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Can transparency boost market cap?

Mar 31, 2011

Just imagine that you are managing a US$ 100 bn emerging market fund. In an attempt to have growth stocks in your portfolio you may want to look at some Indian companies. Your next job would be to identify a few sectors that have the potential to emerge as clear winners over the longer term. More importantly, ones that have strong correlation with the India growth story.

Two sectors that would be at the top of your mind would be consumption and infrastructure. Consumption is amongst the most favoured theses in a developing economy. But for a more India centric exposure, nothing better than betting on the long term infrastructure story. We know that if India has to clock double digit growth rate, the country's infrastructure has to be in shape. And considering the government's keenness to attract investments in the space, foreign investors have all the more reason to find the prospects in the sector alluring.

Despite such encouraging prospects overseas funds have been circumspect about investing in the infrastructure sector. Have you ever wondered why? Apart from the sector specific concerns like execution issues, high debt and negative operating cash flow there is one specific attribute that has been withholding the interest of overseas investors. And that is opaque management policies and transparency issues plaguing the sector.

As a rule of thumb while investing in any particular company one would ideally look at the financials and then try and assess the management quality of the company. Although there is no set benchmark to assess management quality transparent reporting policies at least gives an investor some comfort while investing in any particular company.

And when it comes to investing in the infrastructure sector, not many companies have the privilege to boast about their transparency and management quality. As most infrastructure companies deal with multitude of government and private organizations which award projects they tend to fall prey to corrupt practices.

Let us explain it with an example. Suppose you are an FMCG company. You are free to manufacture a product and sell it at your own price. Bureaucratic interference in your business is minimal as you have the ability to manufacture and price your product. However, this is not the case with the infrastructure companies. They are dependent on the government to give them the business (inability to generate business on their own). Secondly, cut throat competition (no technical skills required) ensures even pricing takes a backseat. Thus, bureaucratic interference and dependency on others to get the business forms the root cause of corruption.

For instance, let's take the case of an infrastructure company that wishes to bid for a road project in a particular terrain. Right from submission of the bid to the final award of the project there are multiple instances where the company has to deal with various government agencies. The lengthy project award mechanism prevalent in the system ensures slippages and promotes corruption .

We believe there is only one way through which the government can dismiss the corruption bug prevalent in the infrastructure sector. All the transactions in the infrastructure space have to be routed through proper payment mechanism which will ultimately erase the prevalence of black money rotating in the system. Further, there has to be complete transparency in the project award mechanism undertaken by the government. Steps should be taken to reduce bureaucratic issues which typically form the basis for corruption. Lastly, even the infrastructure companies must be transparent in their business practices.

As most of the infrastructure companies have some real estate exposure transparency in transactions assumes greater importance. If the above issues are sorted out we believe infrastructure as a sector has great prospects to attract foreign capital into the Indian markets.

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