Slowdown? Blame it on crony capitalism

When crony capitalism flourishes, investor sentiment is bound to take a hit, writes M R Venkatesh.

"I have also directed a review of tax provisions that have a retrospective effect in order to find fair and reasonable solutions to pending as well as likely disputes between the tax departments and the assesses concerned."

Obviously, our newly appointed Finance Minister P Chidambaram was referring to a controvertial retrospective amendment carried out by his predecessor Pranab Mukherjee in Budget 2012-13 to the Income-Tax Act.

Readers may recall that a retrospective amendment to the IT Act had the calculated effect of taxing the Hutch-Vodafone deal and bringing in excess of Rs 50,000 crore (Rs 500 billion), directly and indirectly, to the government.

Elders tell me that since 1961, there have been in excess of 350 retrospective amendments to this statute. Some of these were carried out to anul the judgments of various Courts including the Supreme Court.  Yet, there has never been a shrill debate in our media as much as it has been on this occasion. 

Interestingly, the IT Act has been amended retrospectively nearly two-dozen times between 2006 and 2008. This reference to these three select years is simply to highlight the point that even the present FM has a scary track-record on this matter. 

Questions arise. Why then this noise and fury over the amendment when it specifically relates to the Hutch-Vodafone deal? Is this impacting international investor sentiment about India? Is this the cause of capital flight from India, consequential Rupee depreciation and overall economic gloom?

The power of Hutch-Vodafone

The Foreign Investment Promotion Board (FIPB) website points out that it "is a government body" that offers a single window clearance for proposals on Foreign Direct Investment (FDI) in India that are not allowed access through the automatic route.

If being a government body is by itself a handicap, the FIPB is further handicapped by the fact that it "comprises of Secretaries drawn from different ministries." This inter-ministerial body, the official website notes "examines and discusses proposals" for foreign investments in the country for sectors with caps.

The website further adds that the FIPB "has a strong record of actively encouraging the flow of FDI into the country through speedy and transparent processing of applications, and providing on-line clarification."

And therein lies the rub. As a promotional body, the FIPB is by design in pursuit of quantity, not quality, of FDI flows into the country. Put bluntly, it is like a traffic constable who is ill-equipped to handle terrorists.

That implies that a company promoted by a terror group with locals as directors in a Tax Haven and routing its investment into India through several subsidiaries again located in various tax havens could find "active encouragement" of FIPB.

What is important to note here is that invariably each of these subsidiary companies holds portions of specific assets in the final destination, all of which makes divesting easier. In short, exit in any foreign country is simultaneously planned at the time of entry.

And this is called "investment structuring" where multinational accounting and law firms, international consultants and of course global investment banks are involved. In this unequal fight, government of India often comes second best.

The grey side of Hutch deal

Now to the Hutch-Vodafone saga. I had pointed out how Li Ka Shing, the chairman of Hutch had extraordinary links with the Chinese PLA in one of my one of my earlier columns on this subject.

Despite such connections it not clear even to this day how Hutch managed to invest and hold 67 per cent of shares in Indian operations (balance 33 per cent were held by the Essar group, of which 22 per cent were foreign investments) without any regulatory let or fear? Perhaps, not many have any answers to this question.

Hutch at the time of sale to Vodafone held 52 per cent direct equity interest in Indian operations. What is interesting to note is that it was alleged that Hutch was the "indirect" owner of the balance 15 per cent held by local partners through certain Indian companies. 

This 67 per cent holding of Hutch - direct and indirect put together - combined with 22 per cent held by foreign entities of Essar group aggregated to an FDI of approximately 89 per cent, thus causing a breach of the FDI cap of 74 per cent, as prescribed by our FDI policy. 

Why this allegation in the first place of the Indian partners being "indirect owner" of Hutch? This is where the plot becomes extremely complex. The equity portion of the Indian partners was funded by loans by Rabo India based on the back to back financial arrangement with Hutch itself.

Simply put, absent the arrangement from Hutch, Indian partners would not have possibly had the necessary financial muscle to fund the Indian operations. Consequently for some, they were benamis of Hutch, plain and simple.  

Remember that the FIPB is admittedly as investor friendly body. Its website states "In case of ambiguity or a conflict of interpretation, (emphasis supplied) the FIPB has always stepped in with an investor-friendly approach."

But in the instant case even the FIPB with its avowedly investor friendly policy was distinctly uncomfortable. When queried on this by FIPB, Hutch repeatedly argued that "providing loan" or "guarantee" cannot be taken to imply "benami transaction."

Similarly, Hutch could not give satisfactory reply to the specific queries raised by the Board on the "unfettered right of disposal of this share holding" nor allow the Indian shareholders the "right to enjoy the complete usufructs" of the assets.

Crony Capitalism in full flow

It also could not be satisfactorily clarified by Hutch as to how filings made before the Hong Kong and US Regulators, the holding has been shown as "67 per cent," while the claim in the application before FIPB is about a transfer of "52 per cent" stake in Indian operations. Needless to emphasize, even to an investor friendly Board, this was too much to swallow.

The matter was referred to various authorities. The RBI pointed out "that given the nature and magnitude of alleged irregularities, a thorough investigation is required to assess the complexities of the transaction and to establish the actual foreign holding in HEL."

What about security? Did the FIPB refer the matter for security clearances, especially given the relationship between Li and the Chinese PLA?

Yes. It did. A communication from Joint Intelligence Committee of National Security Council Secretariat (JICNSCS) suggests that in view of substantial change in ownership, it was necessary to make a key assessment about the "actual share holding" including those which are held through off shore entities. It was further been suggested that since Telecom falls within the sensitive sector this process must be subjected to "special scrutiny."

Nevertheless as the matter was referred to the Law Ministry which overruled the contentions of the FIPB by stating that one has to "desegregate the loans taken and the actual ownership of the shares" to arrive at the conclusion.

Paradoxically, it quoted the very same arguments that Hutch put forth before FIPB. And once the Law Ministry gave approval, FIPB had no choice but to go give the nod to the sale by Hutch to Vodafone. Why have FDI caps and monitor it by FIPB when foreigners can fund local partners indirectly which in turn is accepted by law ministry?

Let us not forget the Law Ministry clearance is like the grandma's cloak – it covers everything and everyone's back. In effect, the Government saw this merely as a legal issue, not an issue of its integrity and certainly not as a security issue.

Most foreign investors now see this approval by FIPB despite objections by RBI, JICNSCS and FIPB itself as a classical case of crony captitalism - where the rules made out by the government can be selectively bent.

What else would explain as to how Hutch managed to enter India despite its connections to the PLA? Surely, someone was compromising India's security interest. Secondly, despite massive opposition on the gray areas of law, the Law Ministry approved the deal.

Third, we further messed the situation when the IT Act was amended this year. Fourth, we now seek to retrospectively amend the said retrospective amendment to the IT Act. Given the manner in which sections of our government has been keen on helping these two companies, one wonders whether it is a wholly owned subsidiary of Hutch-Vodafone.

Do we realize that the collective impact of all these on investor sentiments - especially international investors?  If FIPB approval was crony capitalism, attempts to review the retrospective amendment is pure lunacy - one that adds to the economic gloom in India.   Yet sections of the media seek to hold only this IT amendment as singularly responsible for the gloomy state of affairs in the country. How foolish.  

Surely, retrospective amendments are anti-investments but yet, given our track record, expected. But the real issue is the manner in which Hutch entered India, operated here and got the FIPB approval for its exit - all conclusive evidence of crony capitalism. Our media and experts may well play ostrich, but international investors are not fools. 

Moral of the story: When crony capitalism flourishes, investor sentiment is bound to take a hit.

Photograph: Jayanta Dey/Reuters