Oh what a tangled web we weave... - Straight from the Hip by J Mulraj
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Investing in India - Straight from the Hip by J Mulraj
Oh what a tangled web we weave... A  A  A

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21 APRIL 2012


It was Sir Walter Scott who wrote 'oh what a tangled web we weave, when first we practice to deceive'. We are seeing several examples of that in Government policy that, if not deceptive, is, at the least, misconceived.

Much has been written about the policy of subsidising petroleum products. Refiners, led by Indian Oil, are threatening to raise petrol prices by Rs 10/litre, as they are continually incurring losses at the prices fixed by Government, even though pricing is supposedly free. The subsidised price of petrol and a more subsidised price of diesel is encouraging its overuse, as a result of which our bill on imported crude oil was 31% of the total import bill. The resultant current account deficit is what is causing a continuous deterioration in the Indian rupee.

We further compound the problem by mollycoddling the automobile industry by delaying (why?) the introduction of fuel efficiency norms. USA introduced, through legislation, fuel efficiency norms, and the auto industry responded, by more than doubling the fuel efficiency of its cars, which now give over 30miles/gallon.

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But in India, lobbying by the auto industry has stalled introduction of fuel efficiency norms by more than four years, and it is now left to the Prime Minister's Office to decide on introducing them. Why should it? It's a no brainer! We are overly dependent on imported crude and need to take whatever steps we can to reduce consumption.

These steps would also include sprucing up the public transportation network. We have sadly neglected public transport, but encouraged private transport (cars and two wheelers). When a Railway Minister tried to raise resources in order to spruce the rail network, by a long overdue increase in passenger fares, he was summarily sacked! Paucity of resources results in negligence and accidents, such as, last week, a fire in a rake and the senseless death of 3 people killed by an outlying pole.

There has been no action against any rail official for these and other senseless deaths and injuries. Yet, for circulating a cartoon, two septuagenarians were beaten up and jailed! Oh what a tangled web we weave, when first we practice to deceive.

A similar Kafkaesque contradiction is in the fact that whilst an out of court settlement was arrived at between 3 Italian marines who killed a fisherman, the Government would not wish to have one with Vodafone over a tax dispute.

Vodafone has now served a dispute notice on the Government, the first step before going in for international arbitration. The Finance Ministry's contention, not totally devoid of merit, though, is that a transaction of $ 11 b. cannot escape capital gains tax totally, and that it is clarifying its intention, already in statute, about its resolve to collect tax on it. Until the matter is solved through arbitration, or through an out of court settlement, however, the image of the country as an investment destination has certainly taken a beating.

Little wonder, then, that investors are shying away. The latest to do so was Singapore's Changi Airport, one of the best in the world, which has shied away from investing in the airport venture of the GVK group, citing regulatory uncertainties. So, the dilemma of the Government is whether to tax Vodafone (and similar) transactions, at the risk of losing out foreign investment, or not.

There is an enormous amount of money sloshing around the world, waiting for investment opportunities in environments that welcome them. India alone needs to spend $ 1 trillion on its woefully inadequate infrastructure and will need foreign investors' help. Its policies, though, have to be clear, transparent and stable.

Consider its stance to tax, retrospectively, sale of packaged software, on the ground that it is 'royalty'. Sales of packaged software amounted to Rs 18,000 crores last year. Foreign packaged software makers object to retrospectivity, as, indeed, they ought to. Those such as Microsoft, Oracle, Adobe and others are threatening to review their investment plans in India if retrospective claims are made on them. Oh what a tangled web we weave....

We are now weaving other tangled webs. There is a shortage of power capacity in the country, but largely due to theft of power which is hidden as transmission and distribution losses. Pure deception. So, instead of curbing the theft, we create new capacity. Most of this is thermal, requiring coal. There is a shortage of coal, for several reasons, including a lack of competition and stricter environmental clearances, which do not come. So the PMO is twisting one arm of Coal India, asking it to sign Fuel Supply Agreements (FSA) with power producers, under which it would face a stiff penalty if it failed to supply 80% of the committed quantity.

Coal India's other arm is being twisted by an activist shareholder, The Children's Investment Fund, which owns some 2% of it, and is threatening to sue the directors if subsidised coal prices are not raised. Now Coal India has agreed to sign the FSA (although how it could do so with two twisted arms remains a mystery) provided it is able to pass on any hike in imported coal to the buyer. Power producers are objecting to this. It would be interesting to see the Government's stand on this because when private producers of power who had agreed to supply to state Governments at a fixed rate, faced the same problem after foreign Governments imposed a tax on the coal exported by them, the state Governments disallowed the claim. Oh what a tangled web we weave....

Another tangled web being woven is in the case of Air India. This public sector company, wholly owned by the Government, is a pacman for cash, guzzling it at a prodigious speed. It was driven into this position after being compelled to buy more aircraft than it needed, borrowing funds it couldn't afford, and then merging into Indian Airlines it didn't wish. The Government recently approved a Rs 30,000 crore rescue package which is bound to fail because it does not involve any reduction of a bloated workforce, or removal of wasteful practices. This package will largely come from outside the Budget. Air India is set to issue Rs7400 crores of bonds, guaranteed by the Government. But who will buy these?

Oh what a tangled web we weave! It would be LIC and the retirement funds of PSUs (public sector undertakings) that would be 'asked' to! This is wrong, for various reasons.

One, a sovereign guaranteed bond would earn a lower income than a bond which is issued by a solvent company, and hence safe, but not guaranteed. So the retirees would be getting a lower income than they should.

Two, the Rs 7400 crores thus invested into Air India, the pacman, could be better employed by investing in a solvent company. Air India has little hope of ever becoming solvent; it will need more funds after the Rs 30000 crore package is over.

What happens when investment decisions are forced, instead of analysed?

Four of the biggest banks in Greece have now had to write off $ 37b. on their holdings of Greek Government bonds Similarly, when the Rs 7400 crores Air India bonds mature, and Air India is not in a position to pay, the investors will ask for the sovereign guarantee. Hopefully the Government will honour it.

A tangled web had been woven by UTI in its erstwhile US 64 scheme, the one that actually introduced the equity cult to Indians. Like any other mutual fund, the sale price and repurchase price was linked to its net asset value (NAV). Some time during the course of its history it deviated from this normal practise and began announcing sale/repurchase prices that were unrelated to the NAV. How and why this was permitted is not known; perhaps it was to attract corporate funds. This delinking was the tangled web it wove, and the result was that the scheme went bankrupt. One fine day the Government sharply brought down its sale/repurchase price and compelled investors to accept a big loss. It transferred the stocks held by US 64 to a special purpose vehicle called SUUTI.

Now, after a few decades, these stocks are worth over Rs 30,000 crores. But part of this would rightfully belong to investors who were compelled to take a hit, wouldn't it?

Corporate results for the March quarter have not been encouraging. Two cement producers, ACC (net profit down 57%) and Ambuja (down 23%) has poor results, despite an increase in turnover. This was partly due to a change in depreciation policy. RIL's net profit was down 21%. HCL Technology has a 29% increase in its profits.

The BSE-Sensex gained 206 points on Tuesday, after the RBI announced a 50 basis points (half a percentage) cut in interest rates, twice what the market expected. But by the end of the week, it started sliding again, and ended the week at 17393, up 279. The NSE-Nifty added 83 to close at 5290.

When the Reserve Bank of India (RBI) Governor made the unexpected cut in interest rates, he is betting that inflation will be tamed. If it rears its ugly head again, the Governor may stop further cuts or even start raising rates, should the situation warrant. Now kharif minimum support prices are likely to be raised 30% and this will increase food inflation. Crude oil prices are also not coming down. So it is difficult to see how the RBI would have elbow room for another cut.

Domestic investors are not expecting this Government to take any bold reform steps before the 2014 elections. They agree with Kaushik Basu, the Chief Economic Advisor who was, perhaps, misquoted in having said the same thing. What about foreign investors?

Foreign Institutional Investors (FIIs) had invested Rs 44,000 crores (about $8.5b.) in the first quarter, and another Rs 322 crores so far in April. But they are getting disenchanted with policy paralysis, policy flip flops, retrospective amendments and the lack of clarity in thinking and decision making. Should they decide to start selling, who will be able to stanch the resultant fall? In the good old days, UTI was one of the domestic institutions who could be asked to step in to buy; it is now enfeebled. LIC has large surpluses, but these are being used to bail out ONGC and Air India.

What can cause FIIs to sell? One guess is a crisis in Spain which has seen a rise in interest rates of its bonds in the market, over 6%. John Paulson, an astute hedge fund trader, thinks so, and has started shorting German bonds, as a crisis in Spain would affect bund valuations.

So unless the Government manages to get its act together and take some sensible economic reforms, it does not look as though Indian markets are going to run away anywhere.

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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4 Responses to "Oh what a tangled web we weave..."
S B Rasania
Apr 26, 2012
Who listens o our shouting on roof. Ministers, Babus and advisers have deaf ears.
We have to watch the fall of LIC, ONGC, AND AIR INDIA
AND THEN many more due to such policy of the Govt.
Like 
BJJ
Apr 25, 2012
Definitely India would benefit from enforced fuel efficiency norms. But more importantly, they should learn from the States and put more money into public transport. The auto/oil industry here has such a powerful lobby that they have prevented government investment in railroad updates. As a result, we have one of the most antiquated systems in the world. We are much too reliant on our cars and airlines, which are not fuel efficient. And the airlines, without meaningful competition, have become over used and subsequently stressed and customer unfriendly.Now some of their employees are having very public nervous breakdowns. Makes for entertaining reading if passengers get through unscathed, but wouldn't want to be on an airplane when it's happening ! Like 
N V SUBRAMANIAN
Apr 22, 2012
On the subject of oil subsidy, every body is talking about so called under recoveries. What about efficiency of oil mkg companies. They have bloated work force, little or no productivity, huge corruption. Does anybody talk about these points. The government is afraid to tackle these issues and consumers are called to pay up for all these. Whatever price increase or subsidies be given, the oil companies will forever report only UNDER RECOVERIES. These are due to under hand recoveries Like 
LOVEPAREEK
Apr 21, 2012
BEAUTIFULLY WRITTEN. EXCELLENT Like 
  
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