Time to restrict the reckless capitalist... - The 5 Minute WrapUp by Equitymaster
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Time to restrict the reckless capitalist...

Dec 1, 2014

In this issue:
» Will Mr. Rajan give in to the demand of an interest rate cut?
» Economic growth forecasts seem to be ignoring key challenges
» Shareholder activism on the rise in India...
» and more...

We have often highlighted how the issue of crony capitalism lies at the root of a lot that is wrong with Indian economy. Huge corruption in the allocation of financial and natural resources in lieu of corporate favors such as funding at the time of elections has harmed other innocent stakeholders. The worst impact of the same is seen during the downturn in an economy. Now that the Indian economy seems to be recovering, it is time these capitalists will seek funds and favors to ride on the wave. And it is also the time that it is ensured that such reckless capitalists are kept in check.

As an article in Firstpost suggests, a risky scenario has been shaping up in India. Big and politically well connected business heads and Public sector banks are at the centre of this show. The capitalists heading these firms have gone for huge leveraging, unplanned expansions and value losing acquisitions when the economy was in growth phase. As the slowdown started, these were the biggest defaulters on interest and principal payments. Huge debt ridden infrastructure companies deserve a special mention here.

Needless to say, it was the public banks and minority shareholders that paid the cost. Political pressure to extend loans to such firms has led to the huge risk for the Public sector banks. Also, the fear of business becoming sick and banks loans classified as NPA has led to a vicious cycle of restructuring loans. This has resulted in a huge deterioration in the quality of banks' assets. And in turn has also limited capital for other efficient businesses.

With the economy coming out of the woods, some well connected infra companies with highly stressed balance sheets are again approaching Public sector banks for more capital. What is worse is that these are being entertained with Public banks having limited say in such decisions. A case in point is SBI's US$ 1 bn line of credit to Adani Group (that had been facing severe debt and financing issues) for a controversial Australian project. Meanwhile, it is the other stakeholders that are bearing the ultimate risks.

Now that the growth in the economy is expected to ride on the infra boom, it is time to fix the issue of crony capitalism. Indian promoters who have failed to honor their commitments in the past should be questioned and denied the right to access cheap capital. Investors too should avoid placing blind bets on infra theme. Instead, they should be discreet, follow bottom up approach and select only the firms with efficient, ethical and responsible managements.

Do you agree that crony and reckless capitalism poses huge threat to the Indian economy? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
India's GDP has slipped to 5.3% in the quarter ending September, as compared to 5.7% in the preceding quarter. This has come along with the data that inflation for September quarter has slowed to 3.86%, lowest in last five years. With huge focus on growth and inflation data relatively benign, will Mr. Rajan give in to the demand of a rate cut? Well, that is something we will get to know tomorrow. But here are our views for now.

Most of the decline in inflation has come from the agricultural segment. Food prices are something subject to huge volatility, relying more on monsoons and with little control of policies. Another key reason for decline in inflation has been easing oil prices, something that is highly volatile and should not be the basis of key policy decisions. Another thing that should be kept in mind is the base effect (inflation as per GDP deflator fell sharply in quarter ending March 2014). With oil prices easing, overall consumption in the economy is likely to grow which may cause prices to go up again. Last but not the least, as far as investment growth is concerned, it is the lack of proper policies that have been the real hindrance than the level of interest rates. It is better not to take our eyes off financial stability while choosing quarterly growth and inflation statistics to justify rate cut. A hasty decision supporting a rate cut will put in vain all prior efforts by the central bank to ensure stability in the Indian economy.

Will Mr. Rajan give in to the rate cut pressure?

Indian economy is witnessing a wave of optimism like never before. Despite no clear signals, no one wants to spoil the party. A case in point is GDP forecasts by the economists. Despite a sequential slowdown in the economic growth, economists are willing to stick to the full year forecasts. Lower inflation and rate cut expectation have taken attention off the fact that despite the decline in oil prices and lesser subsidy expenses, India's fiscal deficit has already reached about 83% of the annual target. Further, before this growth materializes, Indian economy has some herculean challenges to face.

As mentioned above, the deteriorating quality of bank assets is one of the prime concerns. And this is just one of the many factors that need to be watched. Others being exchange rates and crude prices, something that will be out of our control but will have significant influence on the course of economic recovery. When everybody has put on rose tinted glasses, this is exactly the time investors should be cautious and focus on fundamentals and valuations rather than the broad economic recovery theme.

If you have ever attended an annual general meeting (AGM) or extraordinary general meeting (EGM), you will be familiar with the drill. Besides other things, resolutions are proposed to the shareholders. Earlier, resolutions were often unanimously passed without much opposition from shareholders. But the landscape seems to be changing. Minority investors are slowly taking up the role of shareholder activism and upping their ante against the promoters. Here is one such recent case. At a recent EGM of India's largest liquor firm United Spirits Ltd (USL), minority shareholders shot down 9 out of 12 resolutions put forth by the management. Apparently, the EGM was attended by just about 127 shareholders. This seems to indicate that institutional investors played an active role in rejecting the resolutions.

Mind you, this isn't just a one off case. What is even more interesting is that as far as shareholder activism is concerned, India appears to be ranking higher than other Asian countries (as per a report by BNP Paribas). This has been possible because of new norms that have empowered minority shareholders on certain important matters such as related-party transactions, where their majority approval is required. With minority shareholders becoming more and more active, promoters will not be able to take them for a ride.

After opening on a positive note, the benchmark Indian indices slipped into the red as the session progressed today. The BSE Sensex was trading lower by 127 points (-0.4%) at the time of writing, with energy and power sector leading the losses. In the midst of broad based selling, stocks from the software and FMCG were the key gainers. Barring Japan and Indonesia, the major Asian markets were mixed with Chinese markets leading the gains and the Hong Kong markets leading the loses. Most European markets were trading in the red at the time of writing.

 Today's investing mantra
"Behind every stock is a company. Find out what it's doing" . - Peter Lynch

This edition of The 5 Minute WrapUp is authored by Richa Agarwal and Ankit Shah.

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14 Responses to "Time to restrict the reckless capitalist..."


Dec 2, 2014

The High incidence of NPAs in all Public sector Banks is indicative of the lower scrutiny norms for lending in public sector Banks. Any Huge loan must be shared by a consortium rather than a single Bank. Huge loans must have stricter Guarantee norms and clarity in debt servicing scheme. When these are absent, the risk of loans becoming NPAs becomes High. Beyond all this, Loans should be based on the strength of a project and not on Politics and not also on Promoter strength. Each project must be assessed individually.


Prakash Basrur

Dec 2, 2014

Public sector bank NPA is one of the biggest loot by the big and small industry owners ! In a capitalist society of Free Market economy the dictum is "survival of the best" at the hands of natural "market forces" ! If this is to be followed then why should the PUC banks give "loan to pay interest on the earlier large pending loan"?
Does a small trader/shopkeeper get this facility ? Why is this pampering of bigwigs at the expense of downturn of national economy ?Let the "survival of the fittest" mantra of Free Economy prevail in those cases and let the PUC banks initiate legal action against those "failed" industries !
It is a strange to hear banking stalwarts in private sector , like HDFC's Mr.Parekh , to ask GOI to finance the PUC banks to improve their "capital base" under such "leakage" conditions ! Why not then venture capitalists give more money to "failed" startups in the same way ?
The US ( and consequently the world , economy collapsed in 2008 precisely because of the Wall Street financial wizards created the unnecessary "Financial Bubble" by creating "bubbles over bubbles" knowing well that that could not have lasted without a crash !

Isn't the PUC banks' action of "loan over loan" in case of their NPA's similar to that ?

Fortunately for India there is RBI with its wise men who seem to put brakes on such rampant loot of another national resource , like coal and 2G/3G Spectrum , i.e. the Cash !

Whether UPA or BJP who will bell the cat to bring "acche din" ? Hopefully with such loot the nation does not become "deen" !


AB Pereira

Dec 2, 2014

Indeed and without an iota of doubt, as you have rightly pointed out, crony-capitalism (CC) is rejoicing over the new pro-CC govt that embraces them and feeds them like a nursing mother (at the cost of the small tax payer). Reducing bank interest rates at this stage is only going to be counter productive to the banks - while their large 'fixed deposits' continue at higher rates (costs), banks will be forced to reduce their loan interest rates (profits) which are floating in nature and this will be an additional blow to the sector ridden already by bad loans (again, courtesy CC policy of our governments). Lower rates can only bring more such CC loan requests pushing the banks into further delinquency problems in future. And when the banks lose capital, once again the government will rescue them by recapitalising, using the tax payers money! How wonderful!



Dec 2, 2014

Can any one give absolute figure of GDP instead of % growth or degrowth? Since there is linkage between Mcap and GDP to know whether market in general is overvalued/fairly valued/bubble zone, this figure will be useful.


sandeep banerjee

Dec 2, 2014

From the 1990s we are hearing about such crony capitalists and also about laundering of public money in public sector banks in the garb of "unrecoverable debts". Sadly no government till date came out with a list of individual or corporate defaulters (and the amount of money they didn't return). From the view of good and ethical corporate practice and also from the view of Right to Information, Equity Master, on behalf of citizens, may interfere through different channels including public interest litigation. Thanking you, ...


js dua

Dec 1, 2014

Dear Sir,

I fully agree that Crony capitalism is too dangerous and every effort should be made to stop it in whatever way one can. Public sector banks have huge NPAs of big business houses like Kingfisher Airlines etc where Crores are locked up. There will be many more like Kingfisher. Worst thing is that these banks are fighting court cases for amount as small as Rs.40,000.00 which are going on for over two years thus wasting more money on counsels, employees, court fees, as well as the precious time of the already overloaded cases. More specific details can be furnished, if required. All individuals like Mallya of Kingfisher should not be considered for any fresh loans. J.S.Dua


Jamshed R. Jesia

Dec 1, 2014

Dear Richa and Ankit,
I agree with u fully, equitymaster fails to realise the same, because SBI still a buy in your value pro !!!
Bartronics/3I Infotech/Opto circuits remained on your buy list till subscribers started complaining, then too after a long time a sell call was given ! If someone was actually checking their balance sheets investors could have exited at a reasonable loss. Please check the balance sheets of all companies throughly atleast once a year for stocks which are under your coverage, for example Hindalco near your buy range, financial very poor since acquisation of Novellis, ROE continously coming down, recently mines cancelled also management problems, 25 crores of unaccounted cash !



Dec 1, 2014

Dear Sir,
Crony capitalism is a product of corrupt politicians and their tamed officers. Other alternative viz. so called "Socialism" is even worse. Based on my experience/exposure of dealing with big projects right from concept to commissioning phases, it can be stated that loss due to crony capitalism is much less than its above alternative.
E.g. with whatever vices with Industrialists in power sector, the cost of power generation for projects developed through Competitive Bidding route under Ultra Mega Power Projects policy is much less than cost of power for projects developed through MoU routes (Which is nothing but a big corruption highway) by the Government Sector.
Many such specific examples may be cited with factual data.
It may be noted that both the Ultra Mega Power Projects, one by Adani and other by TATA, at Mundra (Gujarat) has much lower power generation cost as compared to other similar Imported Coal based power projects by any Govt./State authorities/company in India.


Dr. V H Joshi

Dec 1, 2014

Yes, there is crony capitalism active now. It may never disappear. However, small investors have to live with it to some extent. Though Finance Minister Mr. Jetley is a bit eager to prod Governor of Reserve Bank of India to cut the interest rates, the Governor has resisted it and rightly so. However, he may not be able to do so for more than say 3 months from now. By that time the new budget will be due. So, the interest rates are likely to be in tune with the objectives and details of the budhet to be presented in budget in Feb., 2015. It is likely that the interest rates may drop moderately by that time. However, I do not anticipate significant drop in interest rates because, inflation has not been tamed as of now. In upturn in inflactio may eat away all the good effect of drop in interest rates and hence make the proposal to reduce interest rates to be a self defeating proposal.

Regarding the small investors in capital market, it is better to invest in shares as well as in company fixed deposits. There are still companies which offer attractive rates on interest to beat the present rate of inflation. Regarding investment in shares, it is prudent to wait for public issues of shares by reputed companies. Issues of equity by public sector banks, especially the State Bank of India is likely to be a good issue. These shares through public issue are likely to be at 5 to 10% discount compared to market rates, which is good. Equity investments should be made with about 3 year investment time to reap reasonable capital gain.



Ravi Challu

Dec 1, 2014

You would do all members a great service by publishing a list of all such companies who have had their PSU Bank debts restructured.

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