Thursday, January 15, 2015

India set to overtake China?

Optimism about the Indian economy is alive despite 2014-15 being largely washed out. We have commentators again talking of India overtaking China in the second half of the decade. They were saying so at the beginning of the decade as well. At that time, however, China was growing at over 8 per cent. What commentators meant then was that India would inch towards 9 or 10 per cent and thus overtake China.

Today, the overtaking, if it happens, will be at a different level. And it will happen later than commentators had predicted. Chinese growth is poised to fall below 7 per cent. The World Bank sees the Indian economy growing at 7 per cent - in 2017, a good two years later than forecast at the beginning of the decade.

Still, becoming the fastest growing economy in the world is no mean prize. Is the prize within reach? Most commentators would say - yes, if the government could push through "big ticket reforms". An article in today's FT makes this point:
Reforms aimed at boosting manufacturing or encouraging capital investment may prove tougher to implement at national level than they did when he was running Gujarat. Besides, some reforms, such as relaxing the rules on foreign ownership of insurance companies, may not prove to be the magic bullets that industry lobbyists claim. Second, and perhaps more fundamental, democratic India is still caught in an ideological battle over where to strike the balance between pursuit of growth and protection of the environment and land rights.  

This is the sort of thing we have been hearing for two decades now. Reforms didn't happen in UPA-I and growth soared to 9 per cent for at least a three year period, thanks to the global boom. I don't believe India's growth is contingent on the familiar set of "reforms". I think the Indian economy can hit 7 per cent if two things happen. First, banks need to be recapitalised. This, as readers of this blog would know by now, doesn't mean "big ticket" reforms in banking. It means a few simple things like reducing the government's stake to say, 52%, getting the right people into top management, strengthening boards and improving risk management.

Secondly, the world economy needs to get better. Will it be by 2017? All bets are off at the moment. But if the improvement did happen in the world economy, we have a good chance of being the fastest growing economy in the world in 2017.

Friday, January 09, 2015

Kotak- Ing Bank Vysya merger

Shareholders have reportedly approved the Ing Bank Vysya merger. Ing Vysya Bank unions are still seeking assurance that no jobs will be lost.

There are important lessons to be drawn from the merger. One, new private banks, not foreign banks, are the big winners in the post-reform period. Public sector bank share will continue to decline but the loss will be to new private banks, not so much to foreign banks. Two, branches are crucial to cost competitiveness and growth in Indian banking- no new private bank would like less than a 1000 branches. Thirdly, for public sector banks, the branch network needs to be larger as they must rely mainly in interest income to grow profit- their ability to generate fee income is not as good as that of private banks.

It follows that PSBs with less than, say, 2000 branches are vulnerable. We are better off selling of such PSBs instead of merging them with other PSBs- mergers in today's context will weaken stronger banks. More in my EPW article, Merger they wrote.

Tuesday, January 06, 2015

Gyan Sangam

I return to my blog after a long lay-off, thanks to a rather hectic schedule. I'm hoping I will be more regular in the New Year and hoping also that this does not go the way of most New Year resolutions.

Well, I was over in Pune for the Gyan Sangam, a conclave of bankers organised by the finance ministry. I was there as an external expert on one of the six working groups. McKinsey was the 'knowledge partner' for the event. They made a presentation to kick off the proceedings and there was a director who coordinated our group's discussions.

We met at around 4:00 pm and carried on till nearly 8:30 pm. After a break for dinner, the bankers in our group re-assembled to arrive at a consensus on the recommendations. This went on for another two hours. So, you see, this was not the usual talk shop.

Indeed, I was pleasantly surprised at how constructive and intense the discussions were. My group dealt with Risk Profiling and Recovery. After a few rounds of discussions, we were asked to put down on a sheet of paper actions that we wanted of bankers and actions we wanted of policy makers. The final recommendations emerged from the points written on these sheets. Even if a few of our recommendations get implemented, I believe they would make a sea change to risk management in public sector banks.

That said, I am awaiting clarity from the government on a couple of issues. First, does the government wish to retain the " public sector character" of banks (that is, a stake of 51 per cent or more) as the FM promised in his budget last year? Two, does the government expect PSBs to perform a social role or is it happy for them to pursue profit?

The second point is especially important as there was a lot of talk at the Sangam on the gap in performance that had opened up between private banks and PSBs. If PSBs could steer clear of, say, infrastructure and SMEs, the gap would begin to close. But will the government allow it? I doubt very much. In his speech, the PM exhorted banks to shun lazy banking and take more risks in lending. That doesn't sound like a focus on profit alone.

Leaving aside the details on a host of matters including risk management, the government needs to do two things: fix management and fix governance. Fixing management means getting the right people at the top through a rigorous selection process. It's a scandal that this has been neglected for decades now. One CMD mentioned at the meeting that his interview had last all of 12 minutes. It took a 12 minute interview to put a man in charge of some Rs 500,000 crore worth of assets. It's not just the politicians and bureaucrats who are to blame but also the RBI. The RBI governor is represented on the committee to appoint CMDs and EDs of PSBs.

We also need to end the game of musical chairs at PSBs. An ED at a middle size or big bank hops on to a small bank as CMD. He whiles away a couple of years with his eyes focused on a CMD position at a bigger bank. From Indian Overseas Bank, he might leap across to Bank of Baroda. What commitment can we expect of EDs and CMDs who don't expect to be in their jobs for more than a couple of years? What risk management is possible in such a dispensation? Enough of this. If the government is serious, it must insist on succession planning from within for the posts of ED and CMD except in rare cases. It's hard to see how a CMD can deliver performance without having gained an understanding of the culture, systems and processes of  bank over a period of time.

The next thing to do is to fix governance. The government's idea is to split the post of chairman and MD. This has the potential to create two power centres in a PSB. The chairman will exercise power without having any responsibility. The MD will have to get things done with a chairman who may engage in back-seat driving. We have to see how this goes- I have my doubts.

It's true the CMD is all-powerful in the present scheme of things. But the answer is not to split the post but to strengthen the boards with independent directors and also with well-training government and RBI directors. We need a proper selection process for independent directors- perhaps, these appointments are best done by an independent Appointments Committee.

The RBI needs to do its best for both management and governance. It must specify fixed terms for the CMD. And it must lay down stringent 'fit and proper' criteria for independent directors with the right to reject nominations that fail to meet these criteria.

I don't see thinking along these lines. At the Gyan Sangam, there was much talk about a Bank Investment Company, a holding company for all PSBs which was proposed by the P J Nayak committee. Such a holding company would be the ultimate nightmare. It would be unwise to entrust the entire set of 26 PSBs to any set of professionals, however eminent.

The government needs to make up its mind on PSB autonomy. If it wants PSBs to run autonomously, it can ensure that within the existing framework. By the same token, setting up a holding company does not ensure autonomy. Alas, there is no set of professionals, however eminent, that is not amenable to government influence. That's the reality of India today.

Wednesday, December 10, 2014

Satyam case judgement and independent directors

I had a post yesterday on the judgement in the Satyam case in a trial court in Hyderabad. I said it was not clear from media reports what the independent directors were fined for and why Krishna Palepu of HBS was fined Rs 2.66 crore while the other independent directors were fined Rs 20,000 each.

I am still waiting to get my hands on the court judgement. In the meantime, we have a report in BS that sheds some light on the matter:
The court on Monday imposed a fine of Rs 2.6 crore on Palepu for conflict of interest in providing professional services to the company and  remaining on the board of Satyam as an independent director and for failing to get the government's nod for providing professional services. Palepu has to pay the fine within two months.....Palepu was fined by the court as he had received Rs 87 lakh from Satyam towards consultancy fees, while each individual director was paid around Rs 13 lakh for the year 2007, according to Satyam’s annual report.

If the report is correct and the reason for Palepu's attracting a heavier fine is that he helped himself to a consulting fee as independent director, I must say the judgement is very interesting indeed. What the court is saying is that when you get paid by a company for something other than your work as independent director on the board, it creates a conflict of interest. It compromises your independence. And if that is what the court is implying, it has hit the nail on the head.

An independent director is defined as somebody who has not had a pecuniary relationship with the company for a certain number of years before he gets on to the board. Given this definition, it beats me how you can have a pecuniary relationship with the company after you get on to the board. You can collect your fee and commission but not anything else. And yet here we have Palepu, who is said to be a expert on corporate governance, providing consultancy services to Satyam and making a tidy pile. In my view, it was incumbent on other independent directors to have objected to this arrangement if they were aware of it. And the markets regulator, SEBI, should have been alert to such goings-on in companies (as I mention further on, I did raise an alarm at SEBI).

This is a matter that has troubled me for years. How can a so-called independent director earn consulting fee from a company whose board he is sitting on? I happened to be a member of the Primary Markets Advisory Committee of SEBI a few years ago. Deepak Parekh was the Chairman. When we were discussing the issue of corporate governance, I brought up this matter. I argued that we could not allow independent directors to compromise themselves in this way. I asked that SEBI write to listed companies and ask for details of consultancy fee paid to independent directors. Such companies and their directors, I said, needed to be named and shamed.

To my astonishment, my point was brushed aside. It was not even considered fit for further discussion. I heard people say that the sums involved were small, so what was the fuss about? Well, if the sums involved are small, then the independent directors should not been charging them in the first place!

I guess the Satyam judgement- again, going by the BS report- is another instance of the court having to step in where there is an executive or regulatory failure. I hope SEBI wakes up now and does what I asked them to do- collect details of consultancy fee paid to independent directors. After that, it should do two things. One, pass strictures against or issue warnings to the companies and directors concerned. Two, amend clause 49 to make it abundantly clear that independent directors are not supposed to milking the companies whose boards they sit on for personal gain.

Tuesday, December 09, 2014

Satyam case judgement

The judgement in the Satyam case has been poorly reported in the media. Two things are noteworthy.

First, the judgement in a trial court in Hyderabad relates to six relatively minor offences for which charges had been brought by the Serious Fraud Investigation Office. The  main trial is going on in a CBI court and the judgement in that trial is expected towards the end of the month. The fact that B Ramalinga Raju got six months in jail in the trial court should not give the impression yet that he's getting off lightly in the case.

Secondly, the independent directors haven't been let off . HBS prof Krishna Palepu has been fined Rs 2.66 crore. The other independent directors have all been fined Rs 20,000. Unfortunately, the papers don't tell us what the fine is for and why Palepu has attracted such a big fine.

The BS report suggests that Palepu was paid professional charges without obtaining the opinion from the central government. Does this pertain to the consulting fee that was paid to him? It's not clear.

But the message for independent directors is an ominous one. It has often been contended that the independent directors on the Satyam board could not have possibly known about the accounting fraud. Nevertheless, the court has imposed a fine. 

Friday, December 05, 2014

Shareholder activism in India- a new dawn?

Finally, finally, is something changing in the realm of corporate governance in India? I'm seeming a glimmer of hope.

Three things seem to have made a difference. One, allowing shareholders to vote electronically. This has empowered shareholders who could not be troubled to attend the AGM especially if it happened to be in another city.

Secondly, the recent amendments to clause 49 requiring that related party transactions be approved by 75% of minority shareholders.

Thirdly, domestic institutional investors beginning to flex their muscles.

Shareholder activism has produced some interesting results in recent months:
  • The rejection of the compensation hike proposed for top management of Tata Motors despite the company making a loss
  • United Spirits management proposal to sell and distribute spirits of its parent Diageo was rejected 
  • Maruti Suzuki is having to bring to vote its proposal to set up a manufacturing plant in Gujarat under the auspices of its parent 
Note that RPTs also need to be screened and approved by the Audit Committee. That may not make a big difference given that independent directors are chosen by the promoters. Indeed, not much can be expected of the board in India, given that independent directors are beholden for their appointment to management or the promoter. It is inconceivable that the board can ask for the removal of the chairman or the CEO as these posts are filled by the promoter or they are appointees of the promoter.

But shareholder activism, abetted by the three advisory services that have come into being, could make up for lapses of the board. This seems to run counter to the trend in the US and elsewhere. In those places, shareholders have been stymied by various regulatory hurdles. It is boards that have begun to be more active compared to the best.

We must be careful, however, not to overdo the celebration. Shareholder activism in India can prevent expropriation of minority shareholders.  However, it is not still not in a position to discipline non-performing management.

See this story in the FT.

Friday, November 28, 2014

Wanna boost the economy? Go for infrastructure spend

The IMF is now telling us that public spending on infrastructure can provide a great stimulus to the economy- and in the developed world as much as the developing world.

 Larry Summers comments on the IMF findings:
Consider a hypothetical investment in a new highway financed entirely with debt. Assume – counterfactually and conservatively – that the process of building the highway provides no stimulative benefit. Further assume that the investment earns only a 6 per cent real return, also a very conservative assumption given widely accepted estimates of the benefits of public investment. Then, annual tax collections adjusted for inflation would increase by 1.5 per cent of the amount invested, since the government claims about 25 cents out of every additional dollar of income. Real interest costs, that is interest costs less inflation, are below 1 per cent in the US and much of the industrialised world over horizons of up to 30 years. So infrastructure investment actually makes it possible to reduce burdens on future generations.

In fact, this calculation understates the positive budgetary impact of well-designed infrastructure investment, as the IMF recognised. It neglects the tax revenue that comes from the stimulative benefit of putting people to work constructing infrastructure, as well as the possible long-run benefits that come from combating recession. It neglects the reality that deferring infrastructure renewal places a burden on future generations just as surely as does government borrowing.

It ignores the fact that by increasing the economy’s capacity, infrastructure investment increases the ability to handle any given level of debt. Critically, it takes no account of the fact that in many cases government can catalyse a dollar of infrastructure investment at a cost of much less than a dollar by providing a tranche of equity financing, a tax subsidy or a loan guarantee.
Spending on infrastructure thus involves an increase in government spending and an increase in the ratio of public debt to gdp at the beginning of the period but translates into a reduced debt to gdp ratio at the end of the period.

When this is so obvious, it has never been clear to me why in India the government has been leery of a sharp increase in infrastructure spending- and I am not referring to the recent period where concerns about inflation have come to dominate the debate.