget. Even customs and excise duties have been hiked or lowered mid way to dovetail with any import glut or slump in manufacturing. Nomenclatures such as countervailing duty, special additional duty or anti-dumping duty are used to tweak existing rates without disturbing the basic structure, which may be the result of multi-lateral trade agreements. Instead of being a yearly ritual, a taxation package can be presented to parliament with sunset clauses. This means specific revisions will be scrutinized in greater detail instead of passing the Finance Bill in totality or rolling back certain provisions under pressure. The finance ministry can also take a leaf from capital market watchdog Sebi, which frequently revises guidelines to weed out outdated practices. These updations factor in past experiences but are never applied retrospectively. But the objectives of the government and the regulator differ. While Sebi’s charter is protection of investors, the finance minister’s mandate is to maximize tax revenue and minimize expenditure. It will be historic if the finance ministry,too, changes its slogan to minimum taxes, maximum compliance.
Thursday, July 31, 2014
Warming up
With a minimum of fuss, Budget 2014-15 seeks to prepare the economy for the marathon
By Mohan Sule
Right at the beginning of his speech, Finance Minister Arun Jaitley cautioned not to expect too much from a 45-day government. With a short span of seven months for execution before the presentation of a full-fledged budget for the next fiscal, his warning was understandable. Expectation of big-ticket reforms, hence, was unrealistic. Also, the slump in the economy was not due to any policy measures but inaction in clearing projects. The Union Budget 2014-15 aims to assemble a rainbow coalition of the poor; those at the fringes of mainstream society; the farmer; the common man, the aspiring Indian; the middle class; the entrepreneurs; small, medium and big companies; and foreign direct and portfolio investors. The resources-guzzling rural employment guarantee scheme has not been scrapped. It, however, is linked to productive activities, with emphasis on agriculture, thereby ensuring that funds contribute to the GDP. There is promise to tackle fuel and fertilizer subsidies, a big worry for the market, without any timeline. This means there will be small steps in this direction as surging crude prices due to the Iraq crisis and farmers’ precarious state due to weak monsoon have nixed any attempt to fast-track this reform. Overhaul of direct taxes has been done by the Direct Taxes Code and that of indirect taxes will happen when a consensus emerges between the states this year. As such there was no point in going on a road well traveled.
Yet the budget managed to translate all poll promises into policies. There is focus on boosting infrastructure and manufacturing with cuts in excise and import duty, empowering women, putting religious places on the map, bringing the northeast into the mainstream, imparting skills training to the youth, increasing the savings and consumption potential of the middle class, providing 24x7 power supply through 10-year tax holiday to generators and distributors, and improving access to rural areas by building roadways with a fixed daily target. There is interconnectivity between these apparently random allocations. All have the potential to fire up the economy. Prime Minister Narendra Modi has brought into the mainstream sanitation as a catalyst for growth. This does not require large capital but could have a multiplier effect. As the finance minister noted, many countries’ economies solely thrive on tourism. Airports in tier 2 and 3 cities will be a powerful fillip to commerce. Besides directly bolstering the share of services due to the boom in the hospitality industry, indirect beneficiaries will be commodities and family businesses involved in the arts and crafts. Smart cities with low-cost housing will accelerate the process of urbanization of India. Market gain of foreign investors will be on par with that of domestic investors instead of being treated as business income: nil long-term capital gain. Another reason for them to be happy is the promise to keep the fiscal deficit target at 4.1% of GDP, a trigger for soft lending rates. Small investors will get to operate through a single demat account, while small savers get to save more and pay less income tax. For the reform-oriented, FDI ceiling in the defence and insurance sectors has been raised to 49%.
The concern over banks’ health, too, has been addressed. The prescription is recapitalisation through sale of shares and not government-funded infusion, giving them operational autonomy and setting up more debt recovery tribunals. This will ensure that banks become responsible in their lending habits lest these are reflected in the stock prices. An ambitious PSU divestment target of Rs 58425 crore has been fixed for this fiscal. The referring of ongoing legal tussles to a high-powered panel to be constituted by the Central Board of Direct Taxes, though a welcome step, is a throwback to the UPA II era of ruling by committees. Setting up more interactive sessions involving assessees to thrash out knotty problems will be productive only if the solutions are translated into legislations without sacrificing revenue. The period to benefit from long-term capital gain arising from investment in debt mutual funds has been increased to three years and the tax rate doubled under the impression that these vehicles are used predominantly by companies. In fact, many small investors were buying these units of late to escape from equity market volatility. There is also an element of risk as debt funds absorb the fluctuations in interest rates quickly. This proposal could have been made applicable for investment undertaken after the budget. Overall, the budget has avoided any controversial proposals. In Congress vice president Rahul Gandhi’s words, there are no pulse-quickening measures. Perhaps his pulse will race when India is firmly on the double-digit expansion path within five years.
By Mohan Sule
Right at the beginning of his speech, Finance Minister Arun Jaitley cautioned not to expect too much from a 45-day government. With a short span of seven months for execution before the presentation of a full-fledged budget for the next fiscal, his warning was understandable. Expectation of big-ticket reforms, hence, was unrealistic. Also, the slump in the economy was not due to any policy measures but inaction in clearing projects. The Union Budget 2014-15 aims to assemble a rainbow coalition of the poor; those at the fringes of mainstream society; the farmer; the common man, the aspiring Indian; the middle class; the entrepreneurs; small, medium and big companies; and foreign direct and portfolio investors. The resources-guzzling rural employment guarantee scheme has not been scrapped. It, however, is linked to productive activities, with emphasis on agriculture, thereby ensuring that funds contribute to the GDP. There is promise to tackle fuel and fertilizer subsidies, a big worry for the market, without any timeline. This means there will be small steps in this direction as surging crude prices due to the Iraq crisis and farmers’ precarious state due to weak monsoon have nixed any attempt to fast-track this reform. Overhaul of direct taxes has been done by the Direct Taxes Code and that of indirect taxes will happen when a consensus emerges between the states this year. As such there was no point in going on a road well traveled.
Yet the budget managed to translate all poll promises into policies. There is focus on boosting infrastructure and manufacturing with cuts in excise and import duty, empowering women, putting religious places on the map, bringing the northeast into the mainstream, imparting skills training to the youth, increasing the savings and consumption potential of the middle class, providing 24x7 power supply through 10-year tax holiday to generators and distributors, and improving access to rural areas by building roadways with a fixed daily target. There is interconnectivity between these apparently random allocations. All have the potential to fire up the economy. Prime Minister Narendra Modi has brought into the mainstream sanitation as a catalyst for growth. This does not require large capital but could have a multiplier effect. As the finance minister noted, many countries’ economies solely thrive on tourism. Airports in tier 2 and 3 cities will be a powerful fillip to commerce. Besides directly bolstering the share of services due to the boom in the hospitality industry, indirect beneficiaries will be commodities and family businesses involved in the arts and crafts. Smart cities with low-cost housing will accelerate the process of urbanization of India. Market gain of foreign investors will be on par with that of domestic investors instead of being treated as business income: nil long-term capital gain. Another reason for them to be happy is the promise to keep the fiscal deficit target at 4.1% of GDP, a trigger for soft lending rates. Small investors will get to operate through a single demat account, while small savers get to save more and pay less income tax. For the reform-oriented, FDI ceiling in the defence and insurance sectors has been raised to 49%.
The concern over banks’ health, too, has been addressed. The prescription is recapitalisation through sale of shares and not government-funded infusion, giving them operational autonomy and setting up more debt recovery tribunals. This will ensure that banks become responsible in their lending habits lest these are reflected in the stock prices. An ambitious PSU divestment target of Rs 58425 crore has been fixed for this fiscal. The referring of ongoing legal tussles to a high-powered panel to be constituted by the Central Board of Direct Taxes, though a welcome step, is a throwback to the UPA II era of ruling by committees. Setting up more interactive sessions involving assessees to thrash out knotty problems will be productive only if the solutions are translated into legislations without sacrificing revenue. The period to benefit from long-term capital gain arising from investment in debt mutual funds has been increased to three years and the tax rate doubled under the impression that these vehicles are used predominantly by companies. In fact, many small investors were buying these units of late to escape from equity market volatility. There is also an element of risk as debt funds absorb the fluctuations in interest rates quickly. This proposal could have been made applicable for investment undertaken after the budget. Overall, the budget has avoided any controversial proposals. In Congress vice president Rahul Gandhi’s words, there are no pulse-quickening measures. Perhaps his pulse will race when India is firmly on the double-digit expansion path within five years.
Wednesday, July 23, 2014
Cautious love
Instead of big-bang reforms, indications are of incremental opening up in a balancing act
By Mohan Sule
Prime Minister Narendra Modi is a man in a hurry. He has to undo in 60 months the mess that took Congress 60 years to perpetuate. He has to exhibit decisiveness instead of silence, vest the PMO with the powers that had been usurped by parallel power centers, demolish votebank politics, put nation before party and propel India on the path to prosperity. In trying to achieve this, he warned, he would turn unpopular from being merely polarizing. Eventually, he admitted unabashedly, he would win over the love of his country. For the electorate who had backed Modi with a massive mandate in the hope of good days of low prices, 24 hours of power supply, whizzing away in bullet trains, living in smart cities, cheap healthcare, clean rivers and jobs aplenty, the tune did sound jarring. The first dose of the bitter medicine was an increase in passenger and freight fares. Sugar prices spurted on hike in import duty to fetch domestic producers, saddled with debt and unable to pay cane farmers, better prices. While users groaned, the market applauded the steps, once again crossing the 25,000 mark after slipping on worries of spurt in crude oils prices due to the civil war in Iraq. Railway-related and sugar stocks surged. Diesel prices have been rising by 50 paise per month and PSU oil marketing companies are buoyant on hopes of deregulation. The IPO market is stirring with buzz about PSUs and private sector companies lining up for stake-sale.
Despite the revival in business confidence, major challenges remain. Inflation is a key concern. The wholesale price index touched a five-month high in May 2014. The threat of El Nino is real. The southwest monsoon had remained elusive till end June. Onions are proving to be tearjerkers. There is talk of action against hoarders. The partial rollback in Mumbai’s suburban train fares shows the tough task ahead. It looks like an incremental approach to reforms will have to be adopted. Elections are due later this year and next in important states such as Maharashtra, Haryana, Jharkhand, Jammu & Kashmir, Bihar and possibly Uttar Pradesh. Yet Modi should not fear of becoming unpopular. Voters braved above 40-degree centigrade temperature to put him into power with a simple majority. The election conclusively rejected the welfare model of governance, which was considered necessary to get elected. Despite food security right and guarantee of rural jobs, India has opted for an economy that creates growth and not the one that barely meets basic needs courtesy the dole-outs of the government. As Modi has reiterated, development has to be a mass movement like the freedom movement. He should use the example of telecom and two-wheelers to illustrate how a free market can benefit the users through choice and lower prices in contrast to shortages created by controlled pricing. Similarly, higher fuel prices will enable oil explorers and refiners to spend on exploration, leading to higher output. Oil marketing companies can use the money to increase their reach. On the flip side is the anemic sugar industry, with restrictions on cane pricing and selling output.
Besides the direct benefit of market demand-supply determining prices, there are three indirect advantages of phasing out subsidies. The government has to resort often to market borrowing to bridge the cost of selling subsidized goods and services because there is resistance to raising taxes to meet the revenue and expenditure mismatch. Its appetite overshadows the needs of the private sector in the capital market. The diminishing presence of the government would leave more money on the table for companies to fund their requirements and, thereby, lower the cost of borrowing. Softer interest rates will spur consumption and bolster the bottom lines of companies and spur job creation. The burden of higher fuel prices would be made bearable by cheaper credit and brightening job prospects. Ramping up of Railway fare would make the network efficient and enable it to increase coverage. Higher ticket prices could see diversion of some long-distance travelers to airlines, which are expected to see heightened competition. Subsidy paring will be viewed favorably by credit rating agencies and result in country up-gradation to investment-grade from near-junk status. This would accelerate the inflow of foreign investments. In fact, India could pay a crucial role in accelerating global recovery, with the country’s hunger for goods and services from the developed world and China increasing. The negative effect of the appreciation of the rupee due to foreign inflows, thus, could be blunted for export-oriented companies, whose main market is the US. The aftereffects would be felt in the medium to long term but the short-term impact of soft interest rates will provide the trigger.
By Mohan Sule
Prime Minister Narendra Modi is a man in a hurry. He has to undo in 60 months the mess that took Congress 60 years to perpetuate. He has to exhibit decisiveness instead of silence, vest the PMO with the powers that had been usurped by parallel power centers, demolish votebank politics, put nation before party and propel India on the path to prosperity. In trying to achieve this, he warned, he would turn unpopular from being merely polarizing. Eventually, he admitted unabashedly, he would win over the love of his country. For the electorate who had backed Modi with a massive mandate in the hope of good days of low prices, 24 hours of power supply, whizzing away in bullet trains, living in smart cities, cheap healthcare, clean rivers and jobs aplenty, the tune did sound jarring. The first dose of the bitter medicine was an increase in passenger and freight fares. Sugar prices spurted on hike in import duty to fetch domestic producers, saddled with debt and unable to pay cane farmers, better prices. While users groaned, the market applauded the steps, once again crossing the 25,000 mark after slipping on worries of spurt in crude oils prices due to the civil war in Iraq. Railway-related and sugar stocks surged. Diesel prices have been rising by 50 paise per month and PSU oil marketing companies are buoyant on hopes of deregulation. The IPO market is stirring with buzz about PSUs and private sector companies lining up for stake-sale.
Despite the revival in business confidence, major challenges remain. Inflation is a key concern. The wholesale price index touched a five-month high in May 2014. The threat of El Nino is real. The southwest monsoon had remained elusive till end June. Onions are proving to be tearjerkers. There is talk of action against hoarders. The partial rollback in Mumbai’s suburban train fares shows the tough task ahead. It looks like an incremental approach to reforms will have to be adopted. Elections are due later this year and next in important states such as Maharashtra, Haryana, Jharkhand, Jammu & Kashmir, Bihar and possibly Uttar Pradesh. Yet Modi should not fear of becoming unpopular. Voters braved above 40-degree centigrade temperature to put him into power with a simple majority. The election conclusively rejected the welfare model of governance, which was considered necessary to get elected. Despite food security right and guarantee of rural jobs, India has opted for an economy that creates growth and not the one that barely meets basic needs courtesy the dole-outs of the government. As Modi has reiterated, development has to be a mass movement like the freedom movement. He should use the example of telecom and two-wheelers to illustrate how a free market can benefit the users through choice and lower prices in contrast to shortages created by controlled pricing. Similarly, higher fuel prices will enable oil explorers and refiners to spend on exploration, leading to higher output. Oil marketing companies can use the money to increase their reach. On the flip side is the anemic sugar industry, with restrictions on cane pricing and selling output.
Besides the direct benefit of market demand-supply determining prices, there are three indirect advantages of phasing out subsidies. The government has to resort often to market borrowing to bridge the cost of selling subsidized goods and services because there is resistance to raising taxes to meet the revenue and expenditure mismatch. Its appetite overshadows the needs of the private sector in the capital market. The diminishing presence of the government would leave more money on the table for companies to fund their requirements and, thereby, lower the cost of borrowing. Softer interest rates will spur consumption and bolster the bottom lines of companies and spur job creation. The burden of higher fuel prices would be made bearable by cheaper credit and brightening job prospects. Ramping up of Railway fare would make the network efficient and enable it to increase coverage. Higher ticket prices could see diversion of some long-distance travelers to airlines, which are expected to see heightened competition. Subsidy paring will be viewed favorably by credit rating agencies and result in country up-gradation to investment-grade from near-junk status. This would accelerate the inflow of foreign investments. In fact, India could pay a crucial role in accelerating global recovery, with the country’s hunger for goods and services from the developed world and China increasing. The negative effect of the appreciation of the rupee due to foreign inflows, thus, could be blunted for export-oriented companies, whose main market is the US. The aftereffects would be felt in the medium to long term but the short-term impact of soft interest rates will provide the trigger.
Wednesday, July 16, 2014
The don’ts
What a government does not do can reveal as much about its intentions as what it does
By Mohan Sule
Prime Minister Narendra Modi has received a bucketful of advice on what he must do to shake up the economy. In governance, what you do not do is equally important as what you do. Most federal bank governors in the world are reticent and confine to releasing quarterly reviews and outlook lest any of their remarks is wrongly interpreted by the money markets. There is no place for bravado while acting to tame inflation, boost growth, and restore investor confidence. From his first few days in office, it is evident that Modi is not going to practice some of the rhetorical flourishes of his campaign. He did not bow down to pressure from allies on the presence of Pakistan’s prime minister and Srilanka’s president at his inauguration. In the same way, he should not equate the strength of the rupee with India’s might in the global order. The import bill would surely come down if the Indian currency appreciates significantly but so will export earning. Just as inflation, its level hinges on the economic policies of the government. Tweaking of interest rates and intervention in the foreign exchange market by the Reserve Bank of India are merely firefighting exercises. The September 2008 global credit crisis has demonstrated that a currency is capable of moving due to factors beyond the control of the government and the central bank. Besides, what should be the level of the rupee is a debatable question.
One of the prime reasons for the defeat of Congress in the April-May general election was surging consumer prices. The new government is under pressure to tame inflation. In a report commissioned by the UPA I government early during its tenure, Modi had recommended crackdown on hoarders and clearing distributing bottlenecks. As such he is bound to implement his own suggestions. What he should not do is to pressurize the central bank to lower interest rates. Soft lending rates will no doubt boost consumption and trigger investment revival. The downside is these will not be sustainable. The release of pent-up demand and lag effect in ensuring availability could push up prices again. Instead the prime minister should let the RBI take a call, restricting himself to tackling supply-side issues and policy on minimum support prices for food grains. This hands-off approach should extend to scamsters, some of whom have political connections. The promoters of Sahara and NSEL are currently behind bars, accused of duping investors of crores of rupees. The then ruling dispensation at the Centre tried to ensnare the chief minister of Gujarat in many cases. In the end, Modi emerged triumphant by allowing the law to take its course. He should allow the wheels of justice to determine the fate of Subrata Roy and Jignesh Shah. Similarly, the prime minister should not be seen favouring any industrial group. The test case will be pricing of RIL’s gas. The previous government had okayed a hike to be implemented from April but deferred due to the Lok Sabha polls. A rollback will be a popular move but offer temporary respite as pricing of any commodity is not static and has to incorporate demand and supply. Not acting would be capitalized by opposition and could contribute to inflation. Modi should neither try to appease the consumers, which include Reliance Power, or the producer but take a long-term view that would ensure steady supply at reasonable price.
It would not be wrong to say that the UPA II government was ruled by committees. Within the cabinet, there were empowered groups of ministers, now abolished, to decide on sensitive policies. Another fad was appointing commissions to come out with reports on controversial subjects. The government does need expert advice from time to time. With the wisdom of hindsight, it is now clear that the findings can be tailored by packing the panel with members tilted towards a particular view. On many occasions the recommendations of the committees have been junked for being too radical or not suited to the prevalent political climate. Modi has positioned himself as decisive. Hence, he should not fall prey to the temptation of passing the buck. The electorate should know that, in whatever way it was arrived, the decision has his stamp of approval. Last, never should the prime minister say that he does not lose sleep over stock market volatility, like Manmohan Singh famously did during his stint as finance minister. The capital market is a measure of the health of the country. Transparent, forward-looking, and stable policies are essential for issuers and consumers of capital, who are necessary to create jobs, one of the objectives of the prime minister. A robust primary and secondary market is the best gauge for Modi to measure the success of his development agenda.
By Mohan Sule
Prime Minister Narendra Modi has received a bucketful of advice on what he must do to shake up the economy. In governance, what you do not do is equally important as what you do. Most federal bank governors in the world are reticent and confine to releasing quarterly reviews and outlook lest any of their remarks is wrongly interpreted by the money markets. There is no place for bravado while acting to tame inflation, boost growth, and restore investor confidence. From his first few days in office, it is evident that Modi is not going to practice some of the rhetorical flourishes of his campaign. He did not bow down to pressure from allies on the presence of Pakistan’s prime minister and Srilanka’s president at his inauguration. In the same way, he should not equate the strength of the rupee with India’s might in the global order. The import bill would surely come down if the Indian currency appreciates significantly but so will export earning. Just as inflation, its level hinges on the economic policies of the government. Tweaking of interest rates and intervention in the foreign exchange market by the Reserve Bank of India are merely firefighting exercises. The September 2008 global credit crisis has demonstrated that a currency is capable of moving due to factors beyond the control of the government and the central bank. Besides, what should be the level of the rupee is a debatable question.
One of the prime reasons for the defeat of Congress in the April-May general election was surging consumer prices. The new government is under pressure to tame inflation. In a report commissioned by the UPA I government early during its tenure, Modi had recommended crackdown on hoarders and clearing distributing bottlenecks. As such he is bound to implement his own suggestions. What he should not do is to pressurize the central bank to lower interest rates. Soft lending rates will no doubt boost consumption and trigger investment revival. The downside is these will not be sustainable. The release of pent-up demand and lag effect in ensuring availability could push up prices again. Instead the prime minister should let the RBI take a call, restricting himself to tackling supply-side issues and policy on minimum support prices for food grains. This hands-off approach should extend to scamsters, some of whom have political connections. The promoters of Sahara and NSEL are currently behind bars, accused of duping investors of crores of rupees. The then ruling dispensation at the Centre tried to ensnare the chief minister of Gujarat in many cases. In the end, Modi emerged triumphant by allowing the law to take its course. He should allow the wheels of justice to determine the fate of Subrata Roy and Jignesh Shah. Similarly, the prime minister should not be seen favouring any industrial group. The test case will be pricing of RIL’s gas. The previous government had okayed a hike to be implemented from April but deferred due to the Lok Sabha polls. A rollback will be a popular move but offer temporary respite as pricing of any commodity is not static and has to incorporate demand and supply. Not acting would be capitalized by opposition and could contribute to inflation. Modi should neither try to appease the consumers, which include Reliance Power, or the producer but take a long-term view that would ensure steady supply at reasonable price.
It would not be wrong to say that the UPA II government was ruled by committees. Within the cabinet, there were empowered groups of ministers, now abolished, to decide on sensitive policies. Another fad was appointing commissions to come out with reports on controversial subjects. The government does need expert advice from time to time. With the wisdom of hindsight, it is now clear that the findings can be tailored by packing the panel with members tilted towards a particular view. On many occasions the recommendations of the committees have been junked for being too radical or not suited to the prevalent political climate. Modi has positioned himself as decisive. Hence, he should not fall prey to the temptation of passing the buck. The electorate should know that, in whatever way it was arrived, the decision has his stamp of approval. Last, never should the prime minister say that he does not lose sleep over stock market volatility, like Manmohan Singh famously did during his stint as finance minister. The capital market is a measure of the health of the country. Transparent, forward-looking, and stable policies are essential for issuers and consumers of capital, who are necessary to create jobs, one of the objectives of the prime minister. A robust primary and secondary market is the best gauge for Modi to measure the success of his development agenda.
Wednesday, July 2, 2014
The dilemma
Should the new CEO be the face of Infosys or should it remain a faceless company?
By Mohan Sule
The surgery was quick but not painless. A year after being recalled from retirement to head the company he co-promoted, N R Narayana Murthy is making his second exit, scotching apprehension that he was grooming his son to take over. The nearly dozen top-deck departures appear to be the collateral damage of the shakeup to allow the new CEO and MD to begin on a clean slate. Is the worst over for Infosys? Shares looked up on buzz of a buyback and in the run-up to the appointment of a new captain. It is now clear that Murthy’s comeback was necessary for a company that had become complacent. Since his stepping down on 20 August 2006 on attaining 60 years, the stock had underperformed the broad market, the sector index as well as its peers till Murthy returned last year. Since then, it has outperformed the market though return lags in comparision with competitors. A stock’s behavior against the broad benchmark is a widely-used criterion to measure a boss’s success. On that count, Murthy has not disappointed. Nonetheless, it is puzzling why the market panicked at the high-level resignations. The executive turmoil should have been greeted favourably as it enabled the outgoing executive chairman to pick the best person to lead the company. However, the market has greeted the end of Murthy’s short reign with relief, a surprising reaction to a person who was the face of Infosys.
This throws up a contradictory picture of investors wanting stability as well as restructuring in troubled companies. Mass exodus of senior managers is frowned upon but low- and mid-end staff retrenchment is welcomed as a cost-cutting measure. The attitude to promoters, too, is ambivalent. Murthy’s comeback was met with concern that the symbol of India’s outsourcing sucess was going to become one of those family-run firms. Yet, investors derive comfort from promoters holding sizeable equity, which ensures that they remain engage with their businesses. No one expects promoters owning a controlling stake of a company going through a rough patch to step aside. Imagine the market reaction if Anil Ambani were to relinquish charge for the losses at RCom or Ratan Tata were to step down taking responsibility for the misery of the shareholders of Tata Motors and Tata Steel following the costly acquisitions of UK-based Jaguar and Land Rover and Corus. Rather than viewing Murthy’s return as essential to put the company back on track, it was construed as a reiteration of its slide. This is in contrast to the reaction to the sacking of founder Steve Jobs by Apple’s board for his expensive habits. One reason for the market’s different outlook to companies controlled by families and those run by managers could be that most old-fashioned groups are in commodity businesses, where cyclical ups and downs rather than the management style determine profitability. No wonder the FMCG and pharmaceutical sectors, where marketing and product reinvention are crucial, are dominated by MNCs and first-generation entrepreneurs. The governance bar for these promoters is set higher than for those in the business where proximity to the government is important.
Circumstances also play a role. Murthy retired in 2006, when the bull run was gaining momentum. Three years later, the global credit crisis hit Infosys’s main market, the US. There hardly has been a blip since Tata stepped down in favour of his chosen heir Cyrus Mistry, whose ascension coincides with global recovery as is evident from the turnaround in the market’s sentiment towards Tata Motors and Tata Steel. Apple’s stock has lost luster partly after the founder’s demise and also due to intensifying competition. At the same time, Samsung has been going from strength to strength despite lack of name recognition for its CEO. Why is this so? Apple is known for its innovations, while Samsung caters to the cost-conscious market with me-too products. When the Indian tech sector was in the nascent stage and corporate governance unheard of, the differentiator was the credibility of promoters to deliver quality services on time. At that stage, Murthy’s pioneering practice of making employees stakeholders and nipping the prevalent fashion of inducting family members and relying on meritocracy instead resonated with investors in the first flush of liberalization. Outsourcing is now becoming a generic business, where the focus is on clinching deals while protecting the margin. So Infosys has to decide whether it wants to be another Apple closely identified with its promoter but known for its innovations or another Samsung, where the systems are so well entrenched that who the CEO is hardly matters.
By Mohan Sule
The surgery was quick but not painless. A year after being recalled from retirement to head the company he co-promoted, N R Narayana Murthy is making his second exit, scotching apprehension that he was grooming his son to take over. The nearly dozen top-deck departures appear to be the collateral damage of the shakeup to allow the new CEO and MD to begin on a clean slate. Is the worst over for Infosys? Shares looked up on buzz of a buyback and in the run-up to the appointment of a new captain. It is now clear that Murthy’s comeback was necessary for a company that had become complacent. Since his stepping down on 20 August 2006 on attaining 60 years, the stock had underperformed the broad market, the sector index as well as its peers till Murthy returned last year. Since then, it has outperformed the market though return lags in comparision with competitors. A stock’s behavior against the broad benchmark is a widely-used criterion to measure a boss’s success. On that count, Murthy has not disappointed. Nonetheless, it is puzzling why the market panicked at the high-level resignations. The executive turmoil should have been greeted favourably as it enabled the outgoing executive chairman to pick the best person to lead the company. However, the market has greeted the end of Murthy’s short reign with relief, a surprising reaction to a person who was the face of Infosys.
This throws up a contradictory picture of investors wanting stability as well as restructuring in troubled companies. Mass exodus of senior managers is frowned upon but low- and mid-end staff retrenchment is welcomed as a cost-cutting measure. The attitude to promoters, too, is ambivalent. Murthy’s comeback was met with concern that the symbol of India’s outsourcing sucess was going to become one of those family-run firms. Yet, investors derive comfort from promoters holding sizeable equity, which ensures that they remain engage with their businesses. No one expects promoters owning a controlling stake of a company going through a rough patch to step aside. Imagine the market reaction if Anil Ambani were to relinquish charge for the losses at RCom or Ratan Tata were to step down taking responsibility for the misery of the shareholders of Tata Motors and Tata Steel following the costly acquisitions of UK-based Jaguar and Land Rover and Corus. Rather than viewing Murthy’s return as essential to put the company back on track, it was construed as a reiteration of its slide. This is in contrast to the reaction to the sacking of founder Steve Jobs by Apple’s board for his expensive habits. One reason for the market’s different outlook to companies controlled by families and those run by managers could be that most old-fashioned groups are in commodity businesses, where cyclical ups and downs rather than the management style determine profitability. No wonder the FMCG and pharmaceutical sectors, where marketing and product reinvention are crucial, are dominated by MNCs and first-generation entrepreneurs. The governance bar for these promoters is set higher than for those in the business where proximity to the government is important.
Circumstances also play a role. Murthy retired in 2006, when the bull run was gaining momentum. Three years later, the global credit crisis hit Infosys’s main market, the US. There hardly has been a blip since Tata stepped down in favour of his chosen heir Cyrus Mistry, whose ascension coincides with global recovery as is evident from the turnaround in the market’s sentiment towards Tata Motors and Tata Steel. Apple’s stock has lost luster partly after the founder’s demise and also due to intensifying competition. At the same time, Samsung has been going from strength to strength despite lack of name recognition for its CEO. Why is this so? Apple is known for its innovations, while Samsung caters to the cost-conscious market with me-too products. When the Indian tech sector was in the nascent stage and corporate governance unheard of, the differentiator was the credibility of promoters to deliver quality services on time. At that stage, Murthy’s pioneering practice of making employees stakeholders and nipping the prevalent fashion of inducting family members and relying on meritocracy instead resonated with investors in the first flush of liberalization. Outsourcing is now becoming a generic business, where the focus is on clinching deals while protecting the margin. So Infosys has to decide whether it wants to be another Apple closely identified with its promoter but known for its innovations or another Samsung, where the systems are so well entrenched that who the CEO is hardly matters.
Wednesday, June 18, 2014
The don’ts
What a government does not do can reveal as much about its intentions as what it does
By Mohan Sule
Prime Minister Narendra Modi has received a bucketful of advice on what he must do to shake up the economy. In governance, what you do not do is equally important as what you do. Most federal bank governors in the world are reticent and confine to releasing quarterly reviews and outlook lest any of their remarks is wrongly interpreted by the money markets. There is no place for bravado while acting to tame inflation, boost growth, and restore investor confidence. From his first few days in office, it is evident that Modi is not going to practice some of the rhetorical flourishes of his campaign. He did not bow down to pressure from allies on the presence of Pakistan’s prime minister and Srilanka’s president at his inauguration. In the same way, he should not equate the strength of the rupee with India’s might in the global order. The import bill would surely come down if the Indian currency appreciates significantly but so will export earning. Just as inflation, its level hinges on the economic policies of the government. Tweaking of interest rates and intervention in the foreign exchange market by the Reserve Bank of India are merely firefighting exercises. The September 2008 global credit crisis has demonstrated that a currency is capable of moving due to factors beyond the control of the government and the central bank. Besides, what should be the level of the rupee is a debatable question.
One of the prime reasons for the defeat of Congress in the April-May general election was surging consumer prices. The new government is under pressure to tame inflation. In a report commissioned by the UPA I government early during its tenure, Modi had recommended crackdown on hoarders and clearing distributing bottlenecks. As such he is bound to implement his own suggestions. What he should not do is to pressurize the central bank to lower interest rates. Soft lending rates will no doubt boost consumption and trigger investment revival. The downside is these will not be sustainable. The release of pent-up demand and lag effect in ensuring availability could push up prices again. Instead the prime minister should let the RBI take a call, restricting himself to tackling supply-side issues and policy on minimum support prices for food grains. This hands-off approach should extend to scamsters, some of whom have political connections. The promoters of Sahara and NSEL are currently behind bars, accused of duping investors of crores of rupees. The then ruling dispensation at the Centre tried to ensnare the chief minister of Gujarat in many cases. In the end, Modi emerged triumphant by allowing the law to take its course. He should allow the wheels of justice to determine the fate of Subrata Roy and Jignesh Shah. Similarly, the prime minister should not be seen favouring any industrial group. The test case will be pricing of RIL’s gas. The previous government had okayed a hike to be implemented from April but deferred due to the Lok Sabha polls. A rollback will be a popular move but offer temporary respite as pricing of any commodity is not static and has to incorporate demand and supply. Not acting would be capitalized by opposition and could contribute to inflation. Modi should neither try to appease the consumers, which include Reliance Power, or the producer but take a long-term view that would ensure steady supply at reasonable price.
It would not be wrong to say that the UPA II government was ruled by committees. Within the cabinet, there were empowered groups of ministers, now abolished, to decide on sensitive policies. Another fad was appointing commissions to come out with reports on controversial subjects. The government does need expert advice from time to time. With the wisdom of hindsight, it is now clear that the findings can be tailored by packing the panel with members tilted towards a particular view. On many occasions the recommendations of the committees have been junked for being too radical or not suited to the prevalent political climate. Modi has positioned himself as decisive. Hence, he should not fall prey to the temptation of passing the buck. The electorate should know that, in whatever way it was arrived, the decision has his stamp of approval. Last, never should the prime minister say that he does not lose sleep over stock market volatility, like Manmohan Singh famously did during his stint as finance minister. The capital market is a measure of the health of the country. Transparent, forward-looking, and stable policies are essential for issuers and consumers of capital, who are necessary to create jobs, one of the objectives of the prime minister. A robust primary and secondary market is the best gauge for Modi to measure the success of his development agenda.
By Mohan Sule
Prime Minister Narendra Modi has received a bucketful of advice on what he must do to shake up the economy. In governance, what you do not do is equally important as what you do. Most federal bank governors in the world are reticent and confine to releasing quarterly reviews and outlook lest any of their remarks is wrongly interpreted by the money markets. There is no place for bravado while acting to tame inflation, boost growth, and restore investor confidence. From his first few days in office, it is evident that Modi is not going to practice some of the rhetorical flourishes of his campaign. He did not bow down to pressure from allies on the presence of Pakistan’s prime minister and Srilanka’s president at his inauguration. In the same way, he should not equate the strength of the rupee with India’s might in the global order. The import bill would surely come down if the Indian currency appreciates significantly but so will export earning. Just as inflation, its level hinges on the economic policies of the government. Tweaking of interest rates and intervention in the foreign exchange market by the Reserve Bank of India are merely firefighting exercises. The September 2008 global credit crisis has demonstrated that a currency is capable of moving due to factors beyond the control of the government and the central bank. Besides, what should be the level of the rupee is a debatable question.
One of the prime reasons for the defeat of Congress in the April-May general election was surging consumer prices. The new government is under pressure to tame inflation. In a report commissioned by the UPA I government early during its tenure, Modi had recommended crackdown on hoarders and clearing distributing bottlenecks. As such he is bound to implement his own suggestions. What he should not do is to pressurize the central bank to lower interest rates. Soft lending rates will no doubt boost consumption and trigger investment revival. The downside is these will not be sustainable. The release of pent-up demand and lag effect in ensuring availability could push up prices again. Instead the prime minister should let the RBI take a call, restricting himself to tackling supply-side issues and policy on minimum support prices for food grains. This hands-off approach should extend to scamsters, some of whom have political connections. The promoters of Sahara and NSEL are currently behind bars, accused of duping investors of crores of rupees. The then ruling dispensation at the Centre tried to ensnare the chief minister of Gujarat in many cases. In the end, Modi emerged triumphant by allowing the law to take its course. He should allow the wheels of justice to determine the fate of Subrata Roy and Jignesh Shah. Similarly, the prime minister should not be seen favouring any industrial group. The test case will be pricing of RIL’s gas. The previous government had okayed a hike to be implemented from April but deferred due to the Lok Sabha polls. A rollback will be a popular move but offer temporary respite as pricing of any commodity is not static and has to incorporate demand and supply. Not acting would be capitalized by opposition and could contribute to inflation. Modi should neither try to appease the consumers, which include Reliance Power, or the producer but take a long-term view that would ensure steady supply at reasonable price.
It would not be wrong to say that the UPA II government was ruled by committees. Within the cabinet, there were empowered groups of ministers, now abolished, to decide on sensitive policies. Another fad was appointing commissions to come out with reports on controversial subjects. The government does need expert advice from time to time. With the wisdom of hindsight, it is now clear that the findings can be tailored by packing the panel with members tilted towards a particular view. On many occasions the recommendations of the committees have been junked for being too radical or not suited to the prevalent political climate. Modi has positioned himself as decisive. Hence, he should not fall prey to the temptation of passing the buck. The electorate should know that, in whatever way it was arrived, the decision has his stamp of approval. Last, never should the prime minister say that he does not lose sleep over stock market volatility, like Manmohan Singh famously did during his stint as finance minister. The capital market is a measure of the health of the country. Transparent, forward-looking, and stable policies are essential for issuers and consumers of capital, who are necessary to create jobs, one of the objectives of the prime minister. A robust primary and secondary market is the best gauge for Modi to measure the success of his development agenda.
Thursday, June 5, 2014
Selling Mr Modi
Did the campaign draw inspiration from corporate marketing or should companies learn from his strategies?
By Mohan Sule
The recent election to the Lok Sabha was remarkable in many ways. First, the campaign was turned into a referendum on an opposition leader rather than on the ruling party. Second was the combining of non-traditional platforms such as social media with the old fashion way of logging miles. Third was the strategy of tarring rivals. The question at hindsight is if political parties drew lessons from companies’ marketing tactics or is there a lesson for Corporate India in the way the war rooms were analyzing ground-level feedback and organizing logistics for an intricate schedule of rallies across the country? Many inferences can be drawn from the successful culmination of Narendra Modi’s journey to prime minister. First, a product’s local fame can be leveraged nationally with good marketing. Amul has become a pan India brand from being a Made-in-Gujarat variety due to its superior distribution network. However, mass selling should not diffuse product differentiation. This is the second lesson. In a country where politicians prefer the easy way of emotive appeal of religion and caste, Modi propagated development to stand apart. This approach works if it is backed by user experience. Reports suggest that the Modi wave in north India was not just a by-product of hype but also the result of testimonials of migrants from this region about the opportunities and uninterrupted power supply in Gujarat.
Actions, rather than words, reinforce an image is the third lesson. In their bid to blunt Modi’s talked-about administrative acumen, opponents used comparative advertising to show that other states were better on some social indicators. Indirectly, the debate ensured that the Gujarat model remained in the news. For the young voters hungry for jobs, the uniqueness was that Modi welcomed business investment. The contrast became stark against the backdrop of huge projects getting stuck for want of environmental clearances even as the UPA government was spending on giveaways. Modi demonstrated decisiveness when he quickly seized the opportunity presented by the agitating farmers of Singur, West Bengal, by welcoming Tatas’ Nano project. On the other hand, Rahul Gandhi’s pro-tribal stand on the troubled Posco mining project in Orissa strengthened the perception that he preferred populist posturing. While assigning valuations to stocks, the market, too, takes into account management credibility. Infrastructure companies are viewed with caution due to their dependence on government contracts. Technology and pharma companies get better discounting as they cater to the fussy developed markets. Similarly, a stock showing a sudden spurt in prices raises suspicion. While Modi’s more than 10-year track record as chief minister of Gujarat could be examined and debated, Rahul was thrust as a fresh face that the country should rely on. The hitch was that the electorate viewed him as part of the problem rather than the solution. After his criticism resulted in the withdrawal of the ordinance that would have allowed convicted politicians to contest polls, he could no longer position himself as an outsider. Voters read his inaction for most of the decade-long UPA rule either as indifference to the policy paralysis or as covert support to various ministers’ acts of omission and commission. The fourth lesson, therefore, is that consumers are open to experiment with innovations but not those merely packaged as new.
The message has to be tailored to the market. When HUL was blindsided by low-end Nirma washing powder, the leader in the premium segment hit back with its own cheaper brands. Similarly, the FMCG sector’s experiment with sachets for the small and rural users has turned out be a roaring success. Starting off with the development agenda in urban and semi-urban areas in the first half of the long election schedule, Modi switched track to his humble beginning as a tea seller. The fifth lesson is widely practised in the consumer durables segment. Automobile manufacturers produce a range of vehicles for the premium segment and the common man. The last lesson is that running down competitors should be based on facts that are not open to any other interpretation. Harping on Modi’s largesse of giving land cheaply to the Adani group did not resonate among educated urban voters who knew that the price of an immovable asset depends on its location. So the alleged setback to the exchequer on this account was not comparable with the revenue loss suffered due to selling telecom spectrum and coal blocks to cronies at throwaway prices. In fact, Rahul’s attempt to provoke outrage boomeranged as it triggered association with his brother-in-law’s dealings in real estate. In the end, it is sometimes better to sacrifice the pawns rather than expose the Queen by rash moves.
By Mohan Sule
The recent election to the Lok Sabha was remarkable in many ways. First, the campaign was turned into a referendum on an opposition leader rather than on the ruling party. Second was the combining of non-traditional platforms such as social media with the old fashion way of logging miles. Third was the strategy of tarring rivals. The question at hindsight is if political parties drew lessons from companies’ marketing tactics or is there a lesson for Corporate India in the way the war rooms were analyzing ground-level feedback and organizing logistics for an intricate schedule of rallies across the country? Many inferences can be drawn from the successful culmination of Narendra Modi’s journey to prime minister. First, a product’s local fame can be leveraged nationally with good marketing. Amul has become a pan India brand from being a Made-in-Gujarat variety due to its superior distribution network. However, mass selling should not diffuse product differentiation. This is the second lesson. In a country where politicians prefer the easy way of emotive appeal of religion and caste, Modi propagated development to stand apart. This approach works if it is backed by user experience. Reports suggest that the Modi wave in north India was not just a by-product of hype but also the result of testimonials of migrants from this region about the opportunities and uninterrupted power supply in Gujarat.
Actions, rather than words, reinforce an image is the third lesson. In their bid to blunt Modi’s talked-about administrative acumen, opponents used comparative advertising to show that other states were better on some social indicators. Indirectly, the debate ensured that the Gujarat model remained in the news. For the young voters hungry for jobs, the uniqueness was that Modi welcomed business investment. The contrast became stark against the backdrop of huge projects getting stuck for want of environmental clearances even as the UPA government was spending on giveaways. Modi demonstrated decisiveness when he quickly seized the opportunity presented by the agitating farmers of Singur, West Bengal, by welcoming Tatas’ Nano project. On the other hand, Rahul Gandhi’s pro-tribal stand on the troubled Posco mining project in Orissa strengthened the perception that he preferred populist posturing. While assigning valuations to stocks, the market, too, takes into account management credibility. Infrastructure companies are viewed with caution due to their dependence on government contracts. Technology and pharma companies get better discounting as they cater to the fussy developed markets. Similarly, a stock showing a sudden spurt in prices raises suspicion. While Modi’s more than 10-year track record as chief minister of Gujarat could be examined and debated, Rahul was thrust as a fresh face that the country should rely on. The hitch was that the electorate viewed him as part of the problem rather than the solution. After his criticism resulted in the withdrawal of the ordinance that would have allowed convicted politicians to contest polls, he could no longer position himself as an outsider. Voters read his inaction for most of the decade-long UPA rule either as indifference to the policy paralysis or as covert support to various ministers’ acts of omission and commission. The fourth lesson, therefore, is that consumers are open to experiment with innovations but not those merely packaged as new.
The message has to be tailored to the market. When HUL was blindsided by low-end Nirma washing powder, the leader in the premium segment hit back with its own cheaper brands. Similarly, the FMCG sector’s experiment with sachets for the small and rural users has turned out be a roaring success. Starting off with the development agenda in urban and semi-urban areas in the first half of the long election schedule, Modi switched track to his humble beginning as a tea seller. The fifth lesson is widely practised in the consumer durables segment. Automobile manufacturers produce a range of vehicles for the premium segment and the common man. The last lesson is that running down competitors should be based on facts that are not open to any other interpretation. Harping on Modi’s largesse of giving land cheaply to the Adani group did not resonate among educated urban voters who knew that the price of an immovable asset depends on its location. So the alleged setback to the exchequer on this account was not comparable with the revenue loss suffered due to selling telecom spectrum and coal blocks to cronies at throwaway prices. In fact, Rahul’s attempt to provoke outrage boomeranged as it triggered association with his brother-in-law’s dealings in real estate. In the end, it is sometimes better to sacrifice the pawns rather than expose the Queen by rash moves.
Wednesday, May 21, 2014
Monsoon blues
The El Nino impact on southwest rains could complicate efforts to put the economy back on fast track
By Mohan Sule
After reaching a new closing high on 23 April, the market lost over a quarter of the 8% gain notched in the current calendar year in the next five trading sessions following an alert about the El Nino effect on southwest monsoon. Historical evidence suggests that below-average rainfall is losing its potency to dent growth, though it does affect agriculture output. A year after the global financial meltdown in September 2008, the economy grew 8.6% despite receiving just 78% of normal rainfall. FY 2010 was officially declared as a drought year. Two years later, the GDP rose just 6.7% even after 101% of normal rainfall. FY 2014 saw 106% of normal rains. Yet, output is expected to slump below 5%. Besides, the Indian Met has been off the mark about its forecast. Only in FY 2011 has the actual rainfall matched the predictions made since FY 2001. In a normal year, the warning would have caused a blip for a day or two, before the market returning to its preoccupation with inflows from foreign investors. 2014, however, is no ordinary year. Besides uncertainty about the formation of a stable Union government, withdrawal of stimulus in instalments by the US Federal Reserve since December 2013 and the slowdown in China are overhangs. Concerns that a coalition government will have less flexibility to carry out reforms have already led to foreign capital outflow. Foreign institutional investors were net sellers of debt in April, perhaps worried about the inability of the Reserve Bank of India to lower interest rates, and slowed down purchases of equity after their buying reached the highest level in March of this calendar year.
The immediate concern about scanty rainfall is the pressure on food prices. Food items have been the biggest contributor to the Consumer Price Index despite good rainfall in seven of the past 10 years. Slump in demand has stalled manufacturing growth. But consumption of food continues to be buoyant as the population coming out of poverty due to reforms and welfare schemes is increasing. Shortages, therefore, could lead to a spike in food inflation and nix the chances of the RBI beginning its interest rate reduction cycle soon. Cut in household expenses could affect discretionary usage. In fact, India is caught in a paradoxical situation. Both above average and less-than-normal rainfall bolster food prices. The government hikes prices of farm output to lend support during bumper production and to compensate for the fall in harvest during drought. Hence, consumers end up paying more year after year. Indication of scarcity of any agricultural produce leads to spurt in international prices. This is what happened when India wanted to import sugar for the October 2009-Sepetmebr 2010 season after the failure of sugarcane crop. Global sugar prices shot up more than 60% from end 2008 till August 2009. A glut in Indian production, on the other hand, saw a worldwide slump in global sugar prices and duty on sugar imports had to be raised to 15% in October 2013 from 10%.
What can be done? The economy could expand in FY 2010 despite drought due to fiscal stimulus of the earlier year. Standard excise on non-petroleum products was reduced to 8% from 14% to insulate India from the worldwide credit crunch. As a result, fiscal deficit ballooned to 6% of GDP in FY 2009 from 2.5% in the previous year. In contrast, GDP could grow just 3.8% in FY 2003, another drought year, with rainfall 81% below normal, in the absence of booster doses. These sops have not been rolled back fully. Excise duty remains at 12% now. The interim budget presented in February 2014 introduced more relief for automobiles. Any more reduction in domestic levies will have to be at the expense of personal and corporate taxes. Nonetheless, any stimulus would be a short-term measure. In the medium term, infrastructure proposals need to be given clearances quickly and irrigation and low-cost housing projects have to be initiated to increase offtake of commodities such as cement, aluminum and steel and to revive the manufacturing sector. The budget for 2012-13 had proposed setting up a financial holding company for PSU banks to meet their capital needs. The idea should be extended to other PSUs, too. The holding company could offer a mix of PSU shares to get better pricing instead of seeing the stock of a standalone entity poised to enter the market getting hammered. The CPSE exchange traded fund, comprising shares of 10 PSUs constituting the CPSE index, launched in March 2014 has met with good response and should embolden the government to undertake aggressive offloading of its shares to boost the market as well as to mop up funds for growth activities.
By Mohan Sule
After reaching a new closing high on 23 April, the market lost over a quarter of the 8% gain notched in the current calendar year in the next five trading sessions following an alert about the El Nino effect on southwest monsoon. Historical evidence suggests that below-average rainfall is losing its potency to dent growth, though it does affect agriculture output. A year after the global financial meltdown in September 2008, the economy grew 8.6% despite receiving just 78% of normal rainfall. FY 2010 was officially declared as a drought year. Two years later, the GDP rose just 6.7% even after 101% of normal rainfall. FY 2014 saw 106% of normal rains. Yet, output is expected to slump below 5%. Besides, the Indian Met has been off the mark about its forecast. Only in FY 2011 has the actual rainfall matched the predictions made since FY 2001. In a normal year, the warning would have caused a blip for a day or two, before the market returning to its preoccupation with inflows from foreign investors. 2014, however, is no ordinary year. Besides uncertainty about the formation of a stable Union government, withdrawal of stimulus in instalments by the US Federal Reserve since December 2013 and the slowdown in China are overhangs. Concerns that a coalition government will have less flexibility to carry out reforms have already led to foreign capital outflow. Foreign institutional investors were net sellers of debt in April, perhaps worried about the inability of the Reserve Bank of India to lower interest rates, and slowed down purchases of equity after their buying reached the highest level in March of this calendar year.
The immediate concern about scanty rainfall is the pressure on food prices. Food items have been the biggest contributor to the Consumer Price Index despite good rainfall in seven of the past 10 years. Slump in demand has stalled manufacturing growth. But consumption of food continues to be buoyant as the population coming out of poverty due to reforms and welfare schemes is increasing. Shortages, therefore, could lead to a spike in food inflation and nix the chances of the RBI beginning its interest rate reduction cycle soon. Cut in household expenses could affect discretionary usage. In fact, India is caught in a paradoxical situation. Both above average and less-than-normal rainfall bolster food prices. The government hikes prices of farm output to lend support during bumper production and to compensate for the fall in harvest during drought. Hence, consumers end up paying more year after year. Indication of scarcity of any agricultural produce leads to spurt in international prices. This is what happened when India wanted to import sugar for the October 2009-Sepetmebr 2010 season after the failure of sugarcane crop. Global sugar prices shot up more than 60% from end 2008 till August 2009. A glut in Indian production, on the other hand, saw a worldwide slump in global sugar prices and duty on sugar imports had to be raised to 15% in October 2013 from 10%.
What can be done? The economy could expand in FY 2010 despite drought due to fiscal stimulus of the earlier year. Standard excise on non-petroleum products was reduced to 8% from 14% to insulate India from the worldwide credit crunch. As a result, fiscal deficit ballooned to 6% of GDP in FY 2009 from 2.5% in the previous year. In contrast, GDP could grow just 3.8% in FY 2003, another drought year, with rainfall 81% below normal, in the absence of booster doses. These sops have not been rolled back fully. Excise duty remains at 12% now. The interim budget presented in February 2014 introduced more relief for automobiles. Any more reduction in domestic levies will have to be at the expense of personal and corporate taxes. Nonetheless, any stimulus would be a short-term measure. In the medium term, infrastructure proposals need to be given clearances quickly and irrigation and low-cost housing projects have to be initiated to increase offtake of commodities such as cement, aluminum and steel and to revive the manufacturing sector. The budget for 2012-13 had proposed setting up a financial holding company for PSU banks to meet their capital needs. The idea should be extended to other PSUs, too. The holding company could offer a mix of PSU shares to get better pricing instead of seeing the stock of a standalone entity poised to enter the market getting hammered. The CPSE exchange traded fund, comprising shares of 10 PSUs constituting the CPSE index, launched in March 2014 has met with good response and should embolden the government to undertake aggressive offloading of its shares to boost the market as well as to mop up funds for growth activities.
The shape of things
What Sun’s buy of Ranbaxy foretells about the the pharma industry and M&As
By Mohan Sule
The acquisition of Ranbaxy Laboratories by Sun Pharma is another milestone on Deal Street. On the surface, it is seen as a vindication of the trend of fluidity in the pharmaceutical sector. In no other indsutry is there such mobility of companies and uncertainty about future earning. Giants have beaten hasty retreats and small players scaled up to large caps. MNCs have sold off to local investors as well as snapped up promising outfits. No one symbolizes this flux better than the Ajay Piramal group, which bought Indian as well as foreign drug producers and in 2010 divested its branded generics domestic business in favor of a large global producer at bumper valuation of 10 times sales. Copycat producers pushing prices down, the wait for regulatory approvals and changes in government policies keep the industry on the edge. For all the unpredictability, the market has welcomed the Sun-Ranbaxy merger for three reasons. First, promoter Dilip Shanghavi has the tenacity to make his purchases pay off. The battle to control struggling Taro was long-drawn. Despite the Israeli pharma maker’s minority shareholders foiling a merger with Sun, the acquisition is a jewel in Shanghavi’s crown: He added a producer with significant global presence to his portfolio and also lured its CEO to manage the group going global. Second, there was no cash outflow. The share-swap makes Ranbaxy’s owner Daiichi the second largest shareholder of Sun. This has raised concern about future flexibility of the group. But that is a small price to pay to conserve cash, which will be needed to revamp Ranbaxy’s manufacturing processes and to take care of liabilities arising from the US FDA’s crackdown going forward.
Third, Sun’s product portfolio will expand. It can leverage its leadership position in certain niches to position itself as a producer of generics accross spectrum, boosting bulk buying by healthcare giants. In fact, the presence of Daiichi could be taken as a confirmation of the continuing potential of Indian generics, which in the first place prompted the Japanese global maker to snap up Ranbaxy in 2008. This is in contrast to the pessimism about the local industry’s health due to its conversion into a low-margin business because of pricing controls, pushing it to seek outsourcing and exports. The deal is also notable for confirming certain assumptions as well as exploding myths about takeovers. First, companies with global ambitions require footprints in markets across the board. This includes presence in different geographics as well as in a range of products. The US market may consume drugs to counter lifestyle diseases, while the emerging markets need to thwart life-threatening ailments. Besides, patents are going off at a faster pace than new drugs being discovered. This makes the generics market crowded and cost-effective players have a better chance of survival. Second, at two times revenue, the buy was at the lowest valuation in the pharma space, signalling that the industry’s margin might have peaked, even after discounting the seller’s immediate problems, which are repairable in the short to medium term.
Third, the merger throws a light on the blurring of the caste system in the Indian drug industry. During the pre-reform era of controlled capacity and pricing, entrepreneurs could enter the segment by obtaining licences of big players on loan. Now small-scale players are getting back by concentrating on overseas markets and competing in the trading ring with older and established players. For instance, the shift in focus of Ranbaxy from being a local leader to a significant player in the US market. Thus, the deal confirms that Indian players have to look overseas to grow. The downside is the turning of the spotlight on quality issues at production facilities. Fourth, the conventional investing wisdom of ignoring distressed companies in favor of those making profit has been turned on its head as predators would prefer cheap buys rather than load their balance sheet with debt. The fifth lesson is that a brute controlling stake such as over 60% held by Daiichi in Ranbaxy need not be a barrier to change in management control. Instead of exiting through an open offer, minority shareholders of the target company would want to be part of a growth story. But if innovative financial engineering can be a boon it can also be a bane. Piramal Healthcare received cash from the sale of the generics business and later announced a 300% special dividend. But the ordinary shareholders were left with a company devoid of a divison contributing nearly 70% of revenue. Last, concern of dilution of equity (Sun’s by nearly 14%) can be addressed by the earning potential of the target’s (Ranbaxy’s) basket of products. The Sun-Ranbaxy merger, thus, could be a trigger for more cashless consolidation.
By Mohan Sule
The acquisition of Ranbaxy Laboratories by Sun Pharma is another milestone on Deal Street. On the surface, it is seen as a vindication of the trend of fluidity in the pharmaceutical sector. In no other indsutry is there such mobility of companies and uncertainty about future earning. Giants have beaten hasty retreats and small players scaled up to large caps. MNCs have sold off to local investors as well as snapped up promising outfits. No one symbolizes this flux better than the Ajay Piramal group, which bought Indian as well as foreign drug producers and in 2010 divested its branded generics domestic business in favor of a large global producer at bumper valuation of 10 times sales. Copycat producers pushing prices down, the wait for regulatory approvals and changes in government policies keep the industry on the edge. For all the unpredictability, the market has welcomed the Sun-Ranbaxy merger for three reasons. First, promoter Dilip Shanghavi has the tenacity to make his purchases pay off. The battle to control struggling Taro was long-drawn. Despite the Israeli pharma maker’s minority shareholders foiling a merger with Sun, the acquisition is a jewel in Shanghavi’s crown: He added a producer with significant global presence to his portfolio and also lured its CEO to manage the group going global. Second, there was no cash outflow. The share-swap makes Ranbaxy’s owner Daiichi the second largest shareholder of Sun. This has raised concern about future flexibility of the group. But that is a small price to pay to conserve cash, which will be needed to revamp Ranbaxy’s manufacturing processes and to take care of liabilities arising from the US FDA’s crackdown going forward.
Third, Sun’s product portfolio will expand. It can leverage its leadership position in certain niches to position itself as a producer of generics accross spectrum, boosting bulk buying by healthcare giants. In fact, the presence of Daiichi could be taken as a confirmation of the continuing potential of Indian generics, which in the first place prompted the Japanese global maker to snap up Ranbaxy in 2008. This is in contrast to the pessimism about the local industry’s health due to its conversion into a low-margin business because of pricing controls, pushing it to seek outsourcing and exports. The deal is also notable for confirming certain assumptions as well as exploding myths about takeovers. First, companies with global ambitions require footprints in markets across the board. This includes presence in different geographics as well as in a range of products. The US market may consume drugs to counter lifestyle diseases, while the emerging markets need to thwart life-threatening ailments. Besides, patents are going off at a faster pace than new drugs being discovered. This makes the generics market crowded and cost-effective players have a better chance of survival. Second, at two times revenue, the buy was at the lowest valuation in the pharma space, signalling that the industry’s margin might have peaked, even after discounting the seller’s immediate problems, which are repairable in the short to medium term.
Third, the merger throws a light on the blurring of the caste system in the Indian drug industry. During the pre-reform era of controlled capacity and pricing, entrepreneurs could enter the segment by obtaining licences of big players on loan. Now small-scale players are getting back by concentrating on overseas markets and competing in the trading ring with older and established players. For instance, the shift in focus of Ranbaxy from being a local leader to a significant player in the US market. Thus, the deal confirms that Indian players have to look overseas to grow. The downside is the turning of the spotlight on quality issues at production facilities. Fourth, the conventional investing wisdom of ignoring distressed companies in favor of those making profit has been turned on its head as predators would prefer cheap buys rather than load their balance sheet with debt. The fifth lesson is that a brute controlling stake such as over 60% held by Daiichi in Ranbaxy need not be a barrier to change in management control. Instead of exiting through an open offer, minority shareholders of the target company would want to be part of a growth story. But if innovative financial engineering can be a boon it can also be a bane. Piramal Healthcare received cash from the sale of the generics business and later announced a 300% special dividend. But the ordinary shareholders were left with a company devoid of a divison contributing nearly 70% of revenue. Last, concern of dilution of equity (Sun’s by nearly 14%) can be addressed by the earning potential of the target’s (Ranbaxy’s) basket of products. The Sun-Ranbaxy merger, thus, could be a trigger for more cashless consolidation.
The big picture
Besides fiscal projections, the government should fix monetary targets, too, to eliminate conflict of interest
By Mohan Sule
With the biggest democracy in the world kickstarting its five-year cyclical ritual, the economy has come to occupy centerstage. Should the preoccupation with growth be a reason to cheer or is the pushing aside of crony capitalism as the most important issue facing the country a sign that more things appears to change the more they remain the same? As if overjoyed by the renewed sense of importance in the citizens’ mindspace, the broad market benchmarks are scaling new heights despite uncertainty about any political grouping getting a comfortable majority and the specter of an unstable government propped up by regional forces guided by opportunism rather than by ideology. Whatever might be the outcome, there are two inescapable conclusions. The first is the preference for prosperity rather than being bogged down by controversial issues. The second is corruption is not being viewed as a standalone problem though it is considered as a blockage to development. Increasingly, there is recognition of the need for a long-term vision for the country and a package of incentives to achieve the results. The Planning Commission is assigned the role to chart India’s roadmap for the next five years. The primary objective is to assess the current resources including human, raw material and machinery, and capital in meeting the desired objectives. This is a top-down approach, with the finance minister marshalling the tools at his disposal to allocate the necessary finances.
With the opening up of the economy, investment in roads, sea ports, airports, and power generation, clubbed under the sweeping label of infrastructure and till recently the responsibility of the government, is either undertaken as part of public-private initiative or by the private sector on its own. Developers do not have to depend on the treasury to meet their funding. With guidelines framed, land acquisition is to be negotiated by the investor and the owner. Even procurement of natural resources has been left to the discretion of users: some power generators imported coal from Indonesia due to shortages in local supply. The government now acts as a facilitator by expediting clearances and a regulator by monitoring adherence to environmental safeguards and ensuring a fair-playing field. Hence, there should be a rethink on the role of the Plan panel of assigning capacity requirement, particularly for infrastructure projects. Economic indicators should be used to determine if investments are in the right direction and if policy calibration is needed. Like in other industries, overcapacity and non-performing assets should result in consolidation and unlocking of shareholder value.
The Reserve Bank of India uses the benchmark of inflation to guage the health of the economy. Recently, it shifted from the WPI to a more relevant CPI to effect changes in lending rate. The central bank also spells out the comfort level for inflation, which signals impending rate revisions. The finance minister, too, forecasts a fiscal deficit level besides growth rate. These projections are necessary not only for imparting predictability about policies but also to give the market a sense about the indicative route the fiscal and monetary authorities are likely to take to meet them. For instance, it was understood that hiking of import duty on gold was going to be a temporary measure to puncture the ballooning current account deficit and not a reversal in policy. Similarly, the state of fiscal deficit gives a rough idea about the likely course that would be adopted by the government including aggressive PSU divestment, which would have a bearing on supply of paper in the market, and ramp-up in taxes, which would affect consumption. Spurt in government borrowings signals a widening revenue-expenditure gap and heating up of interest rates. What the value of the rupee should be is a debatable issue. Yet, a steep slide is a pointer to the unattractiveness of the country as an investment destination. This would call for dipping into reserves or control on capital outflows. However, the targeting as well as the authority to act to reach the goal posts are divided between the RBI (using interest rates to influence inflation and currency) and the government (using taxes for controlling deficits and growth), leading to conflict of interest. The central bank might want the rupee to finds its own level but the government might want to cap its movement on concerns of costly imports or uncompetitive exports. Hence, there is merit in the suggestion of RBI governor Raghuram Rajan that the government should take up plotting the trajectory for various economic parameters including inflation so that other agencies can accelerate or slow down their efforts to be in step with the big picture.
Friday, April 18, 2014
What investors want
The new government has to spell out a roadmap to free PSUs, control banks’ NPAs and reduce subsidies
By Mohan Sule
Despite attempts to frame the coming general election as a referendum on communalism v secularism by Congress and corruption v governance by BJP, the choice before the voters has never been as stark as it is today. Should India continue to trundle at the pace of a tortoise or is it time to unleash the animal spirits? A controlled economy allows the government to distribute wealth equitably. The cost of this protectionism is risk-averseness, tapering of investment and low growth. On the other hand, a market orientation ensures that demand and supply get balanced out on the basis of quality and pricing. The bill is a volatile market as consumption patterns undergo dramatic and sudden changes. Unsure of which route offered a faster gateway to prosperity, India experimented with a mixed economy for most part of its existence. The exercise undertaken in the last decade of the last century to discard the socialist baggage slowed down in the past 10 years of the two terms of the UPA government in the belief that reforms left out the marginalized sections. Inclusive growth became a populist slogan to disguise the building up of the biggest welfare state anywhere in the world. The problem is that however sincere the attempts might be to direct the flow of resources to those in need, subsidized food and fuel come at a cost. The price is sucking out of liquidity from the system and thereby starving productive sectors in need of cash, resulting in costly goods and services, thereby boosting inflation and interest rates. This combustible combination slows growth, punching a big hole in the balance sheet of the country.
The realization that a robust economy is necessary to even maintain a façade of compassion dawned too late on the UPA II government. After dismantling the NDA-initiated PSU divestment ministry and the fortnightly price revision of fuel prices linked to global movement of crude oil, the UPA government had to once again fall back on PSUs to bridge the fiscal deficit and fully decontrol petrol and partially diesel late 2012. The new dispensation that will take over by end May, investors are hoping, might learn from the disastrous regime of Sonia Gandhi. What do investors want? Essentially, their wish list is simple: a stable government with a sense of purpose. This will allow return of risk-taking. Pre 2008 collapse of the global financial markets, the Manmohan Singh government had taken for granted that India would be notching double-digit growth over the next decade, heady from the inflow of foreign funds, flushed with cash due to a soaring Dow Jones index and in search of yields. Instead of getting its balance sheet in order by cutting the subsidy bill, the UPA government launched resource-sapping programs such as farm-loan waivers and rural employment guarantee scheme without exploring matching revenues. Despite giving freedom to distribution companies to supply electricity at competitive rates, pressure from state governments have disabled their decision making, choking liquidity to generators, who on the other side are facing problems of procuring coal as price caps hobble supplier Coal India to deploy capital expenditure to expand capacity.
India remained immune from the chill of bank collapse and the contagion of the sovereign debt default spreading across the euro region due to tight controls. Yet, policy paralysis and crony capitalism are sinking banks under the weight of NPAs. Shockingly, the beneficieries of the opaque process to sell licences for natural resources and award contracts for infrastructure projects are provided access to tax payers’ savings. Unless this cosy club made up of families close to the ruling elite is closed down, it would be hard to put the banking industry back on track. This leads to the second wish: freeing PSUs. Despite a majority of them being listed, they are constrained from taking decisions that would benefit their bottom lines. For instance, oil-marketing refiners. Their monopoly status has proved to be a trap rather than a honey pot for minority shareholders. Any move to offer government stake for sale results in depression in prices. Hence, investors want a roadmap for slashing subsidy. This would include not only fuel but also power giveaways. What the new government can do is to take the subsidy burden on its own balance sheet by accelerating the cash transfer scheme to those unable to absorb the resultant price rise, leaving the PSUs to sell their products at cost plus. This would enable these companies to get better discounting and embolden them to undertake expansion and modernization. Last, investors want the sanctity of the market to be preserved. They can live with bad investment calls but not investment based on misleading information and rigged stock prices.
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