gfiles magazine

July 17, 2011

Holes in the growth story

Mismanaged globalization is backfiring on the economy

INDIA has reached a critical stage of growth, as a direct offshoot of embracing liberalization. If liberalization opened up the gigantic Indian market to foreign direct investment (FDI), it also cut the other way and facilitated huge investments by Indian companies abroad. While India Inc may celebrate this, economists and sociologists are deeply worried over the implied consequences of our escalating investments abroad, even as the country keeps sliding on every parameter of the human development index.
The process of liberalization was not roses all the way. Between 1995 and 2005, the modernization of Indian industry triggered the phenomenon of jobless growth. The employment elasticity to GDP growth is still not satisfactory. And the situation is compounded by legitimate and illegitimate siphoning off of funds from India into overseas investment channels.
When Dr Manmohan Singh, as Union Finance Minister, unveiled economic reforms in 1991, he revved the growth engine and put the Indian economy on the path of globalization. He perhaps did not visualize that, 20 years on, as Prime Minister, he would find globalization a double-edged sword. When the government opened the FDI floodgates in 1991, it unshackled Indian businessmen. It abolished monopoly regulations, industrial licensing controls, and phased manufacturing norms. It also embarked on a calibrated liberalization of foreign trade and foreign exchange controls. Many Indian businessmen, including professionals-turned-entrepreneurs, seized business opportunities abroad. The dubious ones realized that the reforms also meant an opportunity to launder their hidden wealth abroad through the Non-Resident Indian (NRI) route.
NRIs run empires with annual turnovers of millions and billions with the holding company operating from tax havens.

THE legal definition of the NRI and the operational flexibility conferred on NRIs by the Reserve Bank of India (RBI) have proved a boon for many Indian businessmen and professionals. Some own palatial houses abroad, run business empires with annual turnovers of millions and billions of dollars with the holding company or investment trust operating from tax havens, escaping the gaze of Indian sleuths as well as activists of different hues.

Trust Us!

All business runs on trust. And Indians rely on statutory trusts for all sorts of business, ranging from encashing the lay public’s religious faith to throwing a cloak of secrecy over their wealth stashed in tax havens.
Lakshmi Mittal chairs the Luxembourgheadquartered ArcelorMittal, the world’s largest steel group with manufacturing operations across the globe except India.

The advantage of operating under the cover of trusts lies in the virtual absence of transparency norms. Little wonder then that self-made godmen and global Indian citizens (NRIs and PIOs) have unflinching faith in trusts, both domestic and offshore. Such trusts serve as a platform from which they weave and control a web of companies and subsidiaries at home and abroad, leaving both the taxmen and the public bewildered.
Essar’s shareholders are Virgo and Triton Trusts whose beneficiaries include companies that are 100% owned by Shashi and Ravi Ruia of the promoter family, the Ruias.

Take the case of the Essar group that has a significant presence in steel, telecom, energy and logistics. The group’s holding company, Essar Global Ltd (EGL), is registered in the Cayman Islands, a tax haven. The Essar group’s overseas disclosures show that EGL’s shareholders are Virgo Trust and Triton Trust. These are discretionary trusts whose beneficiaries include, among others, companies that are 100% owned by two members of the promoter family, the Ruias. The duo is Ravi Ruia, younger brother of group Chairman Shashi Ruia, and the latter’s son, Prashant Ruia. The documents identify both Ravi and Prashant as NRIs.
The Anil Agarwal-led Vedanta group has a holding company, Vedanta Resources plc, that was listed on the LSE in December 2003 after a mega-IPO.

The documents relate to Essar Energy plc, flagship company of the group, that was listed on the London Stock Exchange (LSE) in May 2010 after it raised $1.95 billion through an initial public offering. The documents do not shed any light on their citizenship – whether they have retained Indian citizenship or acquired the citizenship of another country. Similarly, information on Virgo and Triton is not available online. In October 2006, the group had announced: “The Essar group is currently consolidating all its businesses in India and worldwide under a Cayman Islands-based global holding company, Essar Global. The restructuring process has been underway for the last six months and Ernst & Young has been guiding the group in this.”
Take a look at the Anil Agarwal-led Vedanta group, whose holding company, Vedanta Resources plc, was listed on the LSE in December 2003 after a mega-IPO. Vedanta Resources was originally incorporated as Angelchange Ltd in April 2003. The company’s controlling stake of 59.88% is held by Volcan Investments Ltd, a company registered in the Bahamas, another tax haven. Volcan is owned and controlled by the Anil Agarwal Discretionary Trust. Onclave PTC Ltd is the trustee and controls all voting and investment decisions of the Trust.
Again, information on whether Agarwal is an NRI or has acquired citizenship of another country is hard to come by. His official address shows he is based in London. Agarwal, who acquired the reins of a small family business in 1979, has had a meteoric rise in the metallurgical sector that includes acquiring two privatized companies – Hindustan Zinc Ltd and the Bharat Aluminium Company.
Vedanta is now repeating its growth story in the energy sector. It includes ongoing acquisition of the Indian oil and gas assets of Cairn Energy plc. Yet another NRI business empire that stands on trust is that of Lakshmi N Mittal (LNM), who chairs the Luxembourg-headquartered ArcelorMittal, the world’s largest steel group with manufacturing operations across the globe except India. LNM is the eldest of three sons of ML Mittal, who founded the Ispat group in 1952. In 1974, the group spread its wings abroad by setting up PT Ispat Indo in Indonesia. In the 1980s, the group embarked on acquisitions of overseas iron and steel companies. The international operations were managed by LNM, according to an Ispat group presentation.
In 1994, business interests within the Ispat group were demarcated with LNM continuing to manage the international operations. The younger brothers, Pramod Mittal and Vinod Mittal, focused on steel and other businesses in India. Since then LNM has carved out an independent identity with the Mittal Steel Corporation (MSC) and Ispat International. The MSC group grew into the world’s largest steel manufacturer before acquisition-cum-merger with European steel giant Arcelor. ArcelorMittal’s website says LNM formed MSC in 1976. It is not clear when LNM became an NRI and whether he is still an Indian passport holder or a British citizen.
Stock market disclosures by ArcelorMittal show a significant shareholder owns 41.15% stake in the company. “The term ‘significant shareholder’ means the trust (HSBC Trust (CI) Ltd, as trustee) of which LNM, his wife, Usha Mittal, and their children are the beneficiaries, holding ArcelorMittal shares through Ispat International Investment, SL and Lumen Investments Sàrl, according to a disclosure.
A search for this trust online takes one to the Channel Islands, a tax haven. The trust is part of the HSBC banking and financial services group. Additional information on the Trust is not available. Other successful Indians who became NRIs in the past 20 years have also made their overseas and/or domestic investments through tax havens with or without reliance on trusts.

They flaunt their Indian voter IDs, passports and driving licences when it comes to complying with Indian regulations. Today, an NRI can be a Member of the Indian Parliament! The system offers lucrative advantages to NRI businessmen, who can live abroad for part of the year. They are better placed to manage their ill-gotten wealth generated through invoice manipulations and kickbacks from companies to whom they award engineering, procurement and construction (EPC) contracts for implementation of projects. They can resort to tax treaty shopping for making investments. Even an honest businessman would be tempted by the ease of managing and multiplying earnings as an NRI.
Exports have become shallow. A 15% value addition to imported inputs is adequate to pass off any product as an export item.

Some NRIs have acquired citizenship abroad by investing in job-creating businesses, as mandated by certain countries that offer investment-linked citizenship. It is thus not surprising to find that the government has put full capital account convertibility of the rupee on the backburner. Even without such radical initiative, the flight of capital from India and the resulting forgoing of opportunities for economic growth and job creation is alarming.
RBI rules for direct investment abroad
THE RBI says overseas investments in joint ventures (JVs) and wholly-owned subsidiaries (WOSs) offer several benefits. These include promotion of exports, access to technologies and skills, and employment generation. There is, however, no study to estimate the comparative benefits of overseas investments and domestic investments from the standpoint of employment generation and multiple benefits to the economy. While certain investments abroad are essential and should be accelerated, other investments are dubious and largely benefit the companies making them. The essential areas include the natural resources that India lacks or is deficient in, such as oil and gas, uranium, potash and phosphates. Investment in these areas has, however, been inadequate especially in potash and phosphates. This, in turn, has made the Indian agriculture and fertilizer industry vulnerable to the machinations of global fertilizer and fertilizer raw material price cartels.
It hardly makes sense to sink a few billion dollars in overseas coal and iron mines because India is well endowed with these resources. It would obviously be better to generate millions of jobs in domestic mining rather than spending foreign exchange abroad first for developing a mine and then regularly on importing from it.
The overseas investments in the coal and iron segments appear bad ones if the expenditure on shipping, port logistics and rail transport to hinterland power plants and other bulk users of coal is factored in. It is ridiculous to burn diesel produced from imported coal to haul more imported coal to power plants in Haryana and Punjab!
Similar cautionary logic applies to the recent spate of investments in overseas oilseed and pulp-related plantations and other farming segments. This is an avoidable waste of foreign exchange on food and non-food commodities imports from such Indian-owned overseas plantations. It would be far better to offer millions of hectares of domestic wasteland to corporates for plantation of bio-diesel crops and pulp-related crops such as bamboo with the legal provision that jobs must be provided to tribals and other local people.
Similarly, it is debatable whether Indian companies should invest billions of dollars in providing telecom services and in generating power in other countries when there is so much work to do in these areas within India. As for investment regulations, the RBI allows companies to make direct investment abroad under the automatic route. The companies can also seek specific approvals from the RBI and other regulatory authorities in cases where the proposed investments are much larger than the ceiling specified under the automatic route.

Highlights of the regulations:

- A company can invest up to 400% of its net worth in overseas JVs and WOSs under the automatic route. Companies are exempted from this investment ceiling when they channel funds from the proceeds of overseas equity offers or from their exports-related exchange earners’ foreign currency (EEFC) account.

- Oil and gas public sector undertakings are allowed to invest without any ceiling in overseas blocks but with requisite approval from the Centre.

- Companies are allowed to capitalize the export dues and other foreign exchange earnings within the 400% investment cap.

- Software exporters are allowed to receive 25% of the value of their exports to an overseas software start-up company in the form of shares.

- Stock market-listed companies are allowed to invest up to 50% of their net worth in overseas shares and other securities.

- Mutual Funds are allowed to invest in securities of overseas entities or in the overseas equity offer of Indian companies within an overall ceiling of $7 billion.

RBI data shows that direct investment abroad (DIA) increased from $5.82 billion in March 2003 to $79.2 billion by March 2010. This includes reinvested earnings by Indian companies, subsidiaries and joint ventures operating overseas. One has to accept FDI with a pinch of salt as the data depends on what constitutes FDI. Moreover, FDI inflow and outflow data for the same period is hard to come by. And yearly comparisons can be misleading owing to the presence or absence of a big acquisition and underlying investment in a year. al">Notwithstanding these caveats, the DIA of $79.2 billion by March 2010 compares well with the cumulative FDI inflow of $129.4 billion over the longer period of January 2000 to February 2011.
THE rules relating to NRIs and overseas investments are quite liberal. This is confirmed by recent big-ticket acquisitions such as the $10.7-billion deal last year by Bharti Airtel to acquire the African operations (excluding Sudan and Morocco) of the Kuwait-based Mobile Telecommunications Company KSC – popularly known as Zain. Such acquisitions and investments in overseas projects are financed through a mix of funds – company savings and surpluses, forex loans from domestic banks, overseas borrowings and equity offers.The liability of servicing such forex expenditure partly or wholly devolves on the Indian economy.
The flight of both corporate and personal wealth is bound to gather momentum due to the growing unfavourable business environment. The trend is due to periodic bashing of businessmen by NGOs, the media and politicians who love to lecture them on austerity and simplicity. In addition, the emerging stiff policies relating to exploration and development of natural resources such as coal, iron, bauxite, oil and gas, and land acquisitions in general has triggered a trend of investing abroad among companies.
With an eye on the projected coal imports of 250 million tonnes in 2017-18, companies – from Coal India Ltd and NTPC to private biggies such as Tata Power, Reliance, Adani Energy, Lanco and JSW – have either acquired or are acquiring coal assets abroad. Some of them see opportunities in the imported coal logistics and shipping business and are thus making overseas investments in this sphere too.
None but the government is to blame for such policy-led imports and the consequent corporate investments abroad. The corporate sector does not like government diktats on corporate social responsibility and provision of jobs to those from the backward castes and communities. Snail-paced reforms in contract farming, commercial plantations, financial services and organized retail have also contributed to the rush abroad. Labour reforms have always been a hot potato for politicians.
Doing business has become a highly uncertain affair in India. The executive and judicial combine can halt implementation of any industrial project even when it is environmentally compliant. Public protests, managed by NGOs and the media, are what counts. The viability of any project can be threatened due to zero or preferential imports envisaged under free trade or a preferential trade pact. The government has been pursuing such bilateral and regional deals on geo-political considerations.
The World Bank’s private sector funding arm, the International Finance Corporation (IFC), ranked India 134 in the Doing Business 2011 global rankings, one notch above the DB 2010 rank. Governance reforms over the past 20 years have made hardly any difference to India’s ranking and performance report, published by the World Bank under its Worldwide Governance Indicators (WGI) Project. The project assesses 212 countries on six dimensions of governance, monitored since 1996 – voice and accountability, political stability and absence of violence/terrorism, government effectiveness, regulatory quality, rule of law and control of corruption.
AMIDST the growing uncertainty, even potential foreign investors are cagey about taking the plunge in India. The FDI inflow lost steam a few years ago. There have been no big-ticket or big-name investments from abroad. The FDI investments do not reflect their intentions or perceptions about India as a good destination for FDI. Notwithstanding India’s manufacturing competitiveness, perceived by some multinational corporations, China and other countries are favoured for investments, especially in chemicals, natural resources development and infrastructure. The depth of manufacturing operations has decreased due to import liberalization. Companies prefer to minimize their risks by outsourcing components and sub-assemblies from overseas or domestic vendors. The government has been working on a national manufacturing policy since 2004! Exports have become equally shallow. A 15% value addition to imported inputs is adequate to pass off any product as an export item.
The frequent post-tender changes in contracts and the associated crony capitalism, corruption scandals, periodic sectarian and caste agitations and violence, and absence of a new phase of substantial reforms have all vitiated the business environment.
All this threatens to transform globalization into a passage out of India. As the imports dependency of economic growth increases along with the FDI outflow, the country’s financial stability will become more vulnerable. As the RBI’s Financial Stability Report of June 2011 states, “Availability of alternative channels of funding has reduced the dependence of firms on domestic bank credit over the years. Rising domestic yields are widening the interest rate differentials vis-à-vis AEs, resulting in a greater access to External Commercial Borrowings (ECB) by Indian firms. This trend is causing a build-up of currency mismatches in their balance sheets. India’s International Investment Position (IIP) statistics show that the currency risk exposure of India’s non-official sector has increased in the last few years, with an increasing net liability position. This means that the translation risk for the non-official sector arises from a depreciation of the Indian rupee.”
THE report adds: “Foreign claims on Indian assets denominated in Indian rupee is far greater than that of residents in foreign currency denominated overseas assets. India’s net external liabilities have increased from US$47 billion as on March 31, 2004 to US$158 billion as on March 31, 2010. It may be mentioned that these external liabilities include the foreign currency loans given by overseas branches of Indian banks to domestic corporates. There has been a consistent increase in such borrowings over the past few years.”

Who is an NRI?THE term “Non-Resident Indian” (NRI) is commonly used to refer to persons of Indian origin who have settled abroad or live overseas for substantial periods but retain Indian citizenship. The government, however, distinguishes between NRIs and Persons of Indian origin (PIOs). A lesser known term is Overseas Citizen of India (OCI).
An NRI is an Indian who lives overseas for studies, employment or business for at least 182 days in a year. The terms and conditions for being eligible to be treated as an NRI are specified separately by the Income Tax Act and the Foreign Exchange Management Act. An NRI can open a rupee bank account named Non-Resident Ordinary (NRO) deposit account for collecting his/her funds from domestic transactions. RBI regulations require banks to designate an existing rupee account as NRO when a resident becomes an NRI. He is allowed to repatriate abroad the current income and interest from this account but not the principal lying in the account.
The RBI also permits NRIs to remit up to $1 million per annum out of the balances held in NRO accounts or the proceeds accruing from sale of assets held/inherited in the country. For doing business through a corporate entity, an NRI can promote an overseas corporate body (OCB). It is defined as a company, partnership firm, society and other corporate body owned directly or indirectly to the extent of at least 60% by NRIs. OCB includes overseas trusts in which not less than 60% beneficial interest is held by NRIs directly or indirectly but irrevocably, which was in existence as of September 16, 2003. A PIO is a citizen of any country (excluding Bangladesh and Pakistan) who earlier held an Indian passport or either of whose parents or grandparents were Indian citizens. An OCI is a person registered with the government as an Overseas Citizen of India (OCI) under Section 7A of the Citizenship Act.
Indian entrepreneurs who became NRIs during the last 20 years
Lakshmi N Mittal, ArcelorMittal
Anil Agarwal, Vedanta
Ravi Ruia, Essar
Prashant Ruia, Essar
Naresh Goyal (above right), Jet Airways
Vijay Mallya (above left), United Breweries
C Sivasankaran, Siva/Sterling Infotech

Signals that mismanaged globalization can backfire on the economy have also emanated from the Department of Commerce. It has pressed the alarm bell on the trade deficit in a paper titled “Strategy for doubling exports in next three years (2011-12 to 2013-14)”, released in May 2011. With imports outpacing exports, the trade deficit has increased from a meager $8.7 billion at the beginning of the Tenth Plan in 2002-03 to $118.3 billion in 2008-09. This may increase by nearly two and-a-half times to $282 billion in 2013-14, which would be 11.5% of GDP in 2013-14. This level of deficit is unsustainable. Whether a trade deficit is sustainable depends on the country’s current account. And this too turned into deficit in 2004-05. The current account deficit (CAD) has been rising since then.
Doing business in India has become uncertain. The government can halt any industrial project even if it is environmentally compliant.

The Department of Commerce strategy paper says: “Even if we expect a rebound in services, exports and invisible earnings rise, the CAD would widen substantially at the projected level of BoT (balance of trade) deficit. The large growth in the size of the BoT deficit on merchandise account will result in a significant expansion of the CAD, in turn, leading to a reliance on foreign capital inflows to finance the deficit. Foreign portfolio investment is still a major part of capital inflows and past experience suggests that such flows are indeed volatile. Hence, a large widening of the trade deficit can potentially result in payments difficulties. And, such a situation is simply unacceptable because it may jeopardize the entire growth process. It is, therefore, of paramount importance that the BoT deficit be kept within manageable bounds.

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