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.
Monday, October 27, 2014
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.
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