Thursday, February 24, 2011 w w w. f i n a n c i a l e x p re s s .

c o m Reflect 9
Record caFE PRADIP SHAH
Chairman, IndAsia Fund Advisors

We won’t meet our investment targets

Pradip Shah, chairman, IndAsia Fund
Advisors, who tracks the Indian financial
scene closely, believes foreign flows could
taper off this year as investors look for
opportunities in other markets. In a con-
versationwithShobhanaSubramanian,
Shah says that this could leave the private
sector with less money with which to fund
its growth plans.
What are you making of the macro-
economic situation with growth slow-
ing down?
For the last 30 years we’ve had a growth
rate of 6.2% and with the reforms coming
in, there was considerable progress so, in
the last few years, we’ve seen 8.5%. But
when we compare ourselves with China,
wecannotbutbedisheartened;wewereat
the same level in 1990—their GDP was
$910billionandwewereat$720billion.To-
day,theirpercapitaincomeisat$4,500and
we’reroughlyatonefourth.Eveninterms
of purchasing power parity, they’re twice
us at $6,500 (we’re at $3,300). So, clearly we
have a lot of catching up to do. But when
we see what is going on in India, we won-
der whether we will ever catch up. There
are such brilliant people in government
but no governance and no accountability
for wrongdoing. We are perpetuating a
culture of allowing wrongdoing to go on
unpunished and we’re encouraging the
young generation, which is our future, to
think in this manner.
Instead of hitting 9% GDP growth,
we’re going back closer to 8%...
Yes, we are seeing a slowdown. The con-
sequence of inflation for the poor has
beensosevereandthepressureonhouse-
holds has been so high that people have
had to cut back on essentials, like soap, to
maintain food budgets. We see govern-
ment policies that are well-intentioned
but implemented badly and allow for
leakage, so the benefits don’t go to the
poor. And there are other adverse conse-
quences too. While the mid-day meals
have helped attendance in schools, chil-
dren’s protein intake and so on, we’re not
seeing the same with the NREGA. About
Rs1,12,000crorehasbeenspentinthelast
five years. What is the outcome? These
expenditures were supposed to result in
some outcome and we are supposed to
have some accountability.
But we’ve seen nothing; it’s been
allowed to become a black hole with a lot
of leakage. There has, no doubt, been
some benefit, but a lot of it has seeped
away into the hands of politicians. And
where it has reached the poor, it has
unfortunately had the deleterious conse-
quence of discouraging productive work
and so underemployment is getting
perpetuated. So, we need to fine-tune
NREGA. Because the government is con-
cerned about votes in the next two and a
half years, it wants to come up with more
programmes like the Right to Food. No
one objects to these but there cannot be
seepage. The Congress knows that sops
are a political weapon but these have dys-
functional consequences via subsidies
distorting the economy.
How are investors reading the slow-
down and the policy paralysis?
Without doubt there is some disappoint-
ment among investors. Even when we
were emerging from the global crisis, In-
diawasgettingapremiumtocompetitors,
like China, but that has been a short-lived
period. We’re now back to a discount and
it’s facile to say that it’s a discount for
democracy. Within the democracy, we
have shining examples of competent
leadership and liberalisation, like in
Bihar, where there has been inclusive
development. So, investors are willing
to come in at a discount but not at a pre-
mium. The Reliance-BP deal is one of
thelargestFDIinvestmentsintoIndiaso
far and it means strategic players are
willing to come in because India has
demonstratedgrowthandpromisesmore.
But along with that growth will come
dissonance because if the needs
of the poor are not ad-
dressed, law and order
will become a prob-
lem. While strate-
gic players will
come in be-
cause they
cannot afford to stay out—you see
Siemens making an open offer at a multi-
ple of 39 times—clearly there is some
caution. The financial investors, who
havetheabilitytomovemoney,areasking
foradiscount,notapremiumthatwewere
asking for last year.
So what kind of foreign portfolio
flows do you see this year compared
with the record $29 billion that we saw
last year?
I think it should be substantially lower,
giventhegovernancestoriesthatarecom-
ing out and given the opportunities for in-
vestors in other markets. The US may not
be bounding ahead but it’s certainly mov-
ing towards growth. Perhaps you will see
the same in some European economies.
Germany, for instance,
continues to do
well. So people will see opportunities out-
side, perhaps even in China, which has
managed to hold its own compared to oth-
ers.Therefore,Indiawillbelessattractive
to foreign investors because the competi-
tion is doing better and our own problems
are tarnishing our image.
A fair share of the foreign flows
goes into the primary market. Given
that interest rates are inching up, do
you think companies might be short
of funds?
Logically, our investment to GDP ratio
should fall; it has already come off from a
peak of 37% odd to 34.5%. I heard the gov-
ernment say it is expecting an investment
toGDPratioof 36%andIwonderwhether
that is achievable. Interest rates are al-
ready high and the availability of capital
has become more difficult, from both the
equity and debt markets because of the
tight liquidity situation we’ve
beenencountering.Soitisnotpos-
sibletobesosanguinethatwewill
have 36%. Also, we have not yet
brought down our capital to out-
put ratio as we should; as infra-
structure improves, one would
expect that to happen. Also there
is a bit of gold-plating in capex
and easy availability of capi-
tal led to over-expenditure
on capex so, to some extent,
wemayhavehiddencapaci-
ty or hidden possibilities of
getting higher revenues but
we havenotbeenabletoexploit
them. Whatever it is, at 36% one
would expect a growth rate of 9%
is possible. But we will not
achieve this because, as I said,
we will not achieve 36%; we
will possibly achieve 32-33%
investmenttoGDP.Because
there are so many projects
in the works and they
will have to be completed.
The government is no
longer a leader in start-
ing new projects
and we are relying
on the private sec-
tor. So, we need
a facilitative
capital market
to fund the
growth.
Will government borrowings crowd
out growth?
One of the good things that happened this
year was that the government didn’t need
to borrow too much because it earned
from spectrum licences and divestments.
Itisnowspending,aspartof itsbudgetary
expenditure,andsomoneywillcomeback
into the system and that will ease the liq-
uidity in the market. But the uncertain
part is how much money will flow in from
outside because that was also supporting
liquidity in the market; if money flows
out,wewillhaveashortageof liquidityin
the system. Also, with the crisis in the
Middle East, there is going to be some
capital flight to safety worldwide, the
Middle East money will go into the dollar.
Oil is at $106 a barrel and that does not
augur well for India. We should logically
have been insulated from some of the
politicalriskof theMiddleEast.Although
we are not in a bad shape politically, but
economically we cannot be insulated.
So how do we manage the current ac-
count deficit, which was being funded
by short-term flows?
Either we increase remittances, get more
tourism revenues and invisibles or we
should control the domestic usage of oil.
The government had taken the bold step
to enable the policy for a passthrough
mechanismbuthasnotdoneit.Sowehave
done it up to $70 but beyond that we are
exposed to a fiscal subsidy. We need to
increase prices of fuels at the pump to
conserveoilandimprovethetradedeficit,
which is unsustainable.
What are three things the FM could do
to reassure the markets?
Since the government wants to move
towards fiscal consolidation, I think it
should get away from fuel subsidies
immediately because, although there
may be some inflation, it will lead to
the conservation of fuel and, at least, it
will solve the fiscal issue. To ease the
pain, they could phase it out and make
adjustments through the excise mecha-
nism. Don’t introduce a food subsidy
bill or a Right to Food Bill just now.
Improve the PDS but don’t create populist
expectations because it is difficult to
withdrawthem.Alsoexcisedutiesshould
be trimmed—revenues will come from
better volumes.

Staying on track REPORTER’S DIARY

Monkey off its back

fuel, mainly, plus some for inflation, where increases are less visible. the fine performance of the rail- fundedfromthesurplus,andevento
S ANANTHANARAYANAN and the expenditure figure of the With limits to investment by the ways during the period was largely ‘hold up’ payment of bills. This had
coming year is worked out. With government, the railways took to thanks to the economic tidal wave. been done to the hilt last year and in FOR weeks everyone

I
t is that time of the year, we are
all waiting to see whether the
railway minister will be kind
one more time and allow us to make
those short or long train trips with-
out major bloodletting in the wallet.
Butwehaveseenreportsinthepress
that all is not well with the railways
andtheministermayhavenochoice
with the budget this time round.
A word on what the railway bud-
get is about. It is both a peep into the
future as well as a plan. It starts with
thewaytheearningshavebeencom-
ing in and expenditure is mounting,
during the first 9 months, till De-
cember, for an idea of how the year
is going to end. With this picture in
focus comes the peek into the year to
come. The earnings come mainly
from goods and passengers that use
the railway. The numbers of tonnes
of goods and passengers of the cur-
rent year are increased, according
to the trend that is seen, and, with a
little more in the name of enthusi-
asm, the earning that should arise,
with rates and fares unchanged, is
workedout. Andthenforthecosts—
a percentage is added, because
everybody will receive increments
and also more allowances because
of inflation; plus carrying more
traffic will cost a little bit more, for
both the figures at hand, we have an
idea of the surplus, for which there
are specific uses.
Apart from just running trains,
the railways also carry out work of
replacing worn out track, bridges,
cable and wagons, to improve the
quality of service and to add new
services. All this activity needs
funds and the budget has to make
provisions. Things like new lines,
buildings or profitable assets are
paid for by ‘capital’, which is money
provided by the government, in
exchange for a return of about
7% every year. But the rest of the
investment, which runs into a good
bit even for replacements alone,
needs to come from the surplus that
the railways make.
The important part of the budget
exercise, then, is to tweak the
rates, both for goods as well as
for passenger service, to provide
the surplus needed for the works
activity, apart from the portion paid
for by the government.
In earlier years, this surplus was
not a great figure and studies
showed that replacements were
not being given enough attention.
Making greater provisions then
forced some increases in rates and
the axe fell heavily on goods traffic,
borrowing from the market and
there was talk about the railways
falling into a debt trap, unless the
government came forward and pro-
vided cheap capital.
Understanding the nature of the
costs of the railways, however, may
temper our reaction to news about
the department. The costs of the
railways are to a very great extent,
fixed, unavoidable costs, of staff
salaries and of basic maintenance.
The portion that rises and falls with
the level of traffic is a much smaller
portion. The result is that after the
railways have found a balance of
costs being met by earnings, even a
small increase in the level of traffic
does not increase the large part of
the cost, but only the smaller part
which changes with traffic. The
earnings, however, increase to the
full extent. Conversely, if there is a
small drop in the level of traffic, the
bulk of the cost is still there, but the
earning drops to the full extent.
During the 1990s and the early
partof thiscentury,theexpansionof
the Indian economy resulted in
greater railway traffic and unprece-
dented surplus. The rise in railways
earnings over the decade can be
shown to closely follow the trend in
theGDPandthereislittledoubtthat
During this period the railways
posted a record surplus, made more
impressive by window dressing,
even questionable accounting, and
there were improvements in visible
services,withoutmajorincreasesin
charges and none in passenger
fares. Management institutes laud-
edtheministerandfinancialdailies
joined in chorus.
Thencametheslowdown,andthe
last two years have seen a snail-pace
growth of rail traffic. With earning
nearly standing still, expenditure
has grown apace. The Sixth Pay
Commission loaded the railway
heavier than the box wagon; fuel
charges have risen and so have costs
all round. The position before the
start of the current year was
grave. But the railways had to save
face and they still came up with
a record works programme, of
Rs 32,000 crore. And funded by a
surplus to come from inflated earn-
ings projections and conservative
expenditure estimates.
The reality check came with the
accounts of December 2010, where
the earnings were well below target
and the expenditure promised a
healthy excess. A standard way of
managing such shrinking of sur-
plus is to slow down the work that is
the current year, the exercise had to
be started early. But still, spending
on work has many supporters and
theworkcosttillDecember2010was
more than the corresponding figure
in the previous year.
The railways have a challenge in
the budget for 2011-12. They will
needtouseeverytricktobalancethe
books, including, maybe, taking a
loan from the government. But
there is a certain level of replace-
ment and development work that is
unavoidable.Justforthisfundingin
the normal course, the projections
for the current year may be higher
than justified and for the coming
year, may be imaginary (astronomi-
cal, greater than imagined).
Mamata Banerjee’s budget will
show if the railways are continuing
the charade or will bite the bullet
and tell the story as it is. The rail-
ways are a great national asset and
pay back in national development
many times the value shown in
their earnings account. It is time to
look at the railways as a national
responsibilityandallowtheaccoun-
tant to do his work.
The author is a retired financial
advisor and chief accounts officer in
the Western Railways, Mumbai
knew that the govern-
menthaddecidedtocon-
cede to the Opposition’s
demand for a Joint Par-
liamentary Committee
(JPC) probe into the 2G
spectrum scam, and yet,
like threatened witness-
NISTULA es in a gang war, govern-
HEBBAR ment managers kept
playing coy.
At the all party meeting convened by the
Speaker on the issue on Sunday, finance min-
ister Pranab Mukherjee had gone as far as
asking all leaders to “take an oath of silence”
as far as the press was concerned. But since
oaths are but words and words but wind, the
kite flying continued uninterrupted.
Once it was clear that the committee would
be set up, talk veered to who would head it. It is
a peculiarity of the Congress that whoever’s
name is mentioned first in connection with a
particular appointment gets jinxed. The party
seems to have a particular fondness for the
dark horse candidate.
Theeagernessforthechairman’sseator,in
fact, a membership of this JPC was only in
evidence until it was announced. Congress-
men were told that membership of the
committeewould,insomeway,precludetheir
being part of the next big Cabinet
reshufflepromisedbythePMaftertheBudget
session. The speed with which candidates for
the JPC disappeared reminded one of a Marx
Brothers’ film.
The Opposition has another problem. The
party that spearheaded the campaign against
A Raja and the 2G Scam, the AIADMK, now

Projections all come tumbling down finds itself out of the JPC. With 9 MPs, it is
hardly in a position to demand space.
While the government should be happy
THE LATEST economic review been dented for various reasons, in- nies are increasingly looking at for making acquisitions. that the monkey on its back is now squarely
from the Economic Advisory Coun- cluding the delays in decision-mak- cheaper assets abroad and are look- In fact, FDI flows on a net basis the Opposition’s problem, a piece of news, re-
Foreign direct investment cil to the Prime Minister shows a ing and problems associated with ing at mergers and acquisitions to wereonly$5.3billioninthefirsthalf layed through its ally, the Dravida Munnetra
$ bn (projections in February 2011) sharpdeclinefromitsearlierprojec- the acquisition of land. scale up their operations. of 2010-11, which is significantly Kazhagam (DMK), has brought the frowns
Year Inward Outward tions on inward foreign direct in- Interestingly, projections on out- The mood of Indian businesses lowerthanthe$12.3billionrecorded back. Former telecom minister A Raja, it
2006-07 22.7 15.0 vestment. In its earlier project in bound FDI remain constant. In July for overseas acquisitions can be in the first half of 2009-10. The coun- seems, wants to make one last stand in Parlia-
July last year, the council projected 2010, the council had projected out- gauged from a recent survey by cilexpectsthedecline to continue in ment and defend himself on any wrongdoing.
2007-08 34.2 18.8
inward FDI of $50 billion for the bound FDI of $20 billion for the cur- Grant Thornton, which says 40% thesecondhalf of thecurrentfiscal. Speaker Meira Kumar denied that any letter
2008-09 37.7 17.9 current fiscal and $55 billion for the rentfiscal.Ithasnowbeenprojected of them would prefer to take the One of the reasons for the sharp de- hadreachedherasof nowbutthegovernment
2009-10 35.6 16.0 fiscal 2011-12. But seven months at$18.2billion.Similarly,forthenext cross-border route to grow their cline in net FDI is the substantial is monitoring all fax machines very closely.
2010-11 27.6 (50) 18.2 (20) later, the council has projected fiscal, the projection of outbound businessthisyearascomparedwith outflows as Indian businesses It is round one for the Opposition, at least
2011-12 40 (55) 20 (25) just $27.5 billion for the current and FDI is down to $20 billion as com- 9% in 2008. Access to new geograph- acquired foreign assets of various for now. But in the see-saw game of occupying
$40 billion for the next fiscal. The pared with $25 billion in the coun- ic markets and new technology kinds, including manufacturing, the Parliamentary moral high ground, the
Figures in bracket are projections made in
July 2010 Source: PMEAC
declining trend indicates that the cil’sprojectioninJulylastyear.This fromestablishedbrandsarethetwo services, oil fields and mines. last word is never spoken.
confidence of foreign investors has trend indicates that Indian compa- most important motivating factors Saikat Neogi