DSIJ Mindshare

Reforms To Drive The Markets

The stock market always discounts the future, and those who are able to ascertain it correctly always stay ahead of the crowd. Regular readers of Dalal Street Investment Journal would certainly vouch for this fact. We, at Dalal Street Investment Journal, have consistently been guiding our readers in the right direction at all times – good or bad. The Indian economy was facing serious headwinds, as growth slowed down to 5.5 per cent or even less for the last two quarters over and above the subdued growth rate of 6.5 per cent that it had clocked in 2011-12. India’s saving and investment rate had also slipped since 2008-09. With a falling savings and investment rate, rise in twin deficits, inflation and a potential slowdown in growth, the overall scenario was quite negative.

The Centre’s fiscal deficit had slipped during 2011-12 to 5.8 per cent against the budgeted 4.6 per cent for the year and 4.9 per cent in 2010-11. With the gross under-recoveries of oil marketing companies working out to over Rs 1.8 trillion or 0.8 per cent of the GDP due to the unrevised prices of diesel, LPG and kerosene, this was expected. In fact, following this macro-economic deterioration, some international credit rating agencies had put India’s sovereign rating on their watchlist for an impending downgrade that would have pushed India to a sub-investment grade.

Despite all the negatives, however, we were looking at the bigger picture and had predicted the upsurge in the markets way ahead of others. Not many would have agreed with our stance at that point, when we had predicted that the markets are expected to move upwards despite the turbulent global scenario and a difficult domestic environment. Sure enough, no one managed to predict the market as precisely as we did. We had stated that the reforms process will continue, which will bring back cheer to the markets. What followed is history.[PAGE BREAK]

Slew Of Reforms - A Big Positive

We are of the opinion that recent policy measures taken by the government are quite significant. The best part is that the government changed its course of action exactly when the Indian growth story was very close to getting seriously damaged. There was a natural need to accelerate the reforms process, and it did exactly that.

In the first of the recent economic reforms unleashed by the Indian government, it raised diesel prices by Rs 5 per litre and capped subsidised LPG cooking gas cylinders to six a year per household. It also permitted foreign direct investment (FDI) of up to 51 per cent in multi-brand retail, up to 49 per cent in aviation and up to 75 per cent in some broadcasting services. It also approved the sale of its minority stakes in four public sector undertakings to raise upto Rs 15000 crore, which amounts to half its disinvestment receipts target for the fiscal.

These measures were followed up with an announcement that withholding tax liability will be reduced to five per cent from 20 per cent for overseas borrowings or bond issuances for infrastructure sector by Indian firms between July 2012 and June 2015. Further, a debt relief package for the state power distribution companies has now been approved.

We feel that these reforms, if implemented efficiently, could turn the investment scenario around again. Recently, the Union Cabinet approved FDI of up to 49 per cent in insurance and pension. Going ahead, more sector-specific packages could follow, allowing the structural bottlenecks to be removed without sacrificing regulatory discipline.

As we have seen, several policy measures have been taken in less than a month’s time. Once these measures are implemented and when they feed through the system, they would contribute significantly to the recovery of India’s growth as well as help in realising the real growth potential of the economy. The foundation has been laid, and one can be confident that India can stand the test of time once again. Here V Balasubramaniam – Equity Fund Manager, IDBI MF adds, “India’s growth story is still intact even though the fiscal deficit may go beyond the target. If you look at the corporate numbers, not all was bad in the first quarter or even in those seen in the last few days. Nonetheless, fiscal consolidation efforts have to be undertaken, if not in FY12-13, then in FY13-14.”[PAGE BREAK]

Capital flows have recovered and would go a long way in restoring confidence for business activity in the country. As a result of this, growth would start improving. Whether the recovery will be quick or slow-paced would depend on several factors including global conditions, which are not very conducive at the moment.

However, a slow and steady improvement is surely being witnessed. What is important is that recent actions by the government have reduced the macro-economic risks and structural impediments.

The government’s optimism with regard to the future course of the economy is fairly evident from what Montek Singh Ahluwalia, Deputy Chairman of the Planning Commission, had to say at a recent event. Ahluwalia was quite positive about maintaining an average growth of around 8.2 per cent in the 12th Five Year Plan (2012-2017). In addition, he also stated that the PPP contribution towards infrastructure has increased to 37 per cent in the 11th Plan from just 10 per cent in the 10th plan. This is further expected to improve to 50 per cent in the 12th Plan. All these factors point to nothing but a steady and sturdy economic recovery in the offing.

While there is a lot being talked about what the future could be like, we present here a prognosis of where the government is headed, and what it could yield for the economy in general and the markets in particular. We have looked at four key acts that are likely to be passed in the Parliament very soon as a part of the government’s reforms agenda. This should give you that added boost of confidence in taking directions for your future course of investment.[PAGE BREAK]

Billing Effect

The Insurance Laws (Amendment) Bill

Salient Features:

  • Increased FDI limits to help companies raise capital without creating additional debt
  • Increased penetration in life insurance as well as non-life insurance
  • Focus on providing advantage to subscribers through policy benefits rather than monetary incentives

StageDate
Introduction Dec 22, 2008
Referral Date to Standing CommitteeSep 14, 2009
Report Date of Standing Committee Dec 13, 2011
Lok Sabha
Rajya Sabha Introduced

The Insurance Bill has been primarily introduced to help insurance companies raise capital. The basic idea behind the bill is to increase awareness regarding insurance in India. According to reports, there is an immediate requirement of capital infusion of around USD 5-6 billion (around Rs 26250-31200 crore) to foster insurance penetration in the country. The penetration levels have been as low as 4.4 per cent in life insurance and a miserable 0.8 per cent in non-life insurance.

Therefore, the first and foremost factor that the bill focusses on is to help companies raise capital without creating additional debt. This has necessitated the increase in the foreign direct investment limit in the sector to 49 per cent from the current 26 per cent. The bill has also prescribed a minimum capital requirement of Rs 100 crore for insurance companies (health, general and reinsurance). We feel that this is the right step, as it will ensure that companies are fully equipped with modern infrastructure and other facilities. Another good part is that life insurance companies will now be able to offer health insurance cover, which was not possible earlier.

The best part of the bill is that it proposes selling covers based on benefits of the policies rather than on monetary incentives. It proposes a penalty to Rs 5 lakh in cases of violation. Further, it also proposes to do away with the percentage of premium stipulated to be payable to agents as commission, and to leave the matter to the IRDA’s discretion.

Overall, the bill has come up with some very strong points covering major issues like capital infusion and new product development. Most importantly, it is beneficial for the insured rather than the insurer.[PAGE BREAK]

The Pension Fund Regulatory And Development Authority Bill

Salient Features:

  • Increased FDI limit to help companies come up with new plans rather than traditional ones
  • Ensures higher returns along with safety of the principal and the facility of withdrawal as per convenience
  • Ensures increased penetration of pension plans and focusses on improving the reach of the NPS
  • Will help in the channelisation of pension funds to the equity markets, especially the infrastructure sector, which will help the economy

StageDate
Introduction Mar 24, 2011
Referral Date to Standing CommitteeApr 08, 2011
Report Date of Standing Committee Aug 30, 2011
Lok Sabha Introduced
Rajya Sabha

The Pension Bill gives statutory recognition to the Pension Fund Regulatory And Development Authority (PFRDA), defines its powers and duties and sets the broad contours of the New Pension Scheme or NPS (now to be called the National Pension System).

We feel that there was a dire need of bringing in reforms on the pension front, as here too, the penetration has been quite low in India as compared to other developed countries. In India, just 12 per cent of the workforce avails itself of the pension scheme. Further, the share of pension fund assets to the GDP is just five per cent as compared to 17 per cent in Brazil. Though it is higher than the one per cent of China and two per cent in Russia, there is a severe need to increase this ratio.

There is a need of foreign capital in this sphere, and for this reason, the bill has proposed a 49 per cent FDI limit in pension funds. The demand for capital from pension funds is important, as these funds would be channelised into the equity markets (according to the bill 50 per cent of pension funds can be channeled into equity), including the infrastructure sector.

The demand of funds for infrastructure development is expected to be around USD 1 trillion by 2017, and pension funds would be much more important in that context. A single rupee invested in infrastructure generates opportunities worth Rs 10, and hence, the availability of these funds for infrastructure development would be the biggest positive.

Apart from this, the bill also focusses on the growth of the NPS, towards which the response has been quite dull so far. This is clear from the fact that the NPS amount stands only at Rs 15466.28 crore as on 31st July, 2012. According to the bill, the NPS will give greater flexibility to subscribers to withdraw funds from their pension accounts. Basically, it provides assured returns to pension fund subscribers with greater safety of funds. The best part is that the minimum returns are going to be higher than those offered by EPF.

The entry of FDI will ensure that new products with better returns are offered. The Pension Bill will also ensure benefits to the equity markets, especially the infrastructure sector.[PAGE BREAK]

The Banking Laws Amendment Bill

Salient Features:

  • PSU banks can raise capital through two new equity avenues – Rights and Bonus issues
  • Mergers and acquisitions to come under the RBI’s lens
  • Increased voting rights for the normal shareholders

StageDate
Introduction Mar 22, 2011
Referral Date to Standing Committee Mar 29, 2011
Report Date of Standing Committee Dec 13, 2011
Lok Sabha Introduction
Rajya Sabha

The Indian banking system has shown strong growth in the past. Going ahead too, there are good growth opportunities in the banking sector as a whole. Hence, in order to take the Indian banking sector to newer and higher levels the Banking Law Amendment Bill was introduced in 2011.

The core idea of the Banking Bill remains capital raising, particularly for the public sector banks. The first and the foremost feature of the bill is that it removes the ceiling of Rs 3000 crore on the amount of authorised capital that nationalised banks must hold. The bill also allows nationalised banks to come out with Bonus and Rights issues. This would help them raise capital from the markets to face the tough competition from their private and foreign counterparts. Further, it raises the ceiling on the rights of shareholders of nationalised banks from one per cent to ten per cent. This provides a strong footing to the shareholders.

To ensure proper control on banking companies, the bill makes it mandatory to obtain prior approval of the RBI for acquiring more than five per cent stake in any bank. The RBI will have the power to impose conditions while granting approval for acquisitions. Mergers and acquisitions that were earlier under CCI regulations would now be regulated by the RBI.

Apart from that, the RBI will have powers to remove directors if they are proved to be working against the interest of depositors. The RBI will also impose a penalty if banks fail to keep the CRR at the stipulated levels every fortnight. All this is to safeguard the interests of depositors as well as shareholders.

Further, in light of the fact that cooperative banks have been in trouble a couple of times earlier, the bill has proposed a special audit for co-operative banks. There are many accounts that have been inoperative for many years. To release these funds for better use, the bill proposes to establish a Depositor Education and Awareness Fund. We feel that this would also help to safeguard depositors.

There are lots of opportunities for the Indian banking sector going ahead, and we feel the bill is a step forward in the direction of unleashing its real growth potential.[PAGE BREAK]

The Companies Bill

Salient Features:

  • Provides for a tighter control by shareholders over management decisions
  • Seeks to strengthen corporate governance by introducing new provisions
  • Seeks to impose strict regulations on the re-opening of books of accounts 
  • Imposes an increased liability on independent directors and a new clause for key managerial personnel remuneration
  • Takes care of strengthening of SIFO
  • Gives more powers to creditors and shareholders

StageDate
Introduction Dec 14, 2011
Referral Date to Standing Committee Jan 05, 2012
Report Date of Standing Committee Within 3 months
Lok Sabha Introduced
Rajya Sabha

While all the bills and the reforms being addressed have their own importance in terms of contributing to the growth of India Inc., we feel that the Companies Bill is a pathbreaking one among those. It provides for stricter standards and tighter control by shareholders rather than giving company promoters and managements a free hand at everything. This is likely to help minority shareholders who have always bore the brunt of value destruction because of rash management decisions.

The establishment of the National Company Law Tribunal (NCLT) is another path breaking move that will emanate from the passage of the new Companies Bill. The NCLT again will be instrumental in putting more powers into the hands of the shareholders. It will be entitled to direct an investigation into companies by the government. Now that will put some fear in the minds of unscrupulous minds in company managements. For those companies who are into the habit of restating their accounts in order to make their more recent performances look better, they need to watch out in future. All that was allowed earlier will not be allowed now.

The primary market is likely to be sanitized with the passage of this bill as it seeks to levy heavy penalties on promoters and also merchant bankers and lawyers associated with IPOs for any false statement in the prospectuses. All in all the cleansing process has begun at a broader level with the introduction of this bill and this will go a long way in helping cleaning up corporate India.[PAGE BREAK]

DTC & GST

The government has already planned to implement the DTC Act (The Direct Tax Code) and the GST Act (The Goods and Services Tax Act). To touch upon a few of these points, the DTC Act would widen the income tax slabs and indirectly, increase the disposable incomes. It would also reduce the complexity and higher compliances in terms of tax payments. The best part is that it is likely to result in higher collection on the direct tax front. The standing committee had suggested that, tax slabs should be automatically adjusted for inflation by indexing them to the consumer price index. This would ensure better compliance and higher revenue collections.

DTC is likely to bring down corporate tax rate to 25 per cent from the current 34 per cent. This will improve tax compliance and profitability of the corporate sector ultimately benefitting shareholders. The Direct Tax code eliminates the entire region and location based tax exemptions and this will ensure that companies come up not only in tax free designated areas but anywhere.

On the indirect taxes front, the GST Act is another trailblazer, as it would treat the whole of India as one territory. It is all set to integrate state economies and boost overall growth as GST will create a single, unified Indian market to make the economy stronger. It will divide the tax burden equitably between manufacturing and services.

However, the procedural complication of alignment between the states and the Central government is still an issue. As it is still unclear as to how much will the centre compensate for the loss of revenues to the State Governments. The combined GST rate is still being discussed and is expected to be around 14-16 per cent. After the total GST rate is arrived at, the States and the Centre will decide on the CGST and SGST rates. Currently, services are taxed at 10 per cent and the combined charge of indirect taxes on most of the goods is around 20 per cent. However, the Act is expected to be implemented very soon. If implemented, it is estimated that India will gain around USD 15 billion a year by its implementation as it would promote exports, raise employment and boost growth.

Both these Acts are a huge policy initiative, and are likely to boost the market sentiment in a big way when they come into force.[PAGE BREAK]

In our Cover Story ‘Warming Up’ (DSIJ Vol. 27, Issue No. 16, dated July 29, 2012), we had predicted that after a sharp depreciation against the USD, the rupee is now expected to appreciate going ahead. In fact, we had provided a graphical representation of the expected appreciation. We have reproduced the same figure here, along with the actual movement of the rupee against USD. We have been proved right, with the rupee appreciating almost according to our estimates.[PAGE BREAK]

Twin Deficits & Inflation - What You Need To Know

Throughout these developments, the most important challenge would be to further lower the twin deficits by staying on the path of fiscal consolidation. However, in the recent FT-YES Bank International Banking Summit, Montek Singh Ahluwalia said, “Current account deficit is a concern; however, with imports outpacing exports and crude prices remaining at current levels, we need to live with that, at least in the short term”.

On a positive note, though, the rupee has already appreciated by 6.8 per cent against the US dollar since the onset of this fresh wave of reforms. This may help lower inflation somewhat as the exchange rate pass-through takes place. So, expect some betterment on this front. However, the monetary policy would need to focus on inflation for some more time, while using the available space to support growth to the degree it can. We feel that the RBI is doing this very efficiently, and the CRR cut is a good example of its initiatives.

[PAGE BREAK]

Corporate Results – Will Improve Further

The past few results seasons have not been good for India Inc. Rising inflation made its impact felt on the margins at the operating levels, while higher interest cost impacted the net profit. The depreciating rupee only made matters worse. However, the scenario is expected to improve in the September 2012 quarter. The reason for this, as mentioned earlier,  is that the rupee has begun to appreciate, interest rates are coming down and last, but not the least, with some decline in commodity prices, the margins are expected to witness some improvement. In our preceding issues, we have categorically stated that the downgrade in EPS is over and we could see some increase in the EPS estimates of Sensex-based companies going forward.

[PAGE BREAK]

Conclusion

The Indian economy is shaping up very positively in the second half of 2012-13. There are positives emerging across the horizon. This is reflected in our currency movement that will bring further positive spin-offs by lowering inflation and fiscal deficit, and reducing corporate stress from the debt that it carries. Growth could start improving into the next fiscal. A late revival of the monsoon should moderate the inflationary pressures too. While the intentions have been made clear, the slew of measures in a short span need to be turned into well-paced actions and execution.

The silver lining we had predicted way back is now visible on the horizon to everyone. The sentiments have suddenly turned positive, and we expect them to remain so as the reforms process picks up further pace. So, will we see the Sensex at 20000 and beyond? Very soon, we would say.

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