Liberalisation - and the many unintended spinoffs - Outside View by Luke Verghese

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Liberalisation - and the many unintended spinoffs
Apr 19, 2011

Liberalisation means the right to do business with minimum government interference. When the Union Government took its first hesitant steps towards liberalising the economy in the early 1990's, it did not quite clearly define for itself what liberalisation meant, and what it implied by way of plan of action.

Liberalisation - A halfway house?

The government did apply the surgeon's scalpel on de-licensing, as well as on direct and indirect taxes, and gave an impetus to exports too. It also progressively reduced the number of items reserved exclusively for the small scale sector. Consequently over time the Union Budget lost its prima donna status. Mercifully, cigarettes which regularly did the vanishing trick from retail outlets two weeks before the budget, now stays on the shelf right through the budget week!

As Swaminathan Aiyar said in his column titled High Graft-High Growth, what liberalisation achieved was a half way house. Today corporates do not have to maintain a fully staffed 'embassy' in New Delhi. Executives make fewer trips to the capital, as businesses can now plan new projects and implement expansion schemes without awaiting Big Brothers nod.

After all these years, government interference remains total

But governmental interference in the functioning of businesses is still total. The checks and balances built into the system to regulate the functioning of businesses, is largely for the limited purpose of personal aggrandisement.

Karnataka is a classic example of the rot that possibly permeates through the system. The 'Bruhat Bengaluru Mahanagara Palike' by their actions gives the impression of having recently wised up on how to generate cash flow. The standing committee on works will make a visit to the project site and find a flaw in the construction when the building is structurally 90% complete, leaving no option save for a negotiated completion as is likely to be the case with the Marriott hotel on upscale Vittal Mallya Road. But the SCW members got punched in the face when they visited Garuda mall and tried to pull a fast one on the proprietors. But it is not government agencies alone who are taking stock of the big picture from the wild side.

India Inc. is no vestal virgin either

India Inc. itself is increasingly up to no good either. Companies operating across the board have prospered from the boom that initially permeated the IT and BPO sectors. As the country now pushes well into the second decade of the 21st century, they are now thinking big and expanding their scale of operations across continents. And How! Some like United Phosphorus for example may have as many subsidiaries and affiliates across geographies as Unilever does - in a manner of speaking.

But the point is also that, Indian entrepreneurs after coexisting through decades of licensing and controls, (which in effect nurtured monopolies, rather than controlled them) are made of much sterner stuff. Their actions reveal that the old order of doing business is if anything even more firmly entrenched in the Indian business psyche than ever before. And in doing so they are protected by the very watchdogs that are tasked with overseeing their functioning. So our corporations continue to flout good governance norms with impunity.

Capital outflows: Is all well here?

The very disturbing fact that is becoming increasingly evident is that the capital outflows made by these companies into the share capital structure of entities that are floated abroad, or in the debt capital of these siblings, do not seem to be made with the right vibes in mind. These new entities are sprouting by the many dozens, and in far away outbacks at that, to also acquire control of companies abroad.

United Spirits which has acquired liquor and wine brands abroad, is the world's second largest liquor manufacturer by volume and soon hopes to be the world's largest manufacturer. Tata Chemicals has expanded abroad and is the second largest producer of soda ash in the world. The management of United Phosphorus says that the company's visibility in the global agrochemical market is apparent. The directors' report adds that it is now considered as a significant reliable player in the global market. There are numerous other such examples of listed Indian corporates which have scaled the global value added chain through a process of mergers and acquisitions.

Granted the funds are also being put to good use. However there is something deeply rotten too about the purported use of these funds. The deployment of the funds is not above reproach.

These subsidiaries (wholly owned, partly owned, step down, and fellow subsidiaries, etc) have very complex shareholding patterns as do joint ventures (which is slowly gaining traction), or affiliates, where the parent's holding is kept at a strategic 49.9%. Such displays of ingenuity appear to be designed more to confound and obfuscate, and get round the disclosure provisions of the Companies Act, rather than with any good intentions or purpose. This cockeyed attitude appears to be more at play in the 'videsi' operations than in the 'desi' operations.

Beating the zaniest spider at its own game

The most favoured ports of call are Mauritius, the British Virgin Islands and Netherlands. Is Netherlands a tax haven too? The other less favoured nest eggs being Luxembourg, Jersey, The Isle of Man, Switzerland, and Singapore. One pharma company, Matrix Laboratories, has a fetish for Belgium and China.

Companies like United Spirits, Matrix laboratories (now delisted for trading), Cadila Healthcare, Gujarat Heavy Chemicals Ltd (GHCL) of the Sanjay Dalmia group, Reliance Industries, Raymond, and yet many more, not chronicled here, have spun such an incredible web of subsidiaries, that it will make even the zaniest spider look like a pup.

Add to this, another prodigious list of enterprises over which key management personnel and their relatives have significant influence. Ballarpur Industries for example has 111 companies or so which constitute a 'group' as defined under the MRTP (Monopolies and Restrictive Trade Practice) Act 1969. The number of subsidiaries that parent companies have germinated has no bearing whatsoever with their present scale of operations. As a matter of fact there are so many subsidiaries attached to companies, that the managements have difficulty in getting the names right. One schedule shows the old name, and the next schedule shows the new name of the company. A case of corporate Alzheimer's perhaps?

Magicians of the world retire!

The financial performance results of many of these subsidiaries have scaled flights of fantasy - so much so that they will find a ready entry in the Ripley's Believe It Or Not prime time show. Believe me; I am not hallucinating here when saying all this.

Many of these subsidiaries are mere scraps of paper. Yet other subsidiaries generate substantial profits on nil revenues, which is about as far out as it can get. Some others with large asset bases do not generate revenues, while still others generate large revenues with zero assets. This is pure magic mantra! What they all have in common however is that none of these companies declare dividends.

Cadila Healthcare, has cottoned on to Sikkim of all places to set up a 96% owned partnership firm, to generate income and profits, which appear to be totally out of sync to the size of Sikkim's economy. Tata Chemicals has an American subsidiary called Valley Holdings Inc, with a capital base of US$ 1, and it ponied up revenues of Rs 18 bn. And, United Spirits has lavished both love and lucre running into tens of billions of rupees either as equity capital or as loans to its favoured siblings - largely of the firangi variety. And, what is the overall return on its investment please? There are several other companies that I have reviewed which will give United Spirits a run for its largesse.

Let's honeymoon in Mauritius!

What is the mysterious 'honey trap' effect of Mauritius, the sun soaked Island republic in the Indian Ocean that attracts Indian companies to it in droves, the way moths are attracted to a flame? Incorporating letter head holding companies in Mauritius is the flavour of many seasons now. Is it because Mauritius offers more fail safe strong rooms than other 'videsi' nations? Or is there some perceived tax benefit from hosting a company there? Okay the double taxation treaty between India and Mauritius gives the benefit of zero tax on dividends received by companies headquartered in Mauritius, and also offers similar benefits for capital gains. But what else is there? Besides, it is not the sun soaked beaches, or even the tax benefits that may accrue to companies that attract India Inc to its shores in the first place, as these companies by and large do not generate any revenues in the first place. There is it would seem some other very important factor at play here.

It appears that companies registered in Mauritius do not have to get their accounts compulsorily audited by an independent auditor at year end. That is to say that what the company's accountants dish out at year end in the form of a P&L (profit and loss) account and balance sheet is deemed sufficient. Wow, this is cool! In other words Indian companies which have subsidiaries domiciled out of Mauritius are appending the unaudited statement of accounts of their subsidiaries. Talk about imparting an iota of authenticity.

Making corporate reporting more accountable

There are several measures that the government must take, if they genuinely want to fight perceived corporate deception. The first point is to make companies give enough genuine reasons to incorporate a subsidiary or an affiliate or some such. It cannot be made a right of a management to do so without any checks and balances.

Second, the performance results of these siblings will have to be monitored - by SEBI perhaps. Otherwise one will end up with a situation of a United Phosphorus having 65 subsidiaries, the vast majority of which are non entities. And pray, why is it so necessary to incorporate companies in tax havens to control foreign operations in the first place? Why cannot the holding company be incorporated in India under Indian laws? What is the catch here?

The next point is on the presentation of the accounts of the subsidiary companies, associate companies, joint ventures and such like. As the law stands today parent companies are expected to present the full form P&L account of their siblings. But it never happens in practise. The MCA (Ministry of Corporate Affairs) as a matter of routine permits them to furnish the results in the abbreviated format and that too only for the latest year. The possible reason for allowing this sleight of hand is that the presentation of full form results will bloat the size of the annual reports, 'waste' precious paper, add to administrative costs, and probably serves 'no purpose' too. (Shareholders can however separately request for the full form working results-but that is another issue.)

This is a convenient escape route for companies, especially when the subsidiaries themselves are found wanting. The reporting of the results of the subsidiaries has to be made more accountable. The way it is furnished today does not do any justice to the concept of public disclosure. Besides, different companies have their own take on how the results should be presented. Gulf Oil Corporation has presented the results of the subsidiaries as a part of the Directors' report in a written format mode, in the briefest possible manner. Some statutory reporting format should also be made applicable for joint ventures and for associates etc also. Especially in the case of associate companies where the shareholding pattern is such that the parent's shareholding is so manipulated so as to remain outside the ambit of the disclosure law. It is not that the MCA is not aware of what is going on - it is just that matters are allowed to drift.

The next point to be looked into is on the separate reporting of the export turnover of companies. Presently the law mandates that companies should compulsorily furnish segment information of the primary segments of its business which also reveals the profit or loss of each segment. Exports today constitute a major segment of the business, and they also represent a separate segment of the business. The way the dice is loaded today there is no way of knowing whether this line of business is bringing in any money.

BIFR - a basket case?

Last but not the least is in the functioning of the BIFR (Board for Industrial and Financial Reconstruction). The Board, which operates under the ambit of the Ministry of Finance, Government of India has been operational since 1987. But it gives the impression of being an organisation which does not having a clue of how to conduct its affairs in spite of the passage of years at the job. Take the instant case of the resuscitation being attempted to bring back to life SPIC (Southern Petrochemicals Industries Corporation) and Mafatlal Industries. Both these companies were brought down to their very knees by the incumbent managements who have been at the helm of affairs since their inception.

To start with it takes forever for the BIFR to come up with a viable revival plan, which in the interim only acerbates the illness of these companies. The BIFR has come to the rather incredulous conclusion that the first step in the revival process involves firmly ensconcing in the corner office the very managements who were wholly responsible for the undoing of the companies under their charge. So it has made it mandatory that the managements must bring in piddling sums of money to increase their voting strength to an unassailable limit as a precondition for the companies to be eligible for doles on the one hand, and write off of dues by their creditors on the other. To think that the BIFR could come to such a perfidious conclusion is in itself a brazen act of effrontery. The first step in any revival process is to bring about a change in the management. BIFR has to be given the powers to affect regime changes, while vesting the lenders of moneys with the same rights. Otherwise what purpose will be achieved? If the BIFR goes about its task in this manner it may at some point of time become a BIFR case itself.

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.


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