The collapse of the social construct - Straight from the Hip by J Mulraj
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Investing in India - Straight from the Hip by J Mulraj
The collapse of the social construct A  A  A

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27 DECEMBER 2008

Democracy is a social construct between the electorate and the leaders they elect to govern them. In return for taxes paid by them, the electorate expect the political leaders to provide them with a few things. These include security, from within and without, education, infrastructure, including roads, power, ports etc and medical care. For over six decades the electorate has paid its taxes but has not got the expected services implied in the social construct, in return. Security is lax, both within (witness the extortionist gangs that are allowed to flourish, some of which have provided logistical support to terrorists) and without (witness the spate of dastardly terrorist attacks). Education is woeful, both in quantity and in qualify, with the State playing a dog-in-the-manger attitude to deny private sector participation that would ensure everyone had access to it. The few that are allowed to open private educational institutes use it as a golden goose to earn capitation fees. The less said about India's infrastructure, the better. Road contracts are hotbeds of corruption, both in their initial allotments and in their annual maintenance which provides an annuity to corrupt municipal officers. Why, then, should Indians continue to pay taxes; can we not have a Californian style revolt, depositing the taxes under a court order, in a bank account until the State starts to live up to its side of the bargain?

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Politicians are displaying increasingly depressing standards of governance; witness the murder of an engineer in UP for refusal to pay 'hafta'. Witness the way in which the Central Government is unable to bring such offenders to task. Or, indeed, one of their own ministers who, by raising a communal bogey, allowed Pakistan to score debating points. When our Government consists of such wimps, how can we expect them to provide any measure of security, barring to their own coterie! Fortunately, some part of the judiciary is still responsive, the Punjab & Haryana High Court has withdrawn pilot escort vehicles to all except the Chief Minister, the Speakers of the House and the Chief Justice.

Investors, too, have a social construct with managements of companies they invest in. In return for buying equity and providing capital, minority shareholders expect management to provide it with good governance, which takes care of other interests, not only that of the main promoter group who is in management. Satyam Computers had maintained that the valuation of family promoted Maytas Infrastructure was based on an independent analysis by one of the big four accountancy firms. All four have denied involvement. Nor was the valuation given to the independent directors; some of the directors have claimed they merely approved the mooting of a merger but not the valuation.

Investors ought to be aware that valuations arrived at by 'independent' and reputed firms need not necessarily be a proper one. There is a celebrated case of a publicly owned company whose promoters wanted to buy out, without open competitive bidding, a subsidiary company at a throw away price. The subsidiary had land assets which were immensely valuable, but its operations were yielding marginal results. The independent consultant (one of the top four accounting firms) provided a very low valuation, permitting the management to buy it at a pittance, without open bidding. It had been instructed by the client (i.e. the management, a party with vested interest) to value the subsidiary on the basis of a going concern and not on a break up value basis. The methodology for the former is based on performance, which was marginal and hence the low valuation. The methodology for the latter would be based on land valuation.

In short, the mere 'tag' of an 'independent' valuation by a 'leading and reputed firm' should never be construed to be a fair valuation. Minority investors must question it and so must SEBI and the courts.

There is a social construct in the institutionalisation of money. One of the reasons for the growth of the mutual fund industry (which is now globally larger than the banking industry in terms of assets) is that by agglomerating voting power, these institutional investors would be better able to exercise influence over management for better governance. After all, a shareholder with, say 3% of the stock, would have a voice which would be heard more than the feeble one of a holder of, say, 300 shares. Sadly, institutional investors vote with their feet instead of with their mouths. In the case of Satyam Computers, their combined holding of 61% is far higher than the 8.6% held by the promoter; yet it would be a rare event if they forced a change in management (which some are reportedly trying), instead of getting in line for the exit door.

In corporate news of interest, the NSE, in its dispute with Financial Technologies India Ltd, (it has barred the latter's software) has claimed it did so because the software contained bugs! This seems curious; users of Windows, for example, constantly complain of bugs. Indeed all software has bugs, which is simply human errors creeping into the millions of lines of code written in the programme. It would be enormously pleasing if the alternative platform introduced by NSE were found free of bugs.

One bit of good news is that, barring 4 states (West Bengal, Kerala, Jharkhand and Punjab) the others have managed to wipe out revenue deficits! However, the Centre, because of increased expenditure to prevent an economic slide, and reduced tax revenue (advance tax collections are down 22% in Dec, yoy), will see a fiscal deficit of 5% or more. It should concentrate on reducing wasteful expenditure (such as the security cover provided as ego booster for all and sundry; which ought to have user charges fixed) rather than increased taxes. Falling crude oil prices means a steep reduction in oil import bill; this would be further reduced after KG gas supplies from Reliance Industries commence in Feb. The gas would be supplied via pipelines directly to fertiliser companies in accordance with Government policy on utilisation. This, in turn, would wipe out the Rs 1 lac crore subsidy bill on fertilisers and help control the fiscal deficit.

The Rs 38,500 crore golden quadrilateral project to provide a 4 lane highway of 5900 kms linking four metros is almost over. The Government now plans to commence work on feeder road network, of 20,000 kms, to link towns and villages to the golden quadrilateral. This would be very good news if there is good governance and an honest appraisal to allot the work, which would be in 4 phases of 5000 kms each. The social construct necessitates that the Government look at international costs for such roads and sets standards for cost, quality and maintenance. In the Middle East, such contracts are awarded alongwith an obligation to maintain the roads for 20 years, which ensures excellent quality by virtue of the obligation. If, however, road maintenance is looked upon as an annual 'hafta', as it is, the quality is poor and the costs of poor quality are borne by users of the roads.

Last week the BSE-Sensex declined 680 points, to end at 9328 and the NSE-Nifty fell 220 to end at 2853.

Any bounce would provide an exit opportunity. The 22% drop in advance tax points to poor quarterly performance. The troop build up on the border points to jingoistic insanity reaching a crescendo. The forthcoming general elections points to uncertainty. Any rally that may occur, therefore, points to the exit door.

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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