Friday, July 29, 2011

Could I have the bill please?

What ails India Incorporated? In the 12 months of the last financial year, overseas investments by Indian firms touched a staggering $44 billion, an unprecedented 150% rise from $18 billion the year before. At the same time, inward direct investment from foreign firms was $27 billion, 25% less than that of the previous year. Indeed, it is strange for the world’s second-fastest growing economy to have disparately higher capital outflows vis-à-vis inflows. And it becomes even stranger when balanced with inward remittances of $55 billion that the 27 million Indian diaspora made last year – the highest globally.

Not strange so far? According to a report released by Global Financial Integrity (GFI) late last year, it is estimated that because of tax evasion, crime, bribery, kickbacks, and corruption, India has lost gross assets worth US $462 billion (adjusted) during 1948-2008, at the phenomenal average rate of $19 billion per year from 2004-2008. About 68% of this aggregate illicit capital loss occurred after India’s economic reforms in 1991, indicating that deregulation and trade liberalization actually contributed to/accelerated the transfer of illicit money abroad. And quite evidently, High Net-Worth Individuals (HNWIs) and private companies were found to be the primary drivers of illicit flows out of India’s private sector. India’s underground economy is also a significant driver of illicit financial flows. Without meaning to be an alarmist (or a pessimist), substantial as these outflows are, they are likely to be understated given that economic models cannot capture all channels through which illicit capital can leave the country.

So again – what ails India Incorporated? Faster rates of economic growth since economic reform started in 1991 led to a deterioration of income distribution which led to more illicit flows from the country. It was the unleashing of an economic barrage, pun intended, without the sluice of corporate governance. Moreover, this poor state of governance is more than aptly reflected in a growing underground economy which in turn has fueled more transfers of illicit capital from India, stagnating levels of poverty and an ever widening gap between India’s rich and poor. While in absolute percentages (and not numbers), overall poverty may have declined from 35.8% to 27.5% for the country during 1991–2008 , income inequity measured in terms of the Gini coefficient actually increased – from 0.303 in 1991 to 0.368 in 2008 (the last year for which statistics are available).
Despite this (or because of this), indeed the rate of return on investment in India is higher than abroad, so obviously this increasing global footprint is more than just “routine expansion of business”.  Over the last year, Mukesh Ambani’s Reliance Industries invested $5 billion in Africa and the US, and now has plans to double its investment abroad in four years. Anil Ambani’s Reliance-ADAG has invested $3 billion globally in 2011, and also wants to double that to $7 billion by 2015. Ratan Tata (the Tata group has 65% revenues generated overseas) has invested more than $1 billion internationally this year. The Essar Group expects to invest $6 billion overseas by 2015. Sunil Mittal’s Bharti Airtel spent $8.2 billion acquiring Middle East-based telecom firm Zain’s Africa operations last year. Could it be that earlier, investing abroad was a risk diversification but the current impasse in governance makes it a necessary evil (sic) for companies to look elsewhere?
Yes I know, I haven’t answered the question at the crux yet, what ails India Incorporated. For that let’s glance at an “abbreviated to-do” list for the netas and babus.

Land acquisition and rehabilitation and resettlement bill: As a much-needed successor to the Land Acquisition Act of 1894, this Bill will ensure that the private sector directly acquires as much as 70% of total targeted land directly from farmers. Our farmers will get a better price, and the rehabilitation and resettlement provisions might even address opposition from those who resist selling out.
Mines (amendment) bill: With the insertion of a clause that will make it mandatory for mining firms to share profits and royalties with affected tribals, the Bill can remove the most significant hurdle to an expansion of mining activity. After much debate and an inordinate delay, it has been cleared by a GoM and awaits Cabinet approval.
Banking laws (amendment) bill: Introduced in Parliament in 2005, this Bill proposes to open up India’s relatively closed banking sector. It will give shareholders in banks the right to vote in proportion with their shareholding. Currently, shareholders have a maximum of 1% vote in a public sector bank and 10% in a private sector bank irrespective of actual equity holding.
Insurance laws (amendment) bill: On the table in Parliament since 2008, the Bill will allow up to 49% (up from 26%) FDI in domestic insurance companies.

Pension fund and development regulatory authority bill: First introduced in Parliament in 2005, the Bill will allow up to 26% FDI in pensions. It will also grant statutory status to the independent regulator.
Companies bill: A much needed successor to the Companies Act 1956, this will permit shareholders to file class action suits against fraudulent promoters. This amendment in company law is pending since the Satyam scandal broke out more than two years ago.

Direct taxes code bill: By lowering corporate and income tax rates, this should increase compliance and raise revenue for the Government. Most importantly, it will do away with the Government cashing in on its powers to grant exemption. But sadly (and predictably), the Government has failed to achieve consensus among stakeholders.
Constitution (115th amendment) bill (GST bill): It will overhaul India’s indirect tax system which in its current form imposes multiple, cascading taxes on the same good or service. Like the direct taxes code, it will abolish exemptions and lower rates, hopefully increasing compliance and revenue for Government. Again, the Government has failed to persuade all states.
Of course, there are many others in a long laundry list (the latest of which is the Lokpal conundrum), but I guess our netas and babus don’t want to wash dirty linen in public! This list is not a panacea, perhaps just Band-Aid on what appears to be a festering wound. Maybe the Government is “damned if it does, and damned if it doesn’t”. But someone needs to yell from the floor of the hallowed (hollowed?) House. Else I will. “Could I have the bill please?”

Monday, July 25, 2011

And the giants come marching in

The oil and gas industry is still recovering from the greatest global economic shock in more than 75 years. As we begin 2011, economic uncertainty remains, but a mood of cautious optimism has emerged. The current surge in commodity prices suggests that an average oil price of $90 or more per barrel over the year is seen as increasingly achievable. As a result, oil and gas exploration companies are beginning to look again at new frontiers of exploration and unconventional fuel resources in a bid to regain momentum. So where does India fit into this trend?
India is and will remain energy hungry. The country is currently the fifth largest energy consumer in the world and given its targeted GDP growth, fuel needs are likely to expand at a significant rate – up to 40% over the next decade according to some estimates. India’s per capita consumption of energy and electricity is well below that of industrialized nations and the world average, meaning that there is scope for rapid expansion. These facts perhaps explain two distinct initiatives from the Indian government. The first is an ongoing pressure for India to compete in the strategic race for global energy resources with other developing economies such as China and Brazil; late last year India’s Ministry for Petroleum and Natural Gas again publicly issued a call for Indian companies to flex their muscles overseas and contribute to the country’s energy security.
The second initiative, which is the focus of this article, is a clear requirement to maximize India’s own domestic natural resources. India already imports over 70 per cent of its crude oil requirements and around 15 per cent of its natural gas. It is with this context in mind that the Indian government launched its New Exploration Licensing Policy (NELP) in 1999, part of its Hydrocarbon Vision 2025 master plan, with a related goal of attracting $40 billion in oil and gas investment by 2012.
With some recent major discoveries hitting the headlines, a range of tax and investment incentives announced by the Indian government, and an estimated 22% of India’s prospective territory remaining so far unexplored, India seems on paper at least to be an attractive market. Yet the most recent sale of exploration rights (NELP 8) drew a less than overwhelming response from foreign bidders, and the ninth round, launched in October last year, is unlikely to fare much better. And although a number of European companies such as BG Group, BP and ENI have established businesses in India, other majors – particularly from the US – have so far stayed away. What are the risks that they perceive which are currently holding them back from exploring India as a new frontier?

Domestic production on the rise
The two major discoveries in India in recent times, namely Reliance Industries’ natural gas find in the offshore Krishna Godavari (KG) fields, and Cairn India’s heavy crude find in the deserts of Rajasthan, have provided a major boost to the domestic oil and gas sector in India. Indeed India’s fuel import bill in 2009-10 was around US$82 billion – significantly lower than expected due to the commencement of production from these two projects. The timing was also fortuitous given that several existing oil and gas fields experienced a decline in production in the same period as they near maturity.
Increased levels of exploration activity have also meant good business for oilfield services companies. Providers of seismic surveys, drilling rigs and ships, well-logging and so on have witnessed robust growth and this is likely to continue, particularly given the focus on deep-water blocks and frontier basins. Nonetheless, many of these blocks come with significant ‘below ground’ risks, a fact tacitly acknowledged by the Petroleum & Natural Gas ministry in the terms offered in the , and the major players are likely to stay away until reserves are proven and production has started.
Policy uncertainty
In terms of ‘above ground’ risks, the extent of State involvement and uncertainties in the direction of energy policy are important considerations. Foreign bidders will no doubt have concerns at the levels of participation in the rounds by State-owned companies such as the Oil & Natural Gas Corporation (ONGC) and Oil India, both of whom receive subsidies from the Indian government and may be perceived as being at an unfair advantage. The extent to which ONGC dominates the Indian oil & gas landscape should not be underestimated, with many existing operators and services companies citing the organization’s cumbersome bureaucracy and slow decision-making as a major negative factor of operating in the market. Its influence as an instrument of government policy is also clear, particularly in its recent moves to block London-listed Vedanta Resources from buying Cairn India.
Nowhere is this issue more clearly illustrated than in the dispute between the brothers Mukesh and Anil Ambani, who control Reliance Industries and Reliance Natural Resources respectively, following an acrimonious split of the family empire. The long dispute centers on the price of natural gas that Mukesh’s RIL had agreed to sell in 2005 to RNR. In 2007, the Indian government decreed that the price should be increased by some 80% in line with the Administered Pricing Mechanism (APM), the government’s price-setting tool for natural gas, a decision that was eventually upheld by the Supreme Court in 2010. The idea that the government has the power to set prices for natural resources is naturally off-putting for oil and gas companies. The ruling is also likely to worry investors across the board in that it appears to undermine the sanctity of contracts in general.
Furthermore, and in line with many other developing countries facing a sharp decline in tax revenues due to the economic slowdown, India is likely to target oil and gas companies with increased tax rates and other fiscal measures. The latest round, for example, will be governed by the proposed new Indian Direct Tax Code which has suggested that business income be computed for each E&P block separately. This could result in the block-wise ring-fencing of expenses and as a result companies being obliged to pay tax on the profits of each block, without the ability to offset against losses in other blocks.

Infrastructure and technology constraints
As in many other parts of the world, hydrocarbon reserves are not always found in the easiest of operating environments and India with its concentrations in remote areas in the north-east of the country and offshore, sometimes in deep-water blocks, is no exception. Ensuring sufficient access (with supporting infrastructure) to oil and gas reserves at a reasonable cost will remain a significant challenge. Infrastructure remains a key business limitation in India for many industries, in terms of transport and communication networks, but particularly for the oil and gas industry. The expansion of the natural gas industry in India will inevitably be constrained by India’s relative lack of pipeline network, especially in the south and east of the country.
For onshore blocks, dealing with land acquisition and the kind of communal issues that have recently dogged other natural resources companies such as Vedanta and POSCO in the east of India, will also require careful thought and long-term planning. For some foreign companies, this is reason enough to leave operatorship to a local partner or to avoid the onshore market altogether.
The shortage of human capital and availability of equipment affecting the entire oil and gas industry also applies in India. Indian companies themselves are starved of technology, particularly in the unconventional technologies space, and this will continue to drive cross-border deals by Indian players looking to buy in that expertise from overseas. The most notable deal last year in this field was RIL’s purchase of a stake in Atlas Energy’s Marcellus project, which gives them exposure to the North American market as well as access to shale gas technology.
An unconventional future
Despite the poor showing in recent rounds, the government is pinning its hopes on unconventional fuel resources as a bright spot on the horizon. India is known to hold huge potential shale gas reserves in the east of the country, as well as in the north-east and offshore, and a number of pilot shale gas projects have already begun. A framework for the new shale gas policy is currently under preparation by the Indian upstream regulator, with a first round of auctions due by the end of 2011.
At the same time government policies are becoming noticeably more investor-friendly. Recent moves towards more transparency in gas pricing have led some experts to predict that the Administered Pricing Mechanism will be dismantled in the near future. Caps on visas for expatriate employees in the oil and gas industry have also been removed after lobbying by the industry in the past 12 months. The sum of which may prove enough to tempt the major foreign players to India’s new gas frontier after all - so will the giants come marching in?
(Author’s note: This article was published in “Asia-Pacific Risk Watch” – the quarterly newsletter of Control Risks Pvt Ltd in January 2011; subsequent to my writing this (and not because of!), the Reliance-BP deal was cleared on 21st July).

Sunday, July 24, 2011

Opening of the shutters

For a country where the GDP is consumption driven, ironically only 4% of India’s shops occupy a space of more than 500 square feet. In grocery stores, young boys perch precariously on ladders to fetch jars from remote crannies. In bookshops, browsers brush bottoms as they jostle and squeeze past each other in crowded aisles. Posh boutiques are reached up narrow, winding staircases. And people hand-pick their fresh fruit and vegetables from hand-cart hawkers and pavement vendors.

Most Indian shopping still takes place in millions of independent grocery shops, or kirana (corner) stores, manned by the owner and perhaps an assistant or two which belong to what is known, quite accurately (and perhaps euphemistically), as the “unorganized” sector; small, family-owned shops surviving on unpaid labor and, often, free land for a small stall. “Organized” retail, such as hypermarkets, supermarkets and department stores, accounts for only 4-5% of the country’s $322 billion market.

India is again pussyfooting with the idea of opening the shutters of its retail market to foreigners. If it does, then plenty of global retailers will be lining up. It is rather easy to see the magnetism of the Indian market. Rapid economic growth in the past decade plus has increased the disposable income of the middle class. It is this urban consumer that the global chains are eyeing. With the Committee of Secretaries giving its nod for 51% FDI in multi-brand retail a few days back, the nodal Department of Industrial Policy and Promotion should be preparing a Cabinet proposal soon. But the deal is far from done.

With nary a doubt, opening up the retail space to foreign investment would help in overhauling the country’s antiquated supply chain. Shortcomings in the distribution systems have created huge differences between wholesale and retail prices. Inefficiencies are common. The government estimates that 40% of the fruit and vegetable production in country is lost due to inadequate storage and transport infrastructure. Waste of this magnitude, troubling in the best of times, is appalling as the country battles double-digit inflation. Yet, despite a consensus among policymakers that opening up of the retail sector to foreign investment has benefits both in the near and long term, the government has been comatose in a decision.

The reason behind this hesitation is the political clout of existing traders. The government’s move is fraught with political risk because retail deregulation is a divisive issue in India. An estimated 35m people or 7.3% of India’s workforce are employed in the unorganized retail sector. With domestic inflation rising, there remain widespread fears that the entry of global retail giants could hurt these kirana stores. The traders have been very vocal about their opposition to any form of organized retail and have regularly conducted mass protests and ransacked supermarkets to make their sentiments known. They fear that the arrival of big-box retailers will price the corner grocery stores out of business.

There is some truth to this. When an organized retailer opens nearby, small retailers typically lose about 23% of their sales in the first year. But after five years they are more or less back to where they started. This was also the case in Thailand, which opened up to foreign retailers after the Asian crisis in 1997. In the short term, according to a report, “the entry of foreign players in a recessionary economy adversely affected all segments—wholesalers, manufacturers and domestic retailers.” However, there were also benefits. The foreign invasion led to the development of organized retailing (now 20% of the Thai market); producers had to become more efficient; foreign retailers started buying more Thai goods.

Despite more pros than cons, will the government be willing to rock its already floundering political boat even more by antagonizing the trader’s cartel?  Or with this being India, will the rules be well shrouded in uneasy compromises? Will the shutters open or the Pandora’s Box?

I don’t think we’ll open the shutters – at least not just yet.