Thursday, April 10, 2008

Safeguarding India's Capital

Shyam Ponappa / March 02, 2006

Let's avoid another East India Company manoeuvre.

A fine time to talk of protection, you might say. There is the furore over Mittal Steel’s bid for Arcelor. There is another over Dubai Ports’ takeover of P&O, because of concerns in America for the six ports P&O operates. And especially from someone like me—an FDI-oriented, pro-reform individual who has enjoyed studying and working in India and abroad and for multinationals. Convinced that there is much to learn from the world to adapt and apply in India, many might expect one to favour unrestricted foreign investment and the shibboleth of free markets.

Actually, one is increasingly uncomfortable with the disjunction between reality and the professed interest in free trade of the world at large. Whether it is agricultural subsidies, shoes, textiles, or services, people’s profession of liberal ideals seems quite out of step with their behaviour in many parts of the world. To be carried away by abstract notions of free markets ignoring reality is a mistake, because these ideas assume a certain comparability between markets—and access to them—that is simply untenable.

I am also increasingly concerned with the way India’s position on foreign investment seems to have evolved, apparently moving from one extreme to the other. I confess that understanding has grown slowly for me, and only after analysing the facts, and not with any dogmatic mindset.

Safeguards Against What?

I’m not talking of French or Swiss companies investing in cement in India (yet), i.e. Lafarge (unless they keep growing in India, but don’t list on its exchanges) and Holcim: the latter controls Gujarat Amabuja and ACC; or US, Belgian, or British investors in power or telecommunications (AES, Cogentrix, PowerGen, CMS, Bechtel, Tractebel, AT&T, etc.); or Singapore in telecommunications and ports; or British oil exploration companies (Cairns!). Indeed, I am thankful for these, and am perhaps one of the few I know of who favoured Dabhol’s success. Based on evidence of a lack of strategic thinking in general in our approach, however, perhaps India’s FDI stance needs more strategic thought and cost-benefit analysis, so that policy positions are taken only after due consideration, and not by default.

The kind of safeguards I have in mind are illustrated by three examples: financial institutions, mining and minerals, and the delisting of multinationals.

Financial Services

These comments concern enterprises that depend on mobilising capital in India, and begin with the assumption that India needs more capital than it has. Consider ICICI Bank, starting with its history. What exists today was initially a development and term-lending institution, the Industrial Credit & Investment Corporation of India, which the government set up with World Bank participation in 1955. ICICI did some things very well starting in the 1990s:

* It transformed its outmoded role in development and term lending into a full-service corporate bank, with a commendable resolution of its non-performing assets (NPAs);

* The government having diluted its holding over time, ICICI started a “private-sector” bank (i.e. without a majority holding by government), which it built much better than several others at the time. With its privileged access, fresh start and limited charter (e.g. no requirement to service the vast rural hinterland of India), it was able to leapfrog the legacy of responsibilities and problems of the nationalised banks. It also did very well in inducting technology as a delivery platform. By doing a reverse merger with the term-lending parent, ICICI Bank metamorphosed into what it is, a much-lauded private sector universal bank.

While its achievements are real, the question is to what extent foreign investors should be the beneficiaries of the profits generated from such privileged access to resource mobilisation from this market space. Foreign investors owned over 70 per cent of ICICI Bank at the end of 2005. I do not suggest opposing foreign investment in the financial sector, particularly if it is accompanied by technology, processes or a special contribution to performance. The question is whether the sharing of more wealth generation domestically from domestic capital resources may be in order.

HDFC, the Housing Development Finance Corporation, was promoted by ICICI in 1977. At the end of 2005, over 78 per cent of the HDFC’s stock was owned by foreign investors. The question is, should the profits of this sound enterprise and its high-performing affiliate, HDFC Bank, likewise be so freely available to foreign investors, or be capped so that a reasonable proportion flows to shareholders in India?

Mining & Minerals

The rationale of seeking investors in minerals and metals is clear enough. There are issues of technology and commercial capacity in exploration and development, including market and capital access, and logistics. However, what is much less obvious is the reason for allowing 100 per cent investment in exploration and production of minerals (with a list of exceptions). Do we really want the big boys of mining setting up in India and exploiting our mineral resources, even if it is with their own capital, simply for the benefits of the direct employment they generate, such infrastructure as they bring, and the amount they spend that cycles through the domestic economy, while on the flip side, there are the costs of human displacement? The evidence from what they have done elsewhere, e.g. Africa or Papua-New Guinea, seems less than compelling. The simple question is this: should foreign companies be allowed this level of access to exploit India’s mineral resources, unless a cost-benefit analysis leads to the conclusion that it is in the public interest?

Delisting of Multinationals

This issue has been revisited often in the development of our capital markets. The government has focused on fair compensation for minority shareholders on the delisting of companies. Sebi guidelines prescribe how the exit price is to be calculated. However, they ignore the sharing of the wealth that the enterprise continues to generate.

What would change these examples? Continued public access to a sizeable proportion of the shares of such companies in India at reasonable prices, while ensuring reasonable transfer pricing for MNCs to the extent possible. In other words, a requirement to list and share the wealth (again, an old issue, e.g. Coca Cola), stop profitable multinationals from delisting, and cap foreign holdings in financial enterprises. If foreign capital owns 30 per cent of floating stock and perhaps 40 per cent of the private sector, it is time to think and act.

Shyam Ponappa

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