The cost of quality and assurance - Straight from the Hip by J Mulraj

The cost of quality and assurance

15 FEBRUARY 2014

Recently, a few Indian car manufacturers have been found to deficient in international safety standards and have been downgraded. So have some of India's leading airlines, by the US Federal Aviation Administration. Indian businesses and services would need to move towards internationally accepted quality standards, and, when they do, it will entail a cost. Current operating profit margins would be impacted. One can argue that, if these costs are factored in, the P/E multiples for most Indian companies are higher than they ought to be.

Over three decades ago, this columnist experienced quality and assurance on his first visit to the US. I bought a T shirt from a store in New York, discovered it was bleeding, and the stitching had come undone, and went (without the receipt) to another store in the same chain, in LA. Without questioning, the store offered the option of an exchange or a refund! Businesses set aside 2-3% of revenue for such exchanges. The contrast with my experience at a leading department store at Kemps Corner in Mumbai couldn't be sharper. The store refused to acknowledge that its T shirt was defective, when returned the same day, with the receipt. When Indian manufacturers and retailers move from a policy of buyer beware to one of seller take care, the OPM would come down by 2-3%. And this was thirty years ago!

Indian consumers are unprotected both by weak regulation as well as by an impossibly slow judicial redress. These need to change.

Our regulatory system seems to lack teeth to take on the powerful and the connected. So it is possible for the Sahara group to arbitrage between regulators and the judiciary to postpone the day of reckoning, and cock a snook at a Supreme Court order to refund some Rs 24,000 crores. It now says that it has done so, in cash, and a whopping Rs 20,000 crores of dealings are in cash!. And they can get away with such a statement? Why so?

The scam tainted NSEL has used the hawala route to illegally transfer money out of the country according to the police, and yet, no action has been taken by the police? The exchange has paid out Rs 148 crores out of the settlement guarantee fund, to a favoured few investors, even when asked not to make any payments by the regulator and yet the regulator is unable or unwilling to take action. Why so?

Kingfisher Airline employees have not been paid salaries for years and the company has defaulted on its borrowings to banks. Yet the group is able to spend huge amounts to buy players in the IPL. Why so?

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The three examples point to the quality of governance by the UPA. As indicated by results of opinion polls for the forthcoming elections, the electorate has noticed the poor governance and the plethora of scams in which a favoured few are protected. This has a price.

Such crony capitalism and abysmal public governance impacts the economy via banks. The share of public sector banks, in which the Government owns a majority stake, is 70% of India's banking business. Senior management of these banks are subjected to pressure from the political bosses to favour a few, big, borrowers. These borrowings then become non performing assets (NPAs), when the borrowers are unable to repay the banks. Upto a few years ago, bank managers had the leeway to classify them as NPAs, but no longer so. The RBI is trying to stanch this rot by making the identification of NPAs system driven.

Borrowers then go in for corporate debt restructuring schemes

(CDRs) via which banks reschedule their loans and avert classification as NPAs. The amounts of CRDs is increasing, a worrying sign. The three largest sectors for CDRs are infrastructure, Iron & Steel and Power. The CDRs are cosy arrangements, and no pressure is brought for a change in defaulting management.

Ultimately it is the taxpayer and the saver who pays for such cosy crony capitalism.

The saver because he gets a lower interest rate for his deposit than he deserves, as the bank needs to set aside provisions for such NPAs. It would not be surprising if, some day in the future, the Government passes an order that all depositors will face a haircut of x % of their deposits. Cyprus did this. Other countries will also do so.

The taxpayer because its his tax that pays for such profligacies.

The Government refuses to let go majority control of its PSU banks, justifiying this by its desire to ensure safety of the financial system. Such safety is necessary, no doubt, but can be achieved if the Government retained majority control over two or three large PSU banks, including, perhaps, State Bank of India (SBI), Bank of baroda (BOB) and Punjab National Bank, and brought the others down through divestment. If the PSU banks have to grow at 15-18% to fund India's GDP growth, the Government would need to provide some $ 35b as additional capital, as per a brilliant piece by Akash Prakash. It does not have the money. If, in addition, it also has to provide these banks with funds to increase provisioning for NPAs to 70%, the figure would be $ 80b. It does not have the money.

So, if we need to grow the economy, we would need to let go of most of the PSU banks, least because they would then be released from the grubby hands of politicians and crony capitalists

. Hopefully the next Government will.

In India the problem is that banks are forced to lend to a few large borrowers, and then forced to use the CDR mechanism as a fig leaf to cover bad loans.

In the US, the problem is that a few banks have become too big to fail and able to influence Government policy. This must-read piece in Rolling Stones talks about how US banks, such as Goldman Sachs and Morgan Stanley, have been able to surreptitiously bring about a legislative amendment through which they can buy any physical asset, completely unrelated to banking!.

They thus own a large chunk of the energy infrastructure, including oil reserves, tankers, refineries, pipelines etc. Combined with their trading clout in derivative products, it enables them to manipulate both physical and financial markets.

And so perverted has shareholder capitalism become that these TBTF banks are rewarding a few and penalising the many. Barclays cut 12,000 jobs, but paid bonuses to senior management, despite a slump in profits of their business.

Back home, the Government got a windfall gain of Rs 61,000 crores from sale of spectrum. This was the spectrum it had sold earlier, which got cancelled by the Supreme Court as it was given out of turn to a favoured few by out of turn allotment. (No further news about punishment to the culprits). The winners of the spectrum, leading companies like Bharti Airtel, Vodafone and Idea, face the prospect of a winner's curse. They have spent more on acquiring it than they can afford, and will not be able to raise telecom tariffs due to the impending entry into 4G by Reliance Jio. Their dept will, in fact, go up by an estimated Rs 80,000 crores! Banks, short of cash, are asking for additional collateral to provide these loans.

The Government was expecting another windfall, from the conciliation talks with Vodafone on various tax disputes. The main one is the claim on Vodafone, a buyer, for capital gains due to be paid by Hutchison, a seller, on sale of the latter's holdings in Vodafone India through an offshore transaction. Such offshore transaction of shares were not liable for tax but, looking to the size of the transaction, were brought into the tax net. When a court held in favour of Vodafone, a retrospective amendment was made to clarify the Government's intent.

Settlement talks have broken down and Vodafone will appeal to Indian courts and probably international arbitration.

Last week Indian stock markets were largely flat. The BSE-Sensex lost 9 points over the week, to end at 20, 366, and the NSE-Nifty dropped 15, to close at 6,048. The markets are waiting for a change in Government for economic activity to resume. This has stagnated for various reasons, but the crux is non existent governance.

The general elections are expected to be announced end Feb/early March to be held mid April-mid May.

Opinion polls show the BJP emerging as the largest single party but not with a majority. It would have to take the support of regional parties, which have their own agendas. Economic decision making would thus be slowed down.

Will we see an improvement in quality of governance as well as quality of manufacture and of service? Will India's banks, which provide funding for economic growth, be freed from the constraint of Government ownership? If not, will they be able to fund a loan growth of 15-18%? But more importantly, will the new Government reward the honest and the hardworking, and punish the fraudsters and the moochers, or will it be business as usual? Will honesty get a chance in India?

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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3 Responses to "The cost of quality and assurance"


Feb 20, 2014

The countries that value Quality are bound to have leading economies. The US had terrible automobile quality and Japan demolished them in the market place in the 1980s. Japanese automakers still have a higher market share for many of their cars. So much so that it is a competitive advantage and they are able to price their cars higher than the American auto makers. Similarly, the US transparency and reliability in banking has enabled it to be a haven for many to "park" their money here. Many countries are willing to loan the US trillions of dollars because they know that their funds are safe. By and large, the US makes sure that the environment is business friendly. This results in lots of investment in the US. The US also has a predictable tax regime and cases such as Vodafone don't happen. The people and the government are mostly honest and this has made the US a magnet for entrepreneurs and risk takers.
The people and the government in India need to learn that corruption and lack of fair play may result in a short term financial gain but will surely have a huge negative impact on the future investment and trade with India.


J Mulraj

Feb 20, 2014

Lakshmi, you are absolutely right. My apologies. CDR is short for corporate debt restructuring, a process by which compannies unable to repay banks, try to get the repayment rescheduled.



Feb 15, 2014

What is CDR. It would help the acronyms , when introduced are explained as to what they stand for. Not every reader lives in India.

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