The Case for Raghuram Rajan and Economy of India

Recently in an article in the Economic Times, the popular Indian columnist and novelist Ms Shobha De, touted the newly appointed Reserve Bank of India (RBI) governor Raghuram Rajan, as the 'rock-star economist', and ‘Poster Boy of Banking’ who can easily top easily top 'India's Most Desirable' lists and is also expected to pull India out of the financial mess. 

The post has attracted lot of media attention and has succeeded in flaring up imagination and varied emotions of the readers, ranging from interesting, to disgusting or even revolting! To add substance to the article it might have made better sense to also look at some of the problems facing India’s economy and the challenges that Rajan has to deal with while he tries to walk his talk. Let's have a go at those less appealing aspects that are actually the areas of concern for all Indians.

The economic problems in India can be attributed more to the country’s fiscal policy and other government policies than to monetary policy of the Reserve Bank of India (RBI). The central bank often finds itself reacting to the consequences of inaction and policy conundrum of the government.

In fiscal year 2013, the Indian economy is characterized by an annual GDP growth rate of 4.4 percent in the first quarter (April-June) of the current fiscal year 2013-14, the lowest in four years, a high current account deficit upto 4.8 per cent of GDP and overdependence on hot money and short-term debt for financing the CAD. Crisis in the resources industry - coal / petroleum-gas, severe supply-side constraints, stalled infrastructure projects and stagnation of employment, all put together have resulted in the depreciation of Re against the dollar from Rs 54.77 at the beginning of 2013 to the current level of about Rs 64 after touching a record low of 68.83 on 28th August.

After taking over as the RBI governor, Raghuram Rajan has announced a number of steps to stabilize the rupee, measures to attract inflows from overseas investors, including the NRIs. Under the leadership of Raghuram Rajan, RBI policy is expected to first cushion the negative impacts as much as it can, control the volatility of Re and to lower the cost of doing business till growth cycle picks up, and monetary policy starts to work to increase the pace of broad based and inclusive growth.

Continued slump in growth, delay in structural reforms, impediments in project execution, and high perception of corruption can erode confidence of the world in India's growth story, Rajan’s proposed steps towards reduction of price inflation and monetary policy for supporting India’s growth were well-received by the markets with the rupee recovering by 6 per cent and the Sensex rallying nearly 10% in four days between September 3 and 6. It may however take time for him to translate his words into action for the simple reason that monetary policy takes time in transmission.

Related articles

• http://economictimes.indiatimes.com/opinion/guest-writer/economy-with-raghuram-rajan-will-be-sizzling-hot/articleshow/22533265.cms
• The Case for India by Raguram Rajan
• http://www.moneycontrol.com/news/economy/rajan-to-fm-fight-inflationme-or-walk-alone_953608.html

Shareholder Engagement or Activism ?

Continuing from my last post ‘Is shareholder engagement good for companies?’, here we look at the scope of shareholders engagement and different approaches to shareholder engagement.

What is the scope of shareholder engagement? 

Shareholders have a legitimate role in areas pertaining to

• Corporate Strategy – such as mergers, diversification, restructuring, non core asset sale.
• Capital Structure – such as capital allocation discipline, use of cash on balance sheet.
• Governance – such as audit-related issues, board structure, managerial remuneration

However shareholders are not expected to micromanage companies. Nor is it desirable that shareholders push for short term profitability over sustainability and long term value creation. It is important that shareholders and board members engage effectively in the shared pursuit of high quality governance.

What are the different ways in which shareholders engage with companies?

Shareholders can either have a proactive approach for engagement with a company or may adopt a passive approach towards a company.

 Passive investors sell off their shares if they are dissatisfied with the corporate decisions.

On the other hand, active investors engage proactively with the management, prior to a corporate decision being affected, in order to change the outcome of the decision. While the term ‘shareholder engagement’ is used to describe a collaborative approach, ‘shareholder activism’ refers to the use of a more assertive approach by the minority shareholders to affect changes in management and strategy of a firm.

The approach to shareholder engagement varies in different countries.  Depending upon the business environment, legal contexts, and their own investment objectives, shareholders may adopt a collaborative, confrontational or mixed approach. Institutional investors like mutual funds and pension funds who tend to hold onto their investments for long-term returns adopt a cooperative approach with management, whereas hedge funds, with short term objectives, may adopt a more confrontational approach. Some countries provide more legal tools for shareholder activism than others. For example in UK, shareholders have a greater influence in questioning management activities and dealings than in the US. 

Global trends and practices in shareholder engagement 

Some global trends and practices in shareholder engagement include 

·         Disclosures.

·         Shareholder voting.

·         Shareholders say in appointment of auditors and directors.

·         Shareholders say in remuneration of the directors.

·         Shareholders’ approval of related party transactions.

·         Class actions that allow a group of investors with common interest in a matter to sue the management of a firm, its auditors or a section of shareholders in case of suspected wrongdoing.

·         Shareholder engagement through proxy advisory firms that analyze corporate proposals placed for shareholder approval and give their recommendations regarding the proposals.

While there are different ways in which shareholders engage with companies, shareholder participation in corporate affairs remains a function of business environment, legal contexts and ownership structures of companies.

Related articles

• Investor Participation in Corporate Governance
• Is shareholder engagement good for companies? 
• Companies Bill 2012 - Giving Voice to Minority Investors in India (prepforum.wordpress.com)
• Shareholder Activism Run Amok (wnyc.org)

Is shareholder engagement good for companies?

Shareholder activism has increased significantly in the last few years, particularly after the financial crisis of 2008. However, it has since then been it has been a debatable topic, as it is difficult to quantify “appropriate” level of shareholder engagement, which is desirable for achieving effective governance, while adding to business value. Quite often there is an apprehension that excessive shareholder intervention may consume a lot of valuable management time and result in short term profit orientation. 

Why should shareholders engage with company management and boards?

A business needs capital to finance its growth Shareholders are the providers of capital to a business and as such are part owners of the business. Shareholders invest in the business hoping for a higher potential return from the investment, while accepting a greater potential risk than other providers of capital. As shareholders own a share of the organization in which they have invested, this entitles them to ownership rights (i.e. rights to profits and assets in proportion to their shareholding) and in most cases control rights (i.e. rights to have a say in the running of that company, e.g. they may vote on key issues).

Image Source : http://ventism.blogspot.com

Management makes use of the capital to run the business and has an obligation to do so in a fair and transparent manner while maximizing value for the shareholders. However in practice management may take actions that benefit themselves, at the cost of dispersed shareholders, who are not involved in the day to day operations of the company. 

The board of directors oversees management to ensure that it is allocating capital appropriately. As a result, the board has a responsibility towards all the shareholders of the company to represent, manage and protect their interests in the company. Shareholders engage with company management and boards to ensure that their interests in the company are protected. If shareholders are not satisfied with the performance of the directors, they may remove the directors or refuse to re-elect them.

Can all shareholders influence corporate decisions?

All shareholders are not alike. Shareholders can be either private individuals or large corporations such as mutual funds, hedge funds, bank trust departments, insurance companies or private equity funds.Due to the differences in their portfolio types, investment objectives, nature of information available to them and their ability to influence the management, different types of shareholders have different priorities and motivations for engagement with companies. Where promoters are the dominant shareholders in the company, they have substantial power and control over the enterprise. Minority shareholders being dispersed, generally lack the resources required for coordination and active engagement with the companies. In contrast, the institutional investors are often in a position to exercise considerable influence in corporate decisions. 

Is shareholder engagement good for companies?

Though there is no empirical evidence about impact of shareholder engagement / activism on long term performance of companies but it is believed that effective shareholder engagement does help in strengthening corporate governance practices within companies. Board-shareholder engagement gives companies a better sense of shareholder concerns and allows them to gauge shareholder interest on significant proposals. Reliable information from companies, transparent disclosure policies and insight into management’s priorities, allow investors to balance risks and to allocate their capital accordingly. In turn, better governance practices augment the companies’ ability to attract risk capital from domestic and foreign investors for funding new or expansion projects. So overall we tend to believe that effective shareholder engagement is good for companies.

In the next article we will discuss the scope for shareholder engagement and different approaches to shareholder engagement.

Related Articles:

• Investor Participation in Corporate Governance
• Companies Bill 2012– Giving Voice to Minority Investors in India
• Role of-independent directors 
• The value of activist shareholders (lawprofessors.typepad.com)

Currency crisis in the Emerging Markets

The year 2013 has seen a global sell off resulting in the fall of currency in most emerging markets including Brazil, India, South Africa, Indonesia and Turkey. The charts below show the currency movement of the emerging nations versus the US Dollar in the last 5 years. (Source: http://www.xe.com/currencycharts )

Brazilian Real has fallen more than 14%  against the USD.

Indian Rupee has fallen about 20% against the dollar in 2013 and hit a lifetime low 68.85 per USD.

South African Rand hit the R10/$-mark for the first time since 2009, the lowest value in four years as poor economic data and labor market tensions weighed on sentiment.

Indonesian Rupiah has slid nearly 12% in 2013.

The Turkish Lira has fallen to a record low of 2 to the US Dollar, the lowest level record since 1981.

The under performance of these currencies can be attributed to the widening of the current account deficit in these countries including Brazil, India, South Africa, Indonesia and Turkey, with the CAD/ GDP ratio exceeding the levels set by the respective governments. The anticipation of the reduction in the US Federal Reserves’s stimulus program from September 2013, is causing outflow of foreign money from the emerging markets  into the United States, resulting in a further weakening these currencies.

In contrast, Chinese Yuan Renminbi has seen an appreciation in the corresponding period. Economists attribute it to high foreign exchange reserves and lower dependency on hot money inflows. 

The fallout of the depreciation can be felt in the rising costs of imports, increasing prices of petroleum products, fertilizers, commodities and loss of purchasing power due to inflation. The borrowers in these countries with dollar-denominated loans may not be able to pay back the loans, thereby increasing the default rates.

While the government and central bankers are taking measures to arrest the depreciation of their currencies by raising interest rates, curbing imports and tightening monetary policy and regulators are taking steps to reduce arbitrage opportunities and speculations in the currency markets, the overall remittances to some of these countries, particularly India has seen a jump, with Non-Resident Indians (NRIs) remitting more money to India, taking advantage of the depreciating rupee.  

Related articles

• CHART OF THE DAY: The Indian Rupee Is Getting Absolutely Brutalized (businessinsider.com)
• Analysts Say Emerging Market Turmoil Not Another Asian Currency Crisis (thejakartaglobe.com)
• And the Emerging Markets Winner is…Eastern Europe (blogs.wsj.com)
• Fall Of Rupee - Part II
• Fall Of Rupee

Companies Bill 2012– Giving Voice to Minority Investors in India

The passing of The Companies Bill 2012 by Rajya Sabha on 8^th August,2013,  is a step forward towards transformation in the corporate governance practices of the country. The new bill that requires President’s assent for it to become law, replaces the Companies Act of 1956. The bill, when enacted will bring in reforms to enhance corporate governance by giving voice to the minority investors in India, strengthening the role of independent directors and expanding the responsibility on auditors. 

A key objective of corporate governance in India has been to strike a balance between the rule of majority shareholders and the protection of the rights of minority shareholders. The protection of minority shareholders rights is particularly critical given the often concentrated ownership of Indian companies.

Unlike in the developed countries such as US & UK, where ownership of a company is widely dispersed and is generally separate from the management of the company, In India listed companies are usually parts of a large business group, characterized by a promoter or a controlling shareholder. This pattern of ownership gives rise to potential conflict of interest between the dominant shareholders and the minority investors, since the controlling shareholders have the power and incentive to monitor corporate activities closely and influence or control the corporate decisions in a manner that could be detrimental to the interests of the minority shareholders.

Traditionally the outside (non-promoter) shareholder participation in the corporate decision in India making has been low. The regulatory framework in India was till recently by & large tilted towards redressal of oppression by management and did not encourage proactive engagement of shareholders on corporate decisions. The new Companies Bill 2012 seeks to provide investors with effective means to voice their opinion in corporate matters that may have potential conflict with the interests of the company and the investors at large.  

The bill as passed by Lok Sabha on 18th December, 2012, has the following key amendments to increase shareholder participation in corporate decision-making:

Related Party Transactions

Companies Bill 2012 includes the provisions for approval by the Board of Directors for Related Party Transactions with transaction amounts exceeding prescribed limits or transactions which are not on conducted on market terms. Exemptions apply to transactions that are on ‘market terms’ and are conducted in the ordinary course of the business. The Bill also requires Independent directors to ensure that adequate deliberations are held before approving related party transactions and authorize every contract/ arrangement entered into with a related party, while providing with a justification for it. The Bill also says that no member of the company shall vote on such resolutions to approve any contract or arrangement if such member is a related part.

Exit Offer

Another key provision in the new Companies Bill is that if the minority shareholders feel that the funds raised from them are utilized by a company for a purpose other than those stated by the company in its objects, then they shall be given an exit offer by promoters or controlling shareholders. It will allow the minority shareholders to exit at such exit price, and in such manner and conditions as may be specified by the Securities and Exchange Board of India.

Class Action

The biggest boost for the small investors comes in the form of the provision in the Companies Bill for class-action lawsuits, which will allow a group of investors with common interest in a matter to sue the management of a firm, its auditors or a section of shareholders in case of suspected wrongdoing. A class action suit is a form of a lawsuit where a large group of people collectively bring a claim to court through a representative. The provision for class action in the Companies Bill 2012, will give shareholders an edge in defend their rights, if they are of the opinion that the management or conduct of the affairs of the company are being conducted in a manner prejudicial to the interests of the company or its members.

These measures are in line with the international practices adopted for empowerment of shareholders and will pave the way for enhancement of corporate governance system in the country.

Related articles

• Role of Independent board directors in Indian companies
• The Companies Bill, 2012: A Pragmatic view (shilpithapar.com)

Changing Global Energy Landscape with US Shale Gas – Part II

In mid- 2012, Kinder Morgan’s acquisition of El Paso for $38 billion,  resulted in a combined company called Kinder Morgan, Inc which is the largest operator of natural gas pipelines in the U.S. with 22% of the U.S. natural gas pipeline network,  connecting almost every gas field and consuming market in the U.S. The expanded pipeline network resulting from the Kinder Morgan-El Paso deal is expected to be especially significant in supplying gas to higher-priced electricity markets such as New York and Florida. The expanded pipeline network will permit the natural gas "bubble" to move downstream, in enough abundance to stimulate new products and locations.

This deal was a game changer because thousands of wells drilled to produce the record-setting "bubble" now have a record-setting pipeline network to get to market. This transaction affirms the potential of the shale gas discoveries, while countering apprehensions regarding stability of the natural gas market.

Sasol has announced a $10-billion facility in Louisiana to manufacture diesel fuel from natural gas, thus creating a new market for Haynesville Shale gas. That's not all. Dow has announced plans to build shale gas downstream capacities based on ethane and propane on the Gulf Coast, and Shell has also made known of their plans to build an ethylene cracker in Appalachia near the Marcellus Shale.

There are domestic and export implications for liquefied natural gas (LNG) as well. Last year, Cheniere Energy was the first company in 35 years to receive export approval for LNG from its Sabine Pass liquefaction facility and has signed an $8-billion contract with BG for supplying LNFG and another one with Spain's Gas Natural Fenosa for a total 7 million tons/year of LNG over 20 years.

The LNG exports are likely to be directed primarily to Asia, where in addition to the strong demand for LNG, the prices being paid for LNG are four times as high as the prices in the U.S. This demand for LNG in Asia is dominated by Japan and South Korea . These two countries together imported 64 percent of global LNG. Japan is replacing nuclear electricity generation capacity lost as a result of the earthquake and tsunami with LNG. Additional demand comes from China and India. China's import of LNG has increased considerably, driven by demand for electricity generation and air quality concerns. The oil companies of India &China have made significant investment in U.S. shale plays in an attempt to bring in supply to their own markets.

The tide has turned — the U.S. is on its way to being not only the supplier of the world's LNG, but other fuels as well. The U.S. is already on course this year to be a net exporter of gasoline, diesel and other fuels for the first time since the post-World War II economy of 1949 — a prospect that was unimaginable even a few years ago.

Guest Post

Related Post:
Changing Global Energy Landscape with US Shale Gas - Part I (prepforum.wordpress.com)

Changing Global Energy Landscape with US Shale Gas – Part I

In the year 2009, United States surpassed Russia to become the world's leader in natural gas production, with production continuing to increase to 80 billion cubic feet/day in 2012. U.S. natural gas reserves are at their highest point since 1971, and year-on-year reserve additions doubled from 2010 to 2011, as a result of shale production. Shale gas, a natural gas found trapped in sedimentary rocks, made up only 1 % of U.S. natural gas production in 2000. It now amounts to 25 % of U.S. natural gas production and is expected to increase to nearly 50 % by 2035.  

Natural gas, cost-competitive with coal at half the carbon emissions, is becoming the fuel of choice for electricity generation. New EPA regulations on particulates, mercury, and other toxic emissions are forcing the closure or retirement of 28 GW or more of coal-burning capacity, or about 8.9 percent of total U.S. coal-burning capacity. Recent increases in coal transportation costs are also problematic for coal. In addition, demand for electricity is forecast to exhibit slow but steady growth over the next few decades. These factors, taken together, are expected to be the primary driver of demand for natural gas in electricity generation over the next several decades. Utilities and end users are choosing the lower emissions and lower capital requirements of natural gas-fired facilities over other fuels, sending the clear message that the risk of natural gas price volatility is a risk worth taking in the current difficult policy environment for coal.

The U.S. Energy Information Administration (EIA) estimates that 223 GW of new generation capacity will be needed between now and 2035, and that at least 60 percent of capacity additions are expected to be natural-gas-powered. However recently EIA has conceded that “the shale oil and shale gas resource estimates are highly uncertain and will remain so until they are extensively tested with production wells”, thus raising concerns the prospects of shale gas. Industry consultants and federal energy experts have privatelyvoiced scepticism about shale gas prospects. 

Scepticism also arises mainly due to the lack of marketability that has not only kept the natural gas price below $4/MMBTU, it has even resulted in the flaring of more than one-third of produced natural gas in 2011 in North Dakota. Without a pipeline, natural gas is not marketable. It's immobile, "stuck" near the production site. Pipelines are long-term investments that generate low returns. Revenue to the pipeline operators is generated by transmission fees on long-term contracts, insulating the operators from fluctuations in the natural gas commodity price.  

Notwithstanding the cynicism,  shale resources and other upstream assets continue to drive U.S. merger and acquisition activity, attracting foreign investors in the process.  In the next part we will look into some deals that validate that the potential of the shale gas discoveries.

Guest Post.

Related Post:
Changing Global Energy Landscape with US Shale Gas - Part II