Thursday, October 27, 2016

Cyrus Mistry spat with Tata- a peek into the board room

As many commentators have noted, the sacking of Cyrus Mistry and the angry letter it has elicited from him has done great damage to the Tata brand. If the dispute drags out, the damage will be that much greater. Tata shareholders have cause for concern.

So do banks that have exposures to the group. Much of this exposure rests on the Tata reputation and TCS profit. The problems at the group will cause banks to seriously rethink the sort of name-lending they have been doing. The RBI's Large Exposure Framework is timely in this context: the restrictions on group exposures were long overdue and it's a pity that the regulator is having to require something that bank boards should have done on their own by way of prudent risk management.

One particular item in Mistry's letter stands out and it had me rubbing my eyes in disbelief. Let me reproduce that portion:
The trust nominated directors, who I would assume would use their own independent judgment and discharge their fiduciary duties, were reduced to mere postmen. As an example, once, the trust directors (Nitin Nohria and Vijay Singh) had to leave a Tata Sons board meeting in progress for almost an hour, keeping the rest of the board waiting, in order to obtain instructions from Mr Tata. Such a work pattern has also created the added risk of contravening insider trading regulations and exposed the Trust, apart from exposing the trustees to potential tax liabilities.
This is incredibleif the staements are indeed correct. The Dean of Harvard Business School, we are told, excused himself from the board meeting and kept the board waiting for nearly an hour in order to take instructions from Mr Tata, who was not even a member of the Board! Is this what they teach by way of corporate governance at HBS? Is this how independent directors are expected to function- go out and take instructions from the leading shareholder even while a board meeting is in progress? The possible violation of insider trading regulations, to which Mr Mistry refers, makes the disclosure even more lethal. SEBI and the stock exchanges, one hopes, will look into this item closely. If proved right, Prof Nitin Nohria's behaviour might well attract strictures from the regulator and the exchanges. Since some of the listed Tata companies are shareholders in Tata Sons, institutional investors would be within their rights to raise this issue.

One wonders what HBS would make of this matter. This is not the first time that an HBS prof's behaviour has raised questions in the Indian context. In the Satyam Computers scandal, Prof Krishna Palepu, another HBS professor, drew attention as he was found to have earned a tidy amount by way of consulting fee from the company with which he was associated as independent director. As reported in the media, the court dealing with matter issued an order asking him to disgorge around Rs 2.7 crore in excess remuneration paid to him.

Mr Mistry makes a number of other statements that are damaging. He would have liked to discontinue Nano but could not do so because of Mr Tata's attachment to it. He was opposed to the group's entry into aviation. There were dubious transactions in Air Asia.The potential write down in the value of assets of group companies is Rs 118,000 crore. IHCL's investment in the Sea Rock property nearly wiped out its net worth. Tata Capital made a large loan under the advice of one trustee and it has since turned into an NPA. And so on.

The question arises: did Mr Mistry raise these concerns at Tata Sons board meetings and were these concerns duly minuted? Did he express his disapproval of the two independent directors holding up proceedings in order to seek Mr Tata's input? What did the other independent directors have to say on various matters? Were their comments, if any, recorded and minuted? It would be appropriate for SEBI to go through the minutes of the board meetings and take stock. Perhaps SEBI needs to issue guidelines on the minuting of board meetings, an area that needs considerable improvement.

Two thoughts arise. One, if this is the state of affairs at what has been India's most respected corporate brand, what can we expect at other boards?What sort of discussion happens at those places? How well are minority shareholder rights protected?

Two, what do we make of the role and functioning of independent directors. As readers of this blog would know, I have been extremely sceptical about the functioning of boards and independent directors. Most boards are rubber-stamp boards that duly accord their approval to whatever the CEO or Chairman wants done. There's very little dissent, very little questioning. This state of affairs cannot change as long as so-called 'independent' directors are selected by the CEO or the promoter. We need a wide variety of stakeholders to appoint independent directors- institutional investors, banks, minority shareholders, employees and others. In my book, RETHINC, which came out last year, I devote a whole chapter to corporate governance and the functioning of boards.

Alas, there's no sign of genuine reform in the board room.

Monday, October 17, 2016

'Bad bank' won't take us very far

The proposal for a 'bad bank' has been revived (although the chairman of the BBB, Vinod Rai, has been quick to dismiss it).

The idea is to rid the public sector banks (PSBs) of their NPAs so that they can generate interest among potential strategic investors or so that they can be merged with stronger banks without dragging down the latter.

I doubt that the idea will take us very far. A bad bank was conceived originally as a bank-specific entity- it was mean to transfer bad assets of a given bank. The bad bank we are talking about will transfer assets of all or many PSBs. That means having to deal with problems of a different scale altogether.

Next, there's the question of whether the bad bank will be have the government as a majority owner or not. If government is to be the majority owner, then all the problems we have with loan resolution at PSBs will continue. If the private sector is to be the majority owner, setting a price at which NPAs are to be sold will be a major headache.

It's not as if the majority of NPAs have to be liquidated. No, the principal challenge in India is to get stalled projects, which have turned into NPAs, to go through to completion. That requires fresh funding. If government cannot provide funds to the existing PSBs, how is it going to provide funds for a government-owned bad bank?

Moreover, the sale of NPAs will be a time-consuming process. The interest burden will mount. Projects which can be made viable today will cease to be viable tomorrow. There's the real danger that large amounts of infrastructure investment will go down the drain. A generalised bad bank for all NPAs seems just a bad idea.

Perhaps, we could attempt something on a small scale. We could transfer some project-specific or borrower-specific assets lying with various banks to a bad bank and see whether resolution can be expedited. In general, however, it's best for the banks to resolve the problem through appropriate restructuring and waivers, supported by government funding.

There's one thing about bad loan resolution we need to be clear about. The most enduring way to get out of an NPA mess is for economic growth to revive. From that perspective, the interest rate cut we saw in the last monetary policy and the expected cuts down the road are the best solutions. The interst rate cuts will revive the financial position of many borrowers and it will help recapitalise banks by boosting the capital gains on their securities portfolio.

Loan resolution will, of course,be necessary but it will be easier to handle once economic growth picks up.

More in my recent article in the Hindu, Why a bad bank is tricky

Wednesday, October 05, 2016

Urjit Patel's maiden monetary policy marks a significant shift

Make no mistake, RBI Governor Urjit Patel's maiden monetary policy statement (embodied in the MPC resolution) marks a significant shift in the approach to inflation.

The framework is the same as in Rajan's time, the mandate is the same (4% plus or minus 2% inflation) but the interpretation of the mandate is quite different. Rajan was committed to a 'glide path' whereby inflation would be brought down to 4% by 2018. Patel did not say so explicitly at any point but the message is pretty clear: 4% now is a target to be attained over five years with the flexibility to depart by 2% in the interim.

At the media interaction, Patel was asked whether the target of 4% by 2018 was still in place. He did not give a straight answer but read a statement on the mandate given to RBI. Most people would have read between the lines and understood.

How do we know? First, we have the 25 bp rate cut. True, food inflation has moderated. But we are looking at 5% inflation by 2017 with significant upside risks. The MPC would not be taking chances with a rate cut if it were fixated on bringing inflation down to 4% by 2018. It can afford to take chances only by interpreting the mandate more broadly.

Secondly, there was mention of the real interest rate target being lowered from 1.5-2% to 1.25%. At the present repo rate of 6.25%, this permits an inflation rate of 5%. The point was made that the real rate is not a fixed number, which means it can drift even lower. That gives even more flexibility in respect of lowering the interest rate.

Then, there's a softer approach towards NPAs- pragmatism will be the name of the game. The governor is keen to ensure that credit flows to industry are not stalled because of NPAs.

So, once again, the pundits have been proved wrong. They said that Patel's appointment marked continuity with Rajan's policies because Patel had authored the report on inflation targeting. They said he was a hawk who wouldn't budge on interest rates. They said two out of the three outside experts on the MPC were also hawks. What we have in the latest policy is six doves.

The pundits may also have been wrong in saying that the government did not persist with Rajan mainly because they didn't approve of some his speeches. I have argued in my blog that, within the Sangh parivar, there was considerable discomfort with the interest rate regime.

Finally, we were warned that any interest rate cut in the context of RRexit and Brexit would spark an exodus of foreign funds, the rupee and the stock market would collapse and economic doom was round the corner. Nothing of the sort has happened.

So much for punditry.