When governments renege on contracts

The confidence of investors, whether global or domestic, cannot be bolstered if there is no sanctity of contract. It is, therefore, very distressing to see the government seeking to go back on two disinvestment contracts its predecessor had signed. One is the February, 2002, sale of 74% of Paradip Phosphates (PP) to Zuari Maroc Phosphates Pvt. Ltd (ZMPPL). The other is the more celebrated case of Balco. The government is trying to renege on both; doing so would send a very bearish signal.

In the case of Paradeep, the government was irked by a Zuari claim for almost the same amount as it paid for the stake. The idea was to seek compensation for losses made by the former after the deal was done but before the handover took place. The government is chagrined that were it to accede to this claim, it would, effectively, have sold 74% of Paradeep for just Rs 15 lakh. There are, however, innumerable cases of businesses having been bought for nothing, because the buyer assumes the liabilities and because the seller has made a right royal mess of running the business. The proper approach would be to determine the merits of Zuari’s claim and arrive at a conclusion through judicial intervention. But it makes no sense to threaten to cancel a done deal!

In the case of Balco, the government has, when selling a 51% stake to Sterlite, given it an option for the rest, which the buyer exercised by sending a cheque for Rs 1,098 crore. In the meantime, the price of the commodity, and hence the value of the business, went up. The government sought the opinion of the attorney general of India, who stated that the grant of the call/put option was against company law.

Hello! Why was this point not brought up when the government signed the shareholder agreement? So either the government does not know the ramifications of its own laws, or it willingly flouts them!

Inadequate preparation has other ramifications. Take airlines, for example. The airport privatisation process was severely delayed and then handled in a manner that has led to legal challenges and further delays. As a result, expansion of runways to meet the build-up in traffic has not taken place fast enough and airplanes have to circle for hours to get a landing slot. This often increases costs for airlines, as they have to fly elsewhere to refuel. Airline stocks can be avoided for the moment.

The same goes for the automobile sector as the demand for cars will be hit by three factors; rising interest rates that would raise loan EMIs, rising fuel prices, and criminally bad roads, for which no punishment is ever meted out to municipal officials who are responsible.

Telecom reform is another tricky area globally. BSNL and MTNL are complaining of tax apartheid. Whilst the payments they make for licences and spectrum are treated as a sharing of profits, the same payment made by private operators, they say, is treated as a business expense, thus tax deductible. The latest bone of contention would be allocation of scarce spectrum, without which telcos’ growth would be affected. The Telecom Regulatory Authority of India (Trai) finds that China uses spectrum more effectively; 60 mhz of spectrum serves 400 million users whilst 55 mhz in India serves 112 million. Telcos haven’t invested in setting up enough base towers (which, of course, results in better profitability) and in new technologies to more effectively use spectrum. When they are compelled to, their bottomlines could get affected.

The bottomlines can also get affected whenever Trai implements number portability. Under this, subscribers own the phone number, not the operator. Hence, whenever a subscriber is dissatisfied with his service provider, he can shift operators while retaining the number. This ensures true competition. Right now there is enough competition in customer acquisition but not in customer retention. Trai should also undertake random audits of phone bills.

Trai has started the ball rolling on another controversy when it set a Rs 5 per channel upper limit on charges for pay channels. Networks are screaming blue murder. In its defence, Trai says that over 80% of the revenues of networks comes from advertising and it needs to protect consumer interest. It is the same in newspapers, where the sticker price of Rs 1 does not cover the cost of printing it. This evolved through competitive pressure, not mandate. On the other hand, one can argue that a newspaper does not require any other equipment to be read; a TV programme requires a TV set, a set-top box and a room to put it in. Hence, Trai’s initial intervention to cap charges is necessary. Over time, probably, networks would see that low charges work to their advantage, by bringing in more consumers and helping to sell advertising space better.

In other news of interest, the mother of all IPOs, DLF Universal, has been postponed, probably awaiting a more opportune time. GMR Infrastructure has tied up with CLP Holdings of Hong Kong to bid for a $ 4.5 billion power plant. Tata Steel plans a $ 600 million GDR which, given its competency in steel-making (lowest cost producer in the world), ought to be well received. Ranbaxy has won a patent appeal in Oslo for its cholesterol-lowering drug, challenging Pfizer’s Lipitor. The global market for this is $ 11-12 billion., though the Norway market is worth only $ 50 million.

The stockmarket is rallying after almost all monetary agencies (the US Fed, the European Central Bank, and the Reserve Bank of India) indicated their satisfaction with inflation being under control, obviating the need to raise them at least till October. Equity markets will thus have a little respite till October.  The BSE Sensex went up last week from 11,572 to11,778, for a gain of 1.8 %. However, one or more of several factors can wipe out complacency over inflation, not least the collapse of the US property market. US home owners have taken some $ 200 million from their home equity by refinancing mortgages when interest rates were falling and property prices rising. They then proceeded to spend that! Now that the trends are reversed and property prices are falling with interest rates rising (leading to higher monthly outgoes) consumers will have to slow down on spending (which hurts GDP growth) and find ways to repay (by selling assets). The portents are not good. Better to be cautious and sell in this rally.