The difficulties and costs of governance - Straight from the Hip by J Mulraj
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Investing in India - Straight from the Hip by J Mulraj
The difficulties and costs of governance A  A  A

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20 JANUARY 2012


Governing ain't easy. Any decision Government, or corporate, leaders take is monitored and they are quite often damned if they do, and damned if they don't. This column will talk of many decisions taken, often under emergency situations when there is an unnecessarily high cost to pay, and the impact they have had on the economy.

The Government is perennially strapped for cash and is fiscally incontinent. Even when tax revenues are buoyant, as they have been in the past few years, it manages to find ways to splurge the money, instead of saving for the proverbial rainy day. The Finance Ministry then has the unenviable task of looking for tax revenues, and its minions in the Tax Department conceive of new ways, often bizarre, to find it.

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Thus a few years ago, the IT Department slapped a tax penalty on Vodafone for not having deducted tax at source on the capital gains that the seller of controlling stake in Hutchison-Essar made, in an offshore transaction. Till then, offshore transactions of shares did not attract capital gains but the IT Department took the view that since the assets were in India, the capital gains were subject to Indian tax. Vodafone had to pay Rs 2500 crore as deposit. The Supreme Court has now quashed the tax liability and asked the department to refund the Rs 2500 crores with interest.

Similarly, the IT Department has asked Bharti Airtel to pay Rs 1060 crores for not having deducted tax at source on payments made to foreign carriers when Bharti's subscribers use international roaming. One believes this stand of the Department would also be untenable. Levy of such taxes is user unfriendly, just as the recent decision of DoT do disallow domestic roaming pacts made by telcos. No telco has been able to acquire 3G bandwidth in all circles and so, to allow their customers the benefit to roam nationwide, have entered into pacts to share services. Why this should be considered illegal, when it is common for 2G services, is not clear and it, too, is user unfriendly.

Or take FDI in civil aviation. Years ago the Tatas, who founded Air India, made an offer to acquire it, together with Singapore Airline, a world class carrier. The Government refused. Air India is bleeding to death and requires continuous pumping in of equity by the Government, and continuous lending by unwilling public sector banks. The PSU Banks are now willing to invest in Air India bonds if they are guaranteed by Government and are treated as Government bonds. Which, essentially means that a failed airline is being rewarded with a high rating on its bonds simply because the Government, or parts of it, want to hold on to full ownership.

There is no good reason for such insistence. The only plausible explanation is that the Government owned airline can be compelled, for whatever reasons, to buy expensive aircraft it doesn't need, which bankrupts it, and for the convenience it affords politically connected people to book (without paying for) flights, upgrade themselves and, on occasion, delay and divert flights to accommodate relatives.

Now that Air India and Kingfisher are deep in a material that, when it hits the fan, causes unpleasantness, the Government has suddenly turned 'pragmatic' and permitted 49% FDI in civil aviation. Faced with the prospect of a bottomless pit of funding Air India, they have even permitted their own self interest to be diluted to allow 49% of Air India to be sold! In short, the parent is now trying to marry off an old hag instead of a comely maiden.

After having messed up the telecom sector and the civil aviation sector, the Government is succeeding in systematically doing so for the energy sector. The Government insists on subsidising prices of petrol (only recently freed from subsidy), diesel, kerosene and LPG, and, since it is fiscally incontinent, forcing public sector companies to share the subsidy burden. This is shared on an arbitrary basis by the producing companies, ONGC and OIL, by the gas transmission company GAIL and by the downstream refining companies Indian Oil Corporation (IOC), Bharat Petroleum Corporation Ltd. (BPCL) and Hindustan Petroleum Corporation Ltd (HPCL). The last three have essentially been transformed from successful 'navratnas' (nine jewels) to loss making companies. Over time they would be sold off, and perhaps be better managed than by bureaucrats in Delhi.

Now it is the turn of the upstream companies ONGC and OIL, to be killed, and the Government has, last week, stuck a dagger in their backs by capping the cost per barrel charged by them to the downstream companies at $ 54/barrel, half of the market price of $ 110. This is only in order to reduce the outflow from the budget. What it would achieve are a few things.

One it would result in Oil and Natural Gas Corporation Ltd. (ONGC), India's most profitable company, starting to go down in profitability, and thus in valuation, over time. This, in turn, would impact its subsidiary, ONGC Videsh, which hunts for energy assets abroad to secure the country's energy future.

It would also impact the profitability of private sector refining companies who would not get the crude at $ 54/b. This is what is happening in the airline industry. Whilst Air India, being wholly Government owned, gets funds from it as well as banks, private sector firms do not. There has to be a level playing field.

In corporate news of interest, the tussle between partners Telenor, of Sweden, which holds a 67% stake in Uninor, with its partner, Unitech, is interesting. Like any other telecom company, it needs funds to expand; it has built up a customer base of 35 m. Telenor says that after it got involved in the 2G telecom scam, for which Unitech's Sanjay Chandra was a guest of Government for a few months, bank borrowing was closed as an option to fund expansion. It wants to have a rights issue, instead. It is valuing the firm at Rs 600 crores (it needs to bring in 67% of the money) whilst Unitech says the valuation should be twenty times higher! Yet it was only about two years ago that the 67% stake had been bought for a whopping Rs 6100 crores. Basically, the main value of a telco lies in its spectrum, and the 2G scam revolved around the way in which spectrum had been allotted. One view, which this columnist agrees with (with a caveat) is that spectrum should be sold at an affordable cost in order to benefit the end customer. The other view is that it should be auctioned to the highest bidder. The caveat is that if the first is followed, the Government should incorporate conditionalities which would prevent the holder of spectrum to benefit from its sale, either through a sale of a share of the company (as to Telenor) or of telecom circles, with the spectrum. Should the holder of spectrum seek to profit from its sale, he should be penalised. This can be done by granting the right to use spectrum, for a fee, but not to own it. The 2G scam was thus of favouritism in allotment of spectrum not necessarily in its pricing.

The other interesting news is that the Directorate General of Hydrocarbons has opined that Reliance Industries Limited (RIL), or other operators, cannot be denied their right, under the PSC (production sharing contract) of increase in their capital costs.

RIL has announced a share buyback scheme, although details are awaited. Given both the above, the downside to its stock price may be limited. Essar Oil's stock price dipped after it lost its appeal in the Supreme Court over a sales tax refund claim by the Gujarat Government. The company had encountered a delay, which it claims was out of its control and largely due to Government action, in the commissioning of its refinery. The delay took the commissioning date beyond that for which the State Government had a scheme for sales tax benefit.

In global news 133 year old Kodak, once a leader in its field, filed for bankruptcy. It was done in by the advent of digital photography and its management did not make the inflection point, as Fuji of Japan did, and has paid the price.

Last week the Indian equity markets rallied as foreign investors started to look with renewed interest at the Indian market, and have pumped in $ 1 b. in the past fortnight, making India one of the best performers in calendar 2012. The BSE-Sensex rose 584 points to end at 16739 and the NSE-Nifty gained 181 to end at 5048. For foreign investors who invested when the rupee was Rs 54 to the $, they have a double whammy as the rupee has firmed to around Rs 50.

How long would the rally last? Given that elections to 5 states, including the largest, UP, are to be held by March, its unlikely to last long. The Budget would be presented soon thereafter and there is no fiscal elbow room left to feel that it would be a kind one. GDP growth forecasts for 2012-13 also cannot pin it at much above 6.5%, if that, since capital formation has slowed down with high interest rates and policy paralysis.

Globally Europe is still shaky and a crisis can be expected any time soon. That would again lead to nervous selling, globally. An unknown factor is Iran. It is going ahead with its plans to have nuclear capabilities, ostensibly for power generation. The West is imposing sanctions on it and China, its biggest oil buyer, is under pressure to stop/slow down on its oil purchase. Israel is threatening to make a preemptive attack which, should it happen, will create a major crisis. Thus the chances of the rally being cut short are higher than the chances of it continuing for long. In case of a sharp fall, however, on either domestic or international reasons, investors may want to consider buying. The India story will remain a good one for years to come.

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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Equitymaster requests your view! Post a comment on "The difficulties and costs of governance". Click here!
5 Responses to "The difficulties and costs of governance"
Piyush Singh
Jan 22, 2012
The idea of healthy economy lies in free trade and level-fielded competition. Although, India is nomenclatured as a 'Mixed economy', the fable of her growth is, primarily, is escorted by the private sector.

A business should be run by credible management, who could confront the competitiveness by efficient policy making. Our beleaguered PSUs seem to be practicing the opposite; & the government seems to nourish them in own coocoons..!

Just hope that the government realises that feeding these cri-babies is not a sustainable solution to a chronic problem - infact, by 'imposed borrowing', they only are fostering more cry-babies!
Like 
Piyush Singh
Jan 22, 2012
The idea of healthy economy lies
in free trade and level-fielded
competition. Although, India is
nomenclatured as a 'Mixed
economy', the fable of her growth
is, primarily, escorted by the
private sector.

A business should be run by
credible management, who could
confront the competitiveness by
efficient policy making. Our
beleaguered PSUs seem to be
practicing the opposite; & the
government seems to nourish them
in own coocoons..!

Just hope that the government
realises that feeding these cri-
babies is not a sustainable
solution to a chronic problem -
infact, by 'imposed borrowing',
they only are fostering more cry-
babies!
Like 
Rajan Nireshwalia
Jan 22, 2012
Mostly too negative but paradoxically ending on a positive note which makes more sense!!!!!!!!!!!! Like 
s k sarda
Jan 21, 2012
A huge sum is offerred for NaREGA. It has stopped the shift of people from village to Urban working place resulting in shortage of manpower in Urban centres. The cost of living for the urban people have gone up. They are already compelled to cough up 30% income tax and 10% Service tax and this money goes for Narega to allow workers to remain at home and the city people who pay taxes are compelled to do more work to feed the Lazy Naregas. Like 
mahesh ganatra
Jan 21, 2012
FII divested some holdings When share values were high and rupee was at 45/46. Funds were repatriated in dollars.

Now they are reinvesting the same dollar when rupee is at 51/52 and the share prices are down by almost 20% to 50%.

So expect the rally to be on at least till budget.The govt was sleeping but has woken up to the crisis. Look how the rupee has started recovering!

Hope you will be able to see more silver lining in the coming days.
Like 
  
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