Wednesday, 3 August 2011

The stock market likes corruption


When the Justice Hedge report came out, the casualties, along with the Karnataka CM, were a few stocks. Implicated in the report were JSW Steel and the Adani Group, where stocks fell over 10% in the same day. Even Mundra Port, a Gautam Adani owned company that operated in Gujarat, far away from the tainted mines in Bellary, fell the obligatory 10%. It was almost as if the companies depended entirely on their founders, who, having been caught with their hands in the cookie jar, can't take out any cookies for them.
No, really. That politically astute founders like Gautam Adani have made their mark through hard work is almost universally accepted; but so is it that success was unlikely without close political contacts. In the business of mining, running ports, creating power plants or building infrastructure, the only people to get anywhere are those closest to the political power strings. The story of Reliance Industries and Dhirubhai Ambani attributes a good part the huge success story to his "managing" politicians. In the 80s, when everything was government dictated including how much you could produce, building political patronage was really the only way to succeed.

And it seems the market is telling us, that story is still the same. In November 2010, in a "bribe-for-loan" scandal, the CEO of Money Matters Financial Services Limited was arrested, accused of LIC Housing Finance officials being bribed in order to "okay" large loans to builders. The MMFSL stock tanked from around 700 to a low of 47, recovering marginally to about 112. The arrest of Shahid Balwa in the 2G scam has taken the stock from the Rs. 400 levels in December 2010 to 72. The UFlex stock tanked 20% when the CEO was sent to jail. The idea isn't that the founders did all the work — it's that the market believes they were primarily responsible for the business the company could get. Once you cut off the political links, or when the promoter is a pariah in the ruling party, there's not much left in the business worth investing.
From brokerage giants to real estate builders, from infrastructure players to telecom providers, there is almost an unsaid need to be more than comfortably close to the folks in power. The 2G scam and the happenings in Bellary were revealed through deep investigation, where there is a deliberately undervalued public resource (mines or spectrum) to benefit a private player. In Greater Noida, builders bid Rs. 10,019 to 10,050 per sq. m. as bids in an auction whose reserve price was 10,000, involving cartelization and collusion with the land authority. The CBI has accused Sun TV, a listed company whose founders are related to the then telecom minister, Dayanidhi Maran, of having drawn 323 lines from Maran's house to the Sun TV headquarters (the stock crashed on the news, as did those of SpiceJet, an airline that shares the same promoters)
But such investigations haven't take place in other areas of more evident government largesse, such as the Public Distribution System (PDS), fertilizer subsidies, or public healthcare. There is corruption and fraud that is the basis of operation of very large companies. (We will pause while I am interrupted by an unsolicited phone call asking me to save money with a plan that primarily involves stealing it away in the form of commissions)
The point: our markets herald corruption because it brings in the profits. It continues to favour those companies where promoters have quite obviously frauded shareholders, by either purchasing promoter-owned companies at a high value, by misreporting income using creative accounting, or by simply lying about the cash they actually have. The very act of attempting to curb that corruption will open a can of worms; every other company that operated below the radar now becomes suspect, and market players know this — they sell first and ask questions later. Corruption, lies and deceit are par for the course; and in this context, its surprising (and refreshing) that a company like Infosys, sporting a clean image, gets a great valuation. (Even if much of that value involved paying very low taxes)
Crony capitalism isn't a feature of India alone. In the US, banks forced the government (also known as Government Sachs) to keep derivatives out of the regulatory ambit, to vastly increase the amount of leverage they could take, and to repeal Glass-Steagall, an act designed to demarcate banks taking public deposits from banks taking massive trading risk. These actions have contributed substantially to the US meltdown in 2008, and even then, with their influence, banks were able to get a multi-billion dollar bailout and two levels of "quantitative easing" while employment, GDP growth and ability for homeowners to pay back have all fallen off a cliff. Europe has bailed out their banks; the keiretsu (large business groups) in Japan have been backed by loose monetary policy. But the stock markets have been less than kind — US banks still quote at a fraction of their pre-crisis values, and the Japanese market is off nearly 75% from the highs twenty years ago.
To chase corruption will mean a market crash. And in the age where policy makers watch markets for reactions and readjust, it is very likely that substantial attempts to break the crony links will be diluted in fear of a collapse. Yet, it's the only way forward; it is better to have an undervalued market that is afraid of being corrupt, than to have an overvalued bazaar where everything is wink-wink and nudge-nudge.
When we complain of the lack of investors, it is driven by the feeling that markets, as they are today, are full of corrupt individuals and institutions. The Lok Pal might be a step (and unfortunately a small and over-hyped step) in the process of detecting and punishing corruption, but we need to do a lot more. Apart from the whistleblower policy, we must allow for plea bargaining so that the less corrupt can indict the more corrupt, who would otherwise escape scot-free. We must have a policy for witness protection. We should force transparency on large companies, such as making them release consolidated cash-flow statements and balance sheets every quarter. We must punish, with substantial deterrents and fines, wrong-doing and fraud.
While it's easy for me to take a moral stand, the process will hurt many an innocent bystander, such as the now-out-of-work mine workers in Bellary. Take away corruption, and the regular Amit that just paid in "black" for that house will be targeted; the regular Swati in big-name-telecom company will be out of work; the Inderjit who would brought sand to build a road now has an idle truck. But it is for our longer term glory that we must weed out the menace of corruption, even if stock markets will react as if it's the end of the world.
Deepak Shenoy is co-founder at MarketVision, a financial knowledge company and writes at Capital Mind. You can reach him at deepakshenoy@gmail.com or @deepakshenoy.

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