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Posted on 15-Feb-2019 Comments  0

Pulwama Economics

After the CRPF attack, India needs to go tough on economics 

The CRPF attack may have been the worst in Kashmir since 2001. But, two things stand out in this case. Firstly, the outpouring of popular support appears to be immense. Secondly, the current government has made its intent clear. While the right diplomatic noises are already being made, the Indian government must actually use its increased economic clout to make a strong statement.

MFN status may not matter

In the first reaction to the terrorist attack in Pulwama, the government has already gone ahead and withdrawn the Most Favored Nation (MFN) status that had been accorded to Pakistan. As a consequence, the Commerce Ministry has officially notified that most of the goods imported from Pakistan would now attract 200% import duty, making them too steep to afford. However, the MFN withdrawal alone may not be really significant. The reasons are not far to seek. India’s total imports from Pakistan are to the tune of $300 million although a chunk of the $3 billion trade between India and Pakistan either gets routed through UAE or via unofficial channels. The official trade that will be hit by the withdrawal of MFN status will be too small to really matter and may most likely shift to the other routes. The real focus should be on trade with Pakistan’s major trading partners and its financers. That is what India really needs to hit at if they want to be effective.

Talking to Saudi Arabia

Saudi Arabia has promised billions of dollars in aid and investment to Pakistan. For Saudi Arabia, Pakistan remains an important ally in its bid to nurture Islamic power in the Asian region. Saudi Arabia also needs Pakistan to offset the influence of Iran. However, Saudi is keen to enhance oil exports to India. Frankly, India has a choice of Iran, Iraq, Saudi Arabia, Nigeria and Venezuela. It is time to play its cards smartly against Saudi Arabia to force them to reduce their tacit and patent support to Pakistan. Saudi Arabia is also a key channel for banking links with Pakistan and that needs to be monitored and controlled better by Saudi Arabia.

China is the X-Factor

While Saudi may be keener to placate India, China may be the tough card. But, the US has shown that if you hit China on trade they will be willing to negotiate. India runs a trade deficit of $60 billion with China and hence India cannot exactly be ignored. Be it investment commitments to Pakistan or support to terrorists holed up in Pakistan, China needs to be squeezed to mend its ways. Even as India plans to avenge the death of the CRPF Jawans, these are two stakeholders that India immediately needs to put pressure on. Neither of them will want to ignore a large consumer market. It is the time for India to makes its heft palpable!

IL&FS Fiasco

Time to get after the stakeholders who precipitated the fall of IL&FS

The Parliamentary Panel on the IL&FS fiasco has made some scathing remarks about the role of LIC in the IL&FS story as well as the role of the credit rating agencies. It is actually time to look at 5 key stakeholders who did not live up to expectations in the IL&FS episode.

Where were the auditors?

They should have been the first ones to flag off the governance conflicts in so many subsidiaries. But the auditors, surprisingly, found nothing amiss. That the auditors were caught napping when the company was descending into a massive crisis, is a clear sign that they have failed on the job. It may be too serious an issue to let the ICAI be the arbiter in this case. SEBI and the government must really haul up the auditors for this massive lapse.

Rating agencies napping?

This was not the first occasion, and may not be the last occasion, when rating agencies were caught napping. The rating agencies continued to accord AAA status to IL&FS paper till the time these bonds came to the brink of default. That was bad enough. What was worse was the downgrade by several notches that actually exacerbated the crisis. Whether the initial inertia and the subsequent enthusiasm were natural or intended needs to be found out? The bottom line is that the auditors were either complicit or incompetent; both equally bad!

What about the investors?

Not just LIC but scores of blue chip mutual funds were guzzling IL&FS paper due to the relative higher yields. Both LIC and mutual funds are custodians of public money. In the absence of enough options in the debt market, debt funds are opting for quasi debt funding; by putting unit holders at high risk. MFs and the LIC need to do some real soul searching about their current strategy. Of course, the government and SEBI also need to ask hard questions.

Banks are in a soup again

The problem with most banks is not just bad credit decisions but also extremely lax monitoring. How could an opaque structure like IL&FS run up bank debt to the tune of $12 billion? This is going to be another hit for the PSU banks that are already beleaguered.

Where is the management?

Why is the government going so slow on the board? There is no way Ravi and his cohorts should be allowed to get away scot-free after creating such a big scam in the garb of infrastructure funding. It is surprising that the star studded board is at large. If the NDA wants to show its seriousness about bringing corporate frauds to book, then IL&FS is where it needs to start. Time for the sharp-shooting IL&FS cowboys to actually pay up!

Pledged Shares

The devil of pledged shares actually lies in the details

In the last few weeks, we have seen a number of large companies getting hit by the sale of pledged shares. This is not the first time it has happened and has been seen before too. But the magnitude of pledged shares has really grown in the recent past. For example, the BSE data estimates that a total of 2942 companies have promoters pledging shares on behalf of the company totaling to Rs.2.15 trillion. Also, the top 100 borrowers have pledged more than 80% of promoter stake making them really vulnerable.

RCOM and Zee trigger a crisis

The real pledged shares crisis began with the Reliance ADAG group and the Zee group. In both the cases, a large chunk of promoter holdings had been pledged. When RCOM announced its intent to go to NCLT for liquidation and when Zee announced a real corporate governance problem, the markets went berserk. Financers had no choice but to sell the shares as the promoters were in no position to bring in additional margins. In both the cases the problem, was a combination of a high percentage of shares pledged and a liquidity crunch at the company. Essel group had made some bad investments in infrastructure and was paying the price. This led to selling across companies where there were corporate governance issues. But there are bigger issues that need to be looked at. Let us look at two critical issues that will matter for markets.

Better pledge disclosure

That is where most of the problems come up. There is a huge time lag between the financer sending a margin notice to the client and the client actually reporting the default. Pledged shares data is known only when the shareholding pattern is disclosed to the exchanges. It is this time lag of 3 months that is material. To begin, the onus to disclose any default by promoter should be on the financer. A margin call need not be communicated but the logic of reporting defaults immediately must be strictly adhered to. If the RBI is preparedICK with this data, then they can appropriately prevent the crisis from snowballing. Also, additional disclosure requirements must be made mandatory where pledge ratio crosses 50% of promoter holding.

Not all above board in pledging

The market reality is that even this pledge data can be quite misleading. There are many companies who effectively pledge their shares to brokers for cash-futures arbitrage. That is not disclosed to the exchange. Also, there are informal arrangements to fund based on mere Power of Attorney to sell without actually creating a pledge. These methods are commonly used to circumvent the pledge reporting. SEBI needs to close the loop on these minor detailing so that pledged shares do not post a real systemic risk to markets!

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