#199 A New Deal?

India Policy Watch: Our Week With Adani

Insights on current policy issues in India

- RSJ

That was an eventful week in India. In the last edition I had written these lines on the ongoing Adani saga that have now come back to bite me:

“The FPO might struggle a bit to sail through. But that amount is a chump change for the group. A week or so of volatility, some questions from regulators, a few lawsuits, some strategically timed PR events and the group will be done with this kerfuffle by February. This is nothing more than a minor speed bump in its fortunes.”

Ooh. It didn’t turn out to be a minor kerfuffle. After the Adani Group came out with their 400+ page response to the Hindenburg report who then retorted with their characteristic bite, we witnessed a free fall in Adani stocks in the first few days of the week. The FPO barely saw any retail participation. A few anchor investors including an Abu Dhabi sovereign fund participated. And then at the eleventh hour we had family offices of prominent Indian industrial houses and few domestic institutional investors subscribe to it and the FPO just about sailed through. Social media was abuzz with either ‘see, this is the spirit of new India’ or ‘upar se call aaya hoga’ (they must have got a call from the top) kind of messages. But even this news didn’t mean much. The free fall continued that day. Eventually, the Group canceled the FPO and positioned itself as a martyr to the cause of investors who have stood by them over the years. Well, you live long and you get to see everything. There was further negative news for the group as the Dow Jones decided to remove Adani Enterprises, the flagship company of the group, from their sustainability index. A few global banks reported they wouldn’t accept Adani bonds as collaterals from their clients for margin trading. Only late on Friday, was there some good news coming in from the Group. They confirmed they kept their bond payout commitments and that all interest payments have been made till date. A couple of credit agencies, that prescient lot who you will remember didn’t have a clue till a day before the Lehman crisis that something was wrong, confirmed there’s no debt maturing among the group companies till 2025. Only then did the stocks find some respite.

So, you see not exactly what I had predicted. And so I’m somewhat less certain now if this will only just be a minor bump in the road for the group.

The other big event during the week was the Union budget that was presented on Feb 1. This was the last full budget to be presented before the 2024 general elections and there was an expectation that the government would tilt towards being more populist. Even here, I had made a prediction at the start of the year:

“..this government has always been careful about fiscal deficit, and it is particular about the risk of the fiscal space. The government has committed to a 4.5 per cent target for the union government deficit in the next 3 years from the current levels, that’s expected to be 6.4 per cent. I see a tightening in the fiscal stance during the year with a gradual reduction in some of the pandemic-related subsidies and better targeting of the benefits improving distribution efficiency."

Phew. On this I was right. The government cared more for its fiscal deficit trajectory than being populist. The surprising part, and the one I got wrong, was the significant capex push that is budgeted to grow 33 percent to Rs. 10 trillion in the coming year. Despite this, the government expects the deficit to be down to 5.9 percent in line with its three-year plan. How did it manage that? Well, forget populism, this government plans to cut down on subsidies and expenditures during a pre-election year. The subsidies budget is down 27 percent from Rs. 5.2 trillion to Rs. 3.7 trillion. At a macro level, this is an important message about its fiscal management philosophy. The infra push follows three themes that are all good in my opinion: a) internal connectivity through investments in railways, roads, airports and last mile connectivity; b)rural and low cost housing and c) decarbonisation to reduce dependence on fossil fuel and stay within range to the Paris commitment.

There wasn’t anything more to write home about. The market borrowing figure is big but in line with expectations. The numbers make sense and broadly stack up. It is good to see this happening and the legacy of being clever with them is now well past. There was the usual tinkering of the personal tax rates - the old switch and bait of give few visible breaks and take some concessions away in footnotes - and some tweaks on custom duties on dozens of items which we love doing all the time. The rest of the speech was spent on announcing the outlays for various sectors with some old and new scheme names. In a way, it was good to have a boring budget with capex focus. 

Anyway, the Adani story and the capex push in the budget sets up this piece nicely. I mean in normal times all the announcements about investment in infra and green economy would have been music to the ears of the Adani shareholders. There are three issues to discuss in this context. One, the usual, what does all of this mean for the Adani Group? Two, does this change the view of global investors about corporate India and its governance? How will that impact the ambitious capex push of this budget? Three, will this trigger a more fundamental look at how to invest in public infrastructure programs in India?

For the Adani group, the immediate issue is how to get out of this bad news cycle and find a patch of terra firma to plan their future. Last week I was certain that this would happen within a couple of weeks for them. Now I’m not so sure. The reason for this goes to the heart of corporate finance, the multiple players involved across the chain and their many interlinkages. It is not Dollars or Rupees which is the currency of corporate finance. It is that strange thing called trust. Someone wants to borrow money from you. Of course, you’re sceptical about their ability to repay. So they come back to you with data, track record, promises and commitments to convince you to trust them. You price your trust and give them the money. There’s nothing that you get in return for the money you have given. It’s all trust. This one transaction founded on trust then spawns hundreds of others. There’s some kind of alchemy at work where that single root branches out into millions of transactions based on parties trusting each other. Sometimes when you look at the complex web of financial relationships that span countries, currencies and time horizons, you forget how this complex megapolis with these towering skyscrapers and beautiful structures is founded on something as fragile and intangible as human integrity. Once that is tainted, even partly, the megapolis isn’t the same anymore. At the heart of it, the Adani Group has built maybe three core competencies. One, it wins more government tenders than others because they have the pulse for it. Not surprising because Adani after all anagrams to naadi (pulse in Hindi). He he, sorry about that. Two, it is a capital raising machine from banks and bond markets using the highly valued equity of its group companies as collateral. And three, unlike the previous infra players, it has, so far, broadly delivered on its projects. You might say the real test lies ahead because of how much it has taken on its plate. But it has a decent track record on delivery.

The key to all of these is its ability to raise capital and no matter what the ‘nation first’ brigade will tell you, a large part of this capital will need to come from outside India. And that capital flow will dry up a bit for the Group. Of course, there’s then apparent $ 2 trillion dry powder that’s available with the oil rich Gulf states who are always ready to come in to rescue. But even they might pause on their funding. That apart, the brazen ease with which the group wins projects might slow down a bit. The mainstream media might not highlight this but now that the light has been shone on its business practices, global media and investors will keep a tab on this. It might mean the law of averages catching up on its win rate. Lastly, the implementation track record that has been good so far might be under cloud if the funding environment becomes tighter or costlier, or both. A few well published delays and failures in completion of projects and the sheen of getting things done will wear off. Will they be able to complete their existing projects to build and maintain ports, roads, airports and more? So, there are more clouds on the horizon than anticipated in the early days of the report. The group is probably aware of the thin ice they are skating on now. Adani also anagrams to anadi (simpleton) but don’t got by that one. Expect some quick, big moves.

For the global investors, this is a moment to put the Indian model of economic development or nation-building as the government calls it in the context of what they have seen elsewhere. India does seem to present a tremendous opportunity in the light of China’s likely secular slowdown and lack of big opportunities elsewhere. So, they will keep a close eye on what is the India model of growth that emerges. So far, the model since 1991 has been to try a bit of everything - market, crony capitalism, socialistic redistribution and flailing in its own way managing them all. The current thinking, or maybe it is that Gujarat model, is to identify ‘national champions’ like Adani and bet on them to deliver. Indian elite take pain to explain that this is different from the Russian kleptocracy model. And it is true to a large extent. Indian business houses, unlike the Russian oligarchs, don’t squat on national resources like oil and gas, sell them abroad at a premium and then stash away their profits in tax havens outside. In fact, it is quite the reverse. Indian business houses raise funds from outside, leverage themselves to the hilt, deliver in India (or hope to) and make profits in India. The risk is largely external while the value creation is domestic. But this is a game where those taking the risk (largely external institutions) should be knowingly in on the game that their downside risk is protected because of the way capitalism works in India. Once that faith in the unique India model goes, they will go back to riding the high horse of governance or ESG and stay out of long term investments. This is something India can ill afford. This is its third attempt at ‘nation building’. So far, implementation has been its bug bear. It cannot come back in this new shape again. What will restore faith is not the usual demand to eliminate ‘national champions’ in favour of true market forces playing out in the nation-building space. That’s a pipe dream. The hope for foreign investors and fund houses is to have an honest attempt to set right the governance of ‘national champions’. Maybe build them like South Korea did with their chaebols. Let no one be too big to fail or too large to govern. Spread the spoils more evenly. Avoid getting into situations where an honest reckoning by domestic regulators and fund houses about such entities won’t be possible because too much is at stake. This doesn’t work well ever. A house of cards, no matter how high, is still a house of cards.

Lastly, how should we look at long term reform of the public infrastructure sector and investments in it? The simplest answer is to follow the first principles here. An open and transparent bidding process, a regulatory regime that’s focused on market failures of information asymmetry and market power and has the teeth to intervene, a clear roadmap for government investment plan and its ability to support private enterprise and a strong market linked mechanism to reward or punish performance. The problem is this will mean the state will have to voluntarily relinquish a lot of its arbitrary power that has brought us here in the first place. The real reform is not just in announcing a 33 percent jump in infra spending in the budget. It is about creating a rule-based mechanism that ensures there is delivery on these big plans that’s on time and continues uninterrupted. Adani is just a symptom of the problem of planning for infrastructure in India. What the symptom shows is the failure of imagination in revamping public policy here. I don’t often agree with Mihir Sharma but he makes a valid point in his Bloomberg piece:

“Nobody else in Modi’s India has this specific mixture of confidence in government support, ability to navigate byzantine regulations, and willingness to risk enormous sums of money. Some worry that Adani is too big to fail. He isn’t. But he may be too unique to fail. Wherever the money may have come from — public sector banks, pension funds, faceless pools of offshore capital — what matters for India’s growth is how productively it is spent. Effective oligarchs might be dangerous for a country and, if they’re corrupt, even more so — just ask Russia. Inept oligarchs are calamitous.

If Adani’s companies can deliver a fraction of what he has pledged, then perhaps, in time, they might even grow into the valuations they have already achieved on paper. If they fail, then a lot more goes down than his investors; Adani will take down India’s industrial policy with him.”

There is indeed a lot more at stake here than just the Adani empire.

Not(PolicyWTF): Chinese Companies Can Make in India - Conditions Apply

This section looks at surprisingly sane policies

- Pranay Kotasthane

An interesting recent development is the government’s change in stance on Chinese manufacturers of electronic components. Instead of an unsaid, outright ban on Chinese manufacturers, the government has now given a preliminary approval to 14 of Apple’s 17 Chinese suppliers to set up joint ventures in India.

This preliminary approval is just that — it comes with many conditions that do not apply to non-Chinese companies. For example, Chinese companies must compulsorily establish a joint venture with an Indian firm. Apparently, the latter also needs to have a controlling stake. Moreover, the FDI restrictions announced after the 2020 Galwan clashes are still in play, meaning that all these investments from China are still subject to receiving the appropriate government aashirwaad.

Back in 2020, we had written that tightening the FDI rules for all sectors is a policyWTF. Existing FDI rules back then already had restrictions on foreign investments in strategic sectors. To overlay this reasonable condition with a region-specific ban on investments across sectors didn’t make sense.

Given this backdrop, the small opening the government has now offered to Chinese suppliers of Apple is a positive course correction.

It’s a bitter pill to swallow, but there’s just no other way to achieve the stated goal of creating $300 billion in electronics manufacturing by 2026, with overseas sales of $120 billion, than to engage Chinese manufacturers. See what this excellent explainer by Surajeet Das Dupta says:

“Nearly 80 per cent of the global mobile device supply chain is in China and is run by Chinese companies. It has been built over the past 15-20 years because the biggest mobile device brands from Apple, Xiaomi, Vivo and Oppo have their production bases there. Suppliers in Vietnam or Thailand are also owned by Chinese companies — and the governments of those countries have gone out of their way to encourage them.” [Business Standard, Jan 29]

We have also written in the past that 64% of India’s chip imports come from China and Hong Kong. And this number will only increase over the next 7-8 years as India’s mobile manufacturing scales up. And that’s alright for now.

We must go beyond economic nationalism and come to a modus vivendi with China on the economic front. If Chinese companies are willing to invest in India in non-strategic products, we shouldn’t be turning our face away. That’s exactly what China did. It took investments from its richer and more capable adversaries—Japan, Taiwan, and the US—when it was the weaker power.

Deng Xiaoping, on his first visit to Japan after Mao’s death, famously said that the roles have now reversed — you are the teachers, and we are the students. While the India-China equation is quite different, we shouldn’t be afraid of exploiting Chinese investments to Make in India.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Tyler Cowen writes that the Industrial Policy of the Information Age will spur globalisation, not impede it.

* [Article] Indian nation-building, Modi and the Adani crisis: Adam Tooze has a thoughtful piece on the Adani episode.

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