Sunil Mittal Invictus - Straight from the Hip by J Mulraj
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Investing in India - Straight from the Hip by J Mulraj
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27 MARCH 2010


Sunil Bharti Mittal has an unconquerable spirit (Invictus), demonstrated by his taking a bicycle manufacturer to become one of India's largest telecom companies, Bharti Airtel. Bharti has, last week, bought, for $ 10.7b., the African assets of Kuwaiti telco, Zain. His spirit seems encapsulated in the words of William Henley's poem, Invictus, which says:

'It matters not how strait the gate,
How charged with punishments the scroll,
I am the master of my fate,
I am the captain of my soul.'

As India grows at a rate of over 8.5%, its industry would also grow, backed by huge domestic demand (witness the announcement by R Comm of having acquired 100 m. customers), and will spread its wings through foreign acquisitions, such as Zain by Bharti, or Corus by Tata Steel, or Tetley by Tata Tea. Some of them may prove with hindsight, to have been too expensive (like the acquisition by Tata Motors of Jaguar Land Rover) but that's part of the process.

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In this process of evolutionary growth, the Government should be an enabler. Remember how the Finance Minister of South Africa was willing to meet our Finance Minister, to talk about dual listing of MTN, when Bharti wanted to acquire a stake in it, and dual listing was a stumbling block? Instead, we find our Government is often itself a stumbling block.

Take, for example, the difference in treatment by tax authorities. The Advance Ruling Authority has ruled that a sale by the wholly owned Mauritian subsidiary of a US company, of a stake in an Indian company, would not attract capital gains tax under the double tax treaty with Mauritius. Now, when an individual investor in India files a return, the same tax authorities arbitrarily decide whether the income is a capital gain (if held over one year, it becomes tax free) or a business income based on 'trading'. The only result of such an artificial power given to tax officers is an increase in corruption.

The same tax authority also clamped capital gains tax on Vodafone (on behalf of Hutichson) when it bought Hutchison's stake in Essar's telecom business, on the ground that, although the transaction was done overseas, the underlying assets were in India.

Consider for example the STT (securities transaction tax) payable in India but, obviously, not outside India. The NSE, which is to list its options on the Singapore Stock Exchange, will soon see a bulk of its business in the derivative market moving to Singapore, since the transaction costs will be lower there. This would place a domestic individual or a domestic institution, at a disadvantage compared to a foreign one trading in Singapore.

Tax authorities are instructed to desperately rake in more revenue, to meet the insatiable appetite by Government for schemes in which most of the money is wasted. The MAT is one example. The Government directs investment by companies by offering tax incentives for things it wishes to promote. For example in renewable energy or in food processing. Once the investment is made, and the entrepreneur locked in because of it, the tax authorities then change the game, by introducing a minimum alternative tax (MAT). Hitherto computed on book profits, it will now be computed on assets! This is bordering on lunacy! Has the Government thought about what would happen if MAT is on assets, to its own PSUs many of which are making losses? Like BSNL, set to declare a huge loss this year, would be wiped out if it had to pay a MAT on assets in a capital intensive business like telecom. Also the 3 oil marketing companies, IOC (on the Fortune 500 list), HPCL and BPCL, already swimming in red ink because they have to subsidise petro products for you and me!

Now comes another possible googly from the tax department (I think one of the IPL teams should take Commissioner of Income tax in their team for the googlies). Under the 'simplified' tax code, its possible that any sale of shares below 'fair value' would attract tax on the difference. Hence, sale to a strategic partner would be taxed if found to be below 'fair value', as also rights issues to existing shareholders (amazing!), preferential allotments and even shares given to employees at a discount!

So if Bharti uses its stock to acquire Zain's African assets, and issues the stock at below 'fair value' as determined by tax authorities, then the difference would become taxable! A great way to encourage enterprise!

The question that begs to be asked is what is 'fair value' and why should the tax authorities' assessement of it be the right one? Were they to be competent to assess fair value, the whole IT Department ought to be turned into a huge mutual fund for all Government companies/banks/departments. The amount of money they could thus generate would be huge; they could do away with income tax altogether!

The root problem with our economy is the poor capital allocation, the theme of my previous column, Small is Dutiful. Using CRR and SLR, the Government gets first right on domestic savings. Indian's manage to save a third, despite our per capita income being $ 2,932, whilst Americans save 6% (it was 1% before the crisis, sometimes going into negative as consumers borrowed against the appreciating value of their homes to finance consumption) of an income of $46,443. Imagine what would happen to India's economic growth if the 33% savings were to earn an extra 1% return simply by releasing them from Government hands!

See the figures of investment in 2010, till date. FII's bought, net of sales, Rs 16,800 crores of equity and Rs 18,500 crores of debt. Domestic institutions were net sellers of equity of Rs 3,200 crores and net buyers of debt of Rs 51,500 crores.

The Government does itself, and the nation, a huge disservice, by retaining a majority control over so many banks; it can, and should, retain control only of 2 or 3 and release the rest. Because of this majority control, the banks are unable to grow at a rate both possible and necessary to finance India Inc's growth. Bharti, for example, tied up $ 8.5 b. in loans, of which SBI contributed only $ 1b for rupee loans. The bulk of the $100 m. fees payable to bankers would thus go to the foreign banks, Standard Chartered and Barclays, which financed the deal.

Some past errors are being, thankfully, corrected. The Planning Commission is finally recognising (or rather doing something about; the recognition existed) the mistreatment of farmers. Despite the popular 'Jai Jawan, Jai Kisan' slogan little has been done for the small farmer. The tax free status of agricultural income is a sham to hide the gains from corruption. Montek Ahluvalia has recommended a delinking of support prices from procurement prices; encouragement of free movement of farm produce; removing ban on export and on futures trading and other, long overdue, reforms. The Government has also FINALLY decided to distribute food subsidy directly to beneficiaries, using food coupons, instead of through intermediaries who became the unintended beneficiaries. (Or was it truly unintended?). The unique identification project of Nandan Nilekeni will go a long way in stanching a wastage of resources through systemic leakages.

Because, over the past six decades, the Governments have frittered away tax and savings resources of the people by leakages in subsidy schemes and by investing in PSUs which is not the Government's remit, it has had few resources to do the things it is meant to do. Such as providing physical and social infrastructure. In the 11th 5 year plan, the estimate spend in infrastructure is $ 500 b. of which 30% is expected to come from the private sector. To enable this to happen, the Government is thinking of permitting private sector banks to offer tax free bonds. This may be tricky; only time will tell if its a good idea or not.

Last week the BSE-Sensex rose 66 points to end at 17646, and the NSE-Nifty rose 19 to end at 5282. Both are close to the peaks of Jan 5, of 17729 and 5300, respectively. There could be a correction. Perhaps triggered by an external event.

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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5 Responses to "Sunil Mittal Invictus"
Dr.Shailesh Kumar
Apr 1, 2010
Very well written.Post-independence Indian govt.has developed a very nasty habit of complacency in decision making.Benifits of welfare schemes are squandered off by lack of correct identification and monitoring AND the govt.fails to collect due tax effectively from buisness community. Like 
Ravi
Apr 1, 2010
Thank you very much for this insightful article.. Like 
Ramesh
Apr 1, 2010
Well said regarding powers given to tax authorities. None of the enlightened auditors or taxmen could difine clearly what is share trading and what is investing. Most of the prospetive share market investors are scared of investing simply because nobody is sure of his future tax liabilities if and when he makes profit. Like 
R KAPUR
Mar 27, 2010
Excellent review. However, why lament loss of fee in Bharti deal by SBI - the deal itself is not beyond fear of a possible loss and the costs involved are not yet clear. Further, any conservative bank would survive in the long run - HDFC also did not finance this deal!! Like 
K.D.Viswanaathan
Mar 27, 2010
The write-up contained several useful pieces of worthwhile information. One can say without the least hesitation that it was enlightening. For my part, I offer my profound gratitude. Like 
  
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