Friday, April 27, 2012

India's inflation rate will stay at 6-7%

There is little chance of India's inflation rate going down in the medium term. If anything, the rate may go up. A rate of 6-7% need not be feared. It is only a very high rate of inflation (at least above 10%) that imposes significant efficiency costs.

The social consequences are not very disruptive, as it appears rural and urban workers, both in the organised and unorganised sectors, are having wage increases that are above the inflation rate. The losers would be pensioners, the unemployed and foreign purchasers of Indian goods (to the extent that rupee depreciation does not offset price increases). Trying to reduce the inflation rate at this point would mean a growth rate of below 7%- and that would be psychologically damaging to Indian and foreign investors. So the RBI was right to cut its reference rate earlier this month.

More in my ET column, Higher inflation is here to stay. 

Thursday, April 26, 2012

Boards of banks

It is news to me that UK's Financial Services Authority actively monitors the effectiveness of bank boards and also interviews candidates proposed by financial firms for their boards. I got to know this when I read a speech delivered by Hector Sants, the outgoing chief of FSA, to which my attention had been drawn by a blog in the FT.

Here's what Sants had to say about how the FSA judges the effectiveness of bank boards:
The regulator assesses this effectiveness on a continuous basis.  It does this through many tools such as board effectiveness reviews, regular supervisory discussions with the Chair, senior independent director, and key executives.  Enforcement will also be used when absolutely necessary.  However, the principal and earliest intervention the regulator can make is through the SIF authorisation process and it is this I would like to turn to now.
Sants has some caustic remarks to make about candidates proposed for boards:

Too frequently we still see applicants who:
  • don't understand what the job entails and have no job description;
  • have done no due diligence into the firm they are proposing to join;
  • are unable to discuss the risks/ issues facing the sector in a proportionate way to the role they are applying for; and
  • often significantly underestimate the commitment required to perform the role effectively.
 Of the 653 applicants interviewed by the FSA, 43 were withdrawn.

What Sants says about bank directors would apply equally to directors at non-financial firms. Most directors would not bother to brush up on basic facts before getting on to a board- and they would not bother to know the basics even while serving on the boards. Here's a suggestion: let the RBI and SEBI run a surprise quiz for directors. They should be asked just two numbers: the sales and profit of the boards they sit on. I would be surprised if even 50% got it right. If you want to really fox the directors, ask them a third question: how much is the CEO paid?

S&P warning

S&P's changing the outlook from stable to negative is seen as a 'warning'. What sort of 'warning'? Well, if things get worse about a year down the road- if the fiscal deficit remains as high or if growth goes down to 5.3%-, India will face a downgrade.

Some warning, that! Any sophomore could tell you that if things worsen, the rating goes down; if things get better, there is an upgrade. Mind you, S&P does not say that things will get worse or that they are likely to get worse.

What do we make of this warning? I know of nobody else who thinks growth could be down to 5.3%. As for the fiscal situation, S&P might have made some mention of the fact that India must be among the very few countries whose public debt to GDP ratio has gone down in recent years; for a whole range of countries, the debt to GDP ratio has shot down. Moreover, while the centre's finances have worsened, state finances are showing an improving trend.

The threat of a downgrade of some Indian companies, including HDFC Bank, means even less. These ratings are partly linked to the sovereign rating, so if there is a sovereign downgrade, it will be reflected in the firm's downgrade. Let me say one thing, however: anybody who suggests that conditions at HDFC Bank warrant a re-look at its rating needs to have his head examined

Friday, April 13, 2012

Right to Education Act

The RTE Act coming into force is an important landmark in the evolution of this country. From long years of neglect of primary education to providing access to superior schooling to the underprivileged is indeed an astonishing transformation. As an unabashed champion of inclusiveness, I cannot help feeling a wave of exultation.

Alas, as a hard-nosed observer of the Indian system and a cold-blooded student of management, I cannot help having reservations. The idea is laudable. The poor should be able to walk into any school in their neighbourhood, not just into a municipal school. But will reserving 25% of seats in private schools (leaving aside exceptions) work? First, the central and state governments will bear some of the cost, not all of it. The rest of the cost will presumably be passed on to the 75% well-off children through higher fees. (The government will pay as per the fee in the central Kendriya Vidyalaya schools).One can expect private schools to face the usual hassles in settlement of dues on account of the reserved category.

Alright, suppose the financial part is taken care of. What then? We will have children from the disadvantaged category sitting next to well-heeled children. The differences in status will be glaring and is bound to tell on morale and confidence in the reserved category. One can expect discrimination from the teaching staff. The reserved category may face a high failure rate, which could itself prompt drop-outs.

Most importantly, the reserved category will find the going difficult beyond a certain class- say, seven or eight- for the simple reason that, even in so-called good quality private schools, the overwhelming burden of teaching- or preparing for the exam- rests with private tutors and coaching classes. In many schools, in the tenth grade, even the pretence of teaching disappears. There is mass absenteeism for much of the year as the children are busy preparing on their own by attending classes outside. You could argue that poor children suffer from this disadvantage - of not being able to afford coaching classes- even when they attend public schools. True, but now they will find themselves in the CBSE and other schools where the handicap could prove more crippling than in the state boards.

In a municipal or public school, the poor child is less likely to feel socially handicapped, whatever the other problems. Can poor children do well in schools where they face enormous hostility and serious handicaps in coping? These are the issues one has to reckon with. I would imagine that the government will have to step in with cash vouchers that enable the children to attend coaching classes as well.

This is a bold experiment that deserves a try. The results should be closely monitored and correctives introduced from time to time. I doubt, however, whether it can be an alternative to adding to and improving the quality of public schools.

China's military expenditure

The Economist issue of April 7 carries a story on China's military rise. It has a tell-tale table on the top 10 nations by military expenditure.China is no 2 with $90bn, more than 2.5 times India's $37bn. The US is no1, with military expenditure of - hold your breath- $739bn. The total military expenditure of the other nine nations is less than $500bn. Now, you understand what underlies Pax Americana.

The numbers help place the so-called Chinese threat in perspective. China does not even remotely threaten American hegemony- a Chinese general is quoted as saying that the gap between US and Chinese defence forces is 30 or even 50 years. But China can clearly defend itself against American attack. And it can also pose a threat to its neighbours, keeping the US out of its vicinity if necessary. That raises the chances of an all-out offensive to take over Taiwan.

What could contain China's attempt to dominate the region? One, China's interest in the global economic system and its preoccupation with increasing the prosperity of its citizens. Two, its focus on maintaining internal stability. Three, the relative obsolescence of its military equipment following sanctions imposed after Tiananmen Square. Four, America's decision to focus its military efforts more on the Asia-Pacific region. One might add a fifth factor, namely, the question mark over China's ability to sustain its high growth rate and the possibility that India might forge ahead and emerge as an active counterweight.

Thursday, April 12, 2012

TCI takes on Coal India

TCI's battle with Coal India Limited (CIL) is giving India a bad press abroad. TCI is known to be an activist shareholder. Just before the financial crisis, it was amongst those who pressure ABN Amro to split up and sell the pieces to various parties, including RBS. The deal eventually sunk RBS- so much for TCI's activism.

TCI's demands on CIL are downright unreasonable- they certainly cannot dictate pricing policy or, for that matter, personnel policy or any other policy. Shareholders must focus overwhelmingly on outcomes- are they getting their target returns or not? Judged by this test, TCI has no business to get worked up over CIL. CIL's return on equity in the past couple of years were 37% and 33%. It seems to me that it is customers who are getting ripped (or maybe suppliers, including the supplier of land, the government), not shareholders.

The bottomline is this: the PSU business model is very different from the private sector model. If you don't like this model, stay out of PSUs. It can't be that you invest in a PSU and expect it to behave like a private company. I am sorry to note that the independent directors on the board of Coal India do not seem to have applied their mind to the problem; they seem to think that independence is best displayed by not toeing the government line.

More in my ET column, CIL: TCI's Misplaced Zeal

Wednesday, April 11, 2012

India Inc rules the world?

India's outward FDI has increased in recent years. It was $16.5 bn in 2010-11. Before the global crisis erupted, we had a number of high-profile takeovers by Indian firms. This gave rise to the view that India Inc was all set to conquer the world. India's low-cost advantage, the high growth rate of the Indian economy and the flood of liquidity, which translated into easy access to finance for Indian firms- these seemed to make an Indian onslaught on the west inevitable.

Much of this euphoria has faded since. When the crisis erupted, international finance evaporated for Indian firms leaving many an incomplete takeover in the lurch. Even otherwise, it hasn't been smooth sailing for a large number of takeovers. Students of finance will not be surprised: we know that the majority of acquisitions fail to enhance shareholder value. Making a success of an acquisition requires formidable managerial ability, a favourable economic environment and a reasonable acquisition price. Indian firms are running into limitations on all counts.

The Economist ran an interesting analysis of a four high-profile acquisitions a few weeks ago: Tata Steel- Corus, Tata Motors- JLR, Hindalo-Novelis and Bharti Airtel-Zain.  Only two, Tata Motors and Hindalco, have seen an improvement in profit. The other two are struggling. In terms of return on capital, only Tata Motors scores.  At the rest, return on capital is likely to be lacklustre for several years.

These four acquisitions accounted for a quarter of India's cross-border activity in the past decade. The smaller deals have not done uniformly well either. The Economist notes that Indian companies have a fundamental problem in doing jumbo deals: they don't want to raise much equity for fear of diluting controlling shareholders.

India Inc ruling the world? Not a chance. Corporate domination is a function of the importance of the economy in the world, as the Economist rightly notes. British firms dominated when the UK was a powerful player on the world stage; ditto for American firms. India still has a long way to go. The sensible thing for Indian firms to do is to attain world class parameters in India, then think of overseas ventures.

Sunday, April 01, 2012

Housing India's urban poor

India's urban poor live overwhelmingly in slums- this is true of half of Mumbai's population. How do we provide housing for them? One answer is low cost housing provided by government, as in Singapore, Hong Kong and other places. Not feasible, alas: government lacks the resources or the ability to get this done. Another answer: hand over slum land to developers on condition that they earmark a portion of low-cost housing. This was tried in Dharavi. The housing that got built is of poor quality. Besides, many of the projects are caught up in lawsuits.

A report in the FT suggests a third way. Allow the poor themselves to upgrade through innovative construction:
Some experts, dismayed at the slow progress and disappointing results of more grandiose government redevelopment plans, believe these informal slum upgrade schemes could form the basis for a longer-term plan to help India’s more than 170m slum dwellers.......   “The best option may be for the government to focus on providing the basic trunk infrastructure of water, sanitation and so on, and then let the people themselves invest in upgrading their own houses,” says Ashish Karamchandani, head of the Mumbai office for Monitor Inclusive Markets, a consultancy that has spent a number of years researching low-cost housing markets in India.
 Is this indeed the way to go? Well, it cannot be that individuals do whatever they like. There has to be a process of approval for any construction. That would immediately involve the municipal bureaucracy and the concomitant hurdles. Typically, what happens is that people build as they please and then pay up to legalise the construction. The trick may be to set up local associations comprising the community, one or two NGOs and municipal representatives. These associations can bring about upgradation in a planned manner. Whatever works is worth trying.