Democracy, capitalism and more... - 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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14 APRIL 2008

Two things will prevent the bull from snorting too loudly this calendar year. One is democracy, which entails elections, which would, in all likelihood, be announced this year. The other is the set of problems created by excessive greed, which is the offshoot of shareholder value creation, the bedrock of shareholder capitalism.

Democracy, especially a multiparty democracy in a multicultural nation of over 1 b. people, involves making of gestures to appease vote banks. Our political leaders are masters at making gestures. Thus the Government, bowing to diktats from its Left coalition partners, refuses to raise prices of petrol, never mind the economic and environmental cost of doing so. (Car owners, it seems, are also proletariat now!). Instead of targeting subsidies to reach the deserving sections, by using technology (smart cards) that are now available, the Government gives blanket subsidies for LPG and diesel, which benefit non deserving people and ruin balance sheets of PSU oil marketing companies with minority shareholders. Simply gestures.

Commerce Minister Kamal Nath makes a gesture of creating over 100 m. jobs by incentivising exports, through tax sops, to increase from $ 145 b. to $ 200 b. Contrast this with what one company, Reliance Industries, has done at its Jamnagar facility where it is setting up the world's largest refinery. It set up a craft training centre which provided training to, and later jobs for, thousands of carpenters, welders, electricians, plumbers, masons, etc. required for setting up the refinery.

As elections come closer the propensity to make more gestures, in order to curry favour with vote banks (even though Gujarat state elections reveal that voters have started caring more for performance than for platitudes), will increase. These will cost money, which the Government doesn't have, despite a booming economy providing buoyant tax revenues (banks have not been provided promised subsidy for giving cheap agri loans). It will have to borrow money, driving up interest rates. Inflation has crept up to 7.4%, and rising, which will also result in higher interest rates, making debt relatively more attractive than equity. If the stock market does not start electrifying investors (and it seems very unlikely to) incremental saving will tend to go more towards safe interest bearing debt instruments.

The other reason for not getting too excited about chances of a mad bull disease striking Dalal Street, are global markets. Shareholder democracy was adopted by US corporations in mid 80s at a time when Japanese and German companies, using stakeholder democracy, were trouncing America. Seven of the top ten global banks were then Japanese, the Nikkei had hit stratospheric levels, NTT DComo was the worlds most valuable company and Sony had taken over Columbia Pictures. Shareholder capitalism concentrated on only one of four stakeholders viz. owners of capital, in the belief that the interests of others (labour, customers, suppliers) would fall in line. This has gone too far, resulting in subprime and credit crisis, as financial institutions lent recklessly in order to boost shareholder value, never mind the risks. The IMF feels that the loss could be close to $ 1 trillion. If so, it will be a few months before capital feels confident enough to invest in emerging markets again.

Last week the BSE-Sensex rallied 464 points to close at 15802. The major chunk of this rise came from Reliance Industries (RIL), which contributed 241 points, followed by BHEL with 48. The NSE-Nifty gained 130 points over the week to end at 4777.

RIL was buoyed by news that it may sell 10% of its D6 block in the KG gas basin, to an oil major like Shell or BP, and that gas output could be significantly higher than thus anticipated. Another reason is the intervention by the Government, which has reportedly asked the Bombay High Court to allow it to become a party to a dispute over pricing of gas between RIL (of Mukesh Ambani) and RNRL (of Anil Ambani), as per a shareholder agreement between the two. As a part (and larger) owner of the gas, the Government feels it has the right to intervene, since the gas would start flowing from June.

Higher gas prices would balloon RIL's bottom line but would also make its input costs higher for large users of it such as power and fertiliser. Since gas would form a big chunk of our future energy needs, the question over its pricing and its allocation would assume great importance and is far too important to be delayed further. One hopes the issue is speedily resolved.

If not, one would suffer the fate of Nigeria, where gas is being flared even past the 2008 deadline to stop its flaring. This has so damaged soil quality that nearby communities are unable to grow food to feed themselves, as they used to. The reason why it is flared and not consumed (which could add $ 500 m. to the economy) is because there is no infrastructure to transport the gas, and therefore no market to consume it. And the reason there is no gas transport infrastructure is because the cost of laying a pipeline in lawless Nigeria is ten times the normal $1m per kilometre. This is how poor governance impacts an economy, its ecology and thus the stockmarket.

The market was enthused by better IIP (Index of Industrial Production) numbers in Feb, which was 8.6% in Feb after having fallen to 5.8% in Jan, thanks to better performance by capital goods, whose index was up to 10.4% in Feb compared to 2.1% in Jan. However, to spoil the party, inflation was up to 7.4% and one can expect a lot of gestures being made to contain it, in an election year. (Ban exports, jail hoarders, cut import duties etc.) What the Government should primarily concern itself with is providing an infrastructure that cut costs of making and transporting things, and having a mind set that allows for efficiency (fill up this form in quadruplicate and submit it to window number 3 etc). However, politicians prefer making gestures by wringing their hands in (contrived) concern rather than getting their hands dirty doing their job honestly.

Such as the cut in CST from 3% to 2% announced in the Union Budget by the Finance Minister, which, until State Governments notify it (many haven't) remains a gesture to control inflation.

Inflation can be tamed only through productivity gains and innovation. For productivity gains to occur hard decisions have to be taken. In industry, productivity gains, and benefits of scale, will accrue with a more flexible labour policy. This cannot happen in a coalitional government thrown up in a multi cultural democracy. Productivity gains in agriculture would happen when a lot of things are done for the kisan after shouting a slogan in his name. We have our priorities inverted. We first finished the golden quadrilateral, which link metros and are now connecting towns, and later villages. Instead, we should have first provided rural India with good roads which would bring down cost of transporting inputs. Companies like ITC, with their e-chaupals that give farmers information, and buying models that cut intermediate layers, have done more meaningful work than Government with their gestures.

Given that, it would be preferable to get lighter on rallies, at whatever level one is comfortable with. The long term prospects are good, the short term waters are murky.

Have you read the latest Honest Truth by Ajit Dayal?

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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