The Case for Raghuram Rajan and Economy of India

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Recently in an article in the Economic Times, popular Indian columnist and novelist Ms Shobha De, touted the newly appointed Reserve Bank of India (RBI) governor Raghuram Rajan, as the ‘rock-star economist’, the ‘Poster Boy of Banking’ who can easily top easily top ‘India’s Most Desirable’ lists and is also expected to pull India out of the financial mess.

RRThe post has attracted lot of media attention and has succeeded in flaring up imagination and  varied emotions of the readers, ranging from interesting, to disgusting or even revolting! To add substance to the article, it might have made better sense to also look at some of the problems facing India’s economy and the challenges that Rajan has to deal with while he tries to walk his talk. Let’s have a go at those less appealing aspects that are actually the areas of concern for all Indians.

The economic problems in India can be attributed more to the country’s fiscal policy and other government policies than to monetary policy of the Reserve Bank of India (RBI). The central bank often finds itself reacting to the consequences of inaction and policy conundrum of the government.

 

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Shareholder Engagement or Activism ?

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Continuing from my last post ‘ Is shareholder engagement good for companies? ’,  here we look at the scope of shareholders engagement and different approaches to shareholder engagement.

What is the scope of shareholder engagement?

Shareholders have a legitimate role in areas pertaining to:

  • Corporate Strategy – such as mergers, diversification, restructuring, non core asset sale.
  • Capital Structure – such as capital allocation discipline, use of cash on balance sheet.
  • Governance – such as audit-related issues, board structure, managerial remuneration.

However shareholders are not expected to micromanage companies. Nor is it desirable that shareholders push for short term profitability over sustainability and long term value creation. It is important that shareholders and board members engage effectively in the shared pursuit of high quality governance.

What are the different ways in which shareholders engage with companies?

Shareholders can either have a proactive approach for engagement with a company or may adopt a passive approach towards a company.

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Passive investors sell off their shares if they are dissatisfied with the corporate decisions.

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On the other hand, active investors engage proactively with the management, prior to a corporate decision being affected, in order to change the outcome of the decision. While the term ‘shareholder engagement’ is used to describe a collaborative approach, ‘shareholder activism’ refers to the use of a more assertive approach by the minority shareholders to affect changes in management and strategy of a firm. Read more

Is shareholder engagement good for companies?

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Shareholder activism has increased significantly in the last few years, particularly after the financial crisis of 2008. However, it has since then been a debatable topic, as it is difficult to quantify “appropriate” level of shareholder engagement, which is desirable for achieving effective governance, while adding to business value. Quite often there is an apprehension that excessive shareholder intervention may consume a lot of valuable management time and result in short term profit orientation.

Why should shareholders engage with company management and boards?

A business needs capital to finance its growth Shareholders are the providers of capital to a business and as such are part owners of the business. Shareholders invest in the business hoping for a higher potential return from the investment while accepting a greater potential risk than other providers of capital. As shareholders own a share of the organization in which they have invested, this entitles them to ownership rights (i.e. rights to profits and assets in proportion to their shareholding) and in most cases control rights (i.e. rights to have a say in the running of that company, e.g. they may vote on key issues).

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Management makes use of the capital to run the business and has an obligation to do so in a fair and transparent manner while maximizing value for the shareholders.  Read more

Currency crisis in the Emerging Markets

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The year 2013 has seen a global sell off resulting in the fall of currency in most emerging markets including Brazil, India, South Africa, Indonesia and Turkey. The charts below show the currency movement of the emerging nations versus the US Dollar in the last 5 years. (Source: http://www.xe.com/currencycharts )
 
 
 
 

Brazilian Real has fallen more than 14%  against the USD.

 

 
 

Indian Rupee has fallen about 20% against the dollar in 2013 and hit a lifetime low 68.85 per USD.

 

 
 

South African Rand hit the R10/$-mark for the first time since 2009, the lowest value in four years as poor economic data and labor market tensions weighed on sentiment.

  
 
 

Indonesian Rupiah has slid nearly 12% in 2013.

  
 
 
 

 The Turkish Lira has fallen to a record low of 2 to the US Dollar, the lowest level record since 1981.

  

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Companies Bill 2012– Giving Voice to Minority Investors in India

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The passing of The Companies Bill 2012 by Rajya Sabha on 8th August 2013,  is a step forward towards transformation in the corporate governance practices of the country. The new bill that requires President’s assent for it to become law, replaces the Companies Act of 1956. The bill, when enacted will bring in reforms to enhance corporate governance by giving voice to the minority investors in India, strengthening the role of independent directors and expanding the responsibility on auditors.

A key objective of corporate governance in India has been to strike a balance between the rule of majority shareholders and the protection of the rights of minority shareholders. The protection of minority shareholders rights is particularly critical given the often concentrated ownership of Indian companies.

Unlike in the developed countries such as US & UK, where ownership of a company is widely dispersed and is generally separate from the management of the company. In India, listed companies are usually parts of a large business group, characterized by a promoter or a controlling shareholder.

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US Immigration Bill – impact on Indian IT industry

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The Indian IT industry will be cautiously following the US immigration bill to be introduced this week by the US Senate, with the objective to provide for comprehensive immigration reform, increase visas for skilled workers; and beef up border security.

Passage of the bill could be a boon to high-tech companies like Intel Corp.  or Facebook Inc., who would be able to hire more highly skilled workers from abroad. But the US immigration bill is likely to impede the operations of the Indian IT services cos.

The IT services industry grew rapidly in the 1990s.  Due to the Y2K hype, businesses were apprehensive about their IT systems and so there was demand for IT service providers. Once the Y2K hype was over, the customers became conscious of their IT spending. Consequently, the suppliers had to hire overseas, particularly in India, and that paved way for the off-shoring trend that is currently seen.

Indian consulting firms like TCS and Wipro introduced off-shoring by charging lower prices per consultant. These firms basically enjoyed the labor arbitrage due to large number of consultants working in India enjoyed and competed in terms of pricing. Big IT consulting houses like IBM and Accenture had to hire IT professionals in India and charge similar prices per consultant.

In order to maintain their cost advantage, besides deploying a large pool of offshore resources, the Indian IT services companies also paid lower wages to employees travelling to the U.S on H-1B or L-1 visas, as compared to equivalently skilled Americans.

The proposed US Immigration bill proposes wage parity between guest workers in the U.S. and equivalently skilled Americans. As such the Indian outsourcing companies that have a large no of on-site employees on US work permits, will need to pay them higher salaries. This will negatively impact the cost advantage that the Indian IT services companies have enjoyed so far.

As per the proposed bill, the companies will have to pay a $10,000 fee per additional worker if the employer has 50 or more employees and more than 50 per cent of these workers are H-1B or L-1 employees without a green card petition pending. Domestic companies like TCS, Infosys and Wipro will have to pay USD 10,000 for each additional H-1B employee they would be hiring.

On the positive side, it will also enable 11 million workers in the US including 2.4 mill Indians to obtain American citizenship. Another proposal is to award residency to those who earn doctorates from U.S. universities in mathematics, engineering, science or technology.

Management of Indian IT services companies are concerned about the increase in compliance cost and higher turnaround times, which would fundamentally affect competitiveness and the margins of these companies.

As it will take a few more months for the bill to be implemented, the Indian government, and outsourcing industry will be closely following the debates. Meanwhile the Indian IT services companies may need to look at revamping their business models to remain competitive.

Markets – On the Roller Coaster

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The excessive market euphoria that was apparent in the beginning of the month has faded and has given way to apprehensions for investors worldwide.

Even as the markets seemed to recover from the concerns over Cyprus bank run, tagging it a one off event, the news of political turmoil in Italy shook the European stock markets. Greece’s ATHEX Composite was off 4.8%. US indexes opened in red today. This certainly signals nervousness and dampened sentiments of investors. The Asian markets will also be impacted negatively.

Bank deposits that were so far considered as safe investment options, no longer seem to be safe after the Cyprus government decided to levy taxes on deposits, in a bid to secure bailout package from the European Union. The banks have remained closed for about a week and are likely to reopen with the imposition of capital controls by Cypriot authorities.

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Global Markets – Riding high on sentiments

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Worldwide markets are echoing bullish sentiments.

The US Dow Jones Industrial Average index has surpassed its 2007 high and continues to make new all-time highs. The Standard & Poor’s 500 Index too is trading at post-2007 highs. Asian & European markets are rallying too based on cues from the US market. Indian markets are recovering from February lows.

All this barely a week after the US sequestration set in on March 1, 2013!!

The bullish markets have revived positive sentiments and created excitement, but it also warrants cautiousness.

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Market Reaction to new CEO announcement

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On 21st Nov, Indian generic drug maker Cipla Ltd. announced its plans to acquire South African firm  Cipla Medpro. Subsequent to the announcement that is likely to boost its prospects in Africa, and is expected to be accretive to earning, Cipla Ltd. shares rose by more than 3 % after the announcement and were trading at Rs 390 on NSE.

On 22nd Nov, Cipla Ltd announced the appointment of Mr. Subhanu Saxena as Chief Executive Officer. Mr. Saxena has rich work experience of over 25 years, in industries as varied as FMCG, consulting, banking and pharmaceuticals. Following the announcement of the appointment of new CEO, Cipla share fell down during the day while the NIFTY index showed a upward movement. Cipla share price clearly did not follow the pattern in sync with the movement of NIFTY.

 

This weak movement of the share price on 22nd Nov could have something to do with the announcement of new CEO appointment. Generally some market reaction is expected around the announcement day of a CEO appointment. In considering CEO candidates, boards of directors and selection committees are almost always concerned about the market reaction on the company’s share price.

 

At times markets tend to react unfavourably to the announcement of a new CEO, as investors may anticipate some amount of uncertainty involved with the change in CEO. There are other instances when there have been positive abnormal returns around the announcement of an outside CEO appointment. In such cases, results suggest that new outsider CEO appointments can be considered as beneficial to investors because they bring in knowledge from other organizations and can objectively evaluate and challenge the current strategy of the company and incorporate new and fresh ideas.

Though the initial market reaction is in anticipation of  the CEO’s likelihood of success, however a  latest research by HBR shows that there is no positive correlation between how a company’s stock fares upon the announcement of a new CEO and the share price over that CEO’s tenure so the initial market reaction should not be considered an indicator of the CEO’s likely performance.

Irrespective of the initial market reaction, it will only be evident over a period of time how the new CEO steers the Cipla towards higher levels of growth and creates value for the shareholders.

 

Impact of policy environment on funding start-ups in India

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Funding has always been the biggest challenge that every venture has to face. Particularly the technology and knowledge based start-up enterprises that are based on intangible assets such as human capital and an entrepreneurial idea. In absence of physical assets, such start-ups find it difficult to secure bank financing and they need to approach equity financiers such as angel investors or VCs. Mostly start-ups do not even have access to working capital loans; though some finance companies offer collateral-free working capital loans to small enterprises with at least three years of operations.

Like any other investment, the investment in start-ups is influenced by the policy environment prevailing in the country. The current policy environment in India is reasonably conducive for start ups, but still leaves a lot more to be desired. Domestic money to VC/PE funds are either restricted or prohibited in current regulatory framework. For example SEBI regulations for Domestic Venture Capital Funds do not permit registration of a fund which would have corpus of less than Rs.5 crore ($ 1 million). This makes it difficult for angel groups and seed funds to get registered and raise funds. Pension funds, which are the biggest source of money worldwide, are not allowed to invest in VC/PE funds. Insurance companies are allowed to invest in infrastructure funds only; even banks’ exposure to VC/PE funds is severally controlled.

The National Innovation Act that proposes tax incentives for angel investors is likely to be passed by the government. The Department of Industrial Policy and Promotion (DIPP) in India also plans to incentivise venture capitalists (VC) who invest in small and medium-size enterprises (SMEs). It is anticipated that with implementation and stabilization of Goods and Services Tax (GST), the environment will be more favourable for promoting entrepreneurship and business.At present, for a business, planning to set up manufacturing units in India, the existing complex and high taxation structure consumes a large portion of the available cost arbitrage. Though the manufacturing cost of most products in India is nearly half than in the west, but due to tax levied at various stages, the cost advantage is reduced by almost 50%. The existing multi tax structures often compel manufacturers to base their inventory and distribution decisions on tax avoidance rather than on operational efficiency. The implementation of Goods and Services Tax (GST) is expected to reduce the hassles associated with the existing tax structure and facilitate investment decisions to be made purely on economic concerns, independent of tax considerations.

The policy environment in India is gradually evolving and regulations are expected to evolve in a manner that encourages more investment bringing it at par with that in the mature markets. However the timelines by which these proposed policy changes will be implemented and the overall impact on the VC community is yet to be seen.
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