Sucheta Dalal :A Killer Blow
Sucheta Dalal

Click here for FREE MEMBERSHIP to Moneylife Foundation which entitles you to:
• Access to information on investment issues

• Invitations to attend free workshops on financial literacy
• Grievance redressal


You are here: Home » Current Articles » A Killer Blow
                       Previous           Next

A Killer Blow  

April 8, 2008

A Killer Blow


Commodity futures trading in India through national bourses was re-started in 2003, after a hiatus of four decades, this time through transparent, automated, screen-based exchanges. These markets are still viewed with suspicion and trading in rice, wheat and pulses was banned on complaints that futures trading had led to a price spiral in 2006. Trading remains restricted to a handful of commodities and the government is still in the process of introducing legislation to give adequate statutory teeth to the Forward Markets Commission (FMC) and has yet to establish the infrastructure that will permit physical settlements in commodities. In fact, commodity markets are at a stage where the government must invest much more time and effort in educating farmers, corporates and other intermediaries to use futures to hedge risks and improve price realisation; when that happens, they will be integrated into a system where it is viable for insurers and lenders to step in and provide further cover and reduce the cost of intermediation, especially in agri-commodities.


It is, hence, a great irony that instead of helping to further the unfinished development agenda for this market, the finance minister decided that commexes are now ready to be milked to fill the government’s coffers. The three commodity exchanges may have racked up a trading turnover of Rs35 lakh crore in 2007, but they are still small by international standards.

P Chidambaram’s Budget has dealt a killer blow to them by slapping a hefty Commodity Transaction Tax (CTT) and service tax on futures trading. Currently, the cost of trade includes an exchange transaction fee of Rs two per lakh of rupees. The FM wants to add a service tax component (Rs0.25) and a huge CTT of Rs17 per lakh. This will add up to a cost of Rs19.25 per lakh - a rise of over 800%!


This ham-handed taxation should surprise no one. Even in the securities market, Chidambaram had first provoked outrage by levying a hefty Securities Transaction Tax (STT) and then rolled it back significantly. This time, the three rival commodity bourses as well as their regulator, the FMC, are together in protesting against this levy. They are parked in the capital, making presentations to anybody who is willing to listen, on why and how the tax could end up destroying a still nascent market.


The big worry is that it will be very easy for the entire commodity trading to switch back to the illegal or dabba market. Remember, the 40-year ban on futures trading had not stopped the core commodities players from trading in commodity futures. There are well-oiled, illegal markets that were restricted to a closed group of commodity market insiders. Even today, despite large trading volumes, the commodity investor population is pathetically small with few corporate entities and the core group that keeps the trades ticking and provides market liquidity would just as easily go back to the old dabba markets. If that happens, India’s commodity market may register a significant decline instead of marching towards the Rs50 lakh crore turnover projected by the FMC. More seriously, our bourses could easily collapse and lose all the credibility and goodwill they have earned, especially in Dubai, Singapore, Mauritius and elsewhere, and the  large global private equity investors they have attracted.

That is not all. In December 2006, the Ministry of Textiles had killed a budding market in raw jute futures through an administrative order that prescribed the maximum price at which jute could be sold. This was done at the instance of jute mills that had contracted to supply gunny bags to the Food Corporation of India at a fixed price and were hurt by rising market prices. The trading collapsed, but the price prescription was withdrawn only after six months when market participants refused to supply jute at the maximum prescribed price. Most importantly, raw jute futures never regained their earlier liquidity after they were re-introduced.

The Finance Ministry’s badly conceived proposal has even extended the CTT to commodity options, which are still not traded in India! Talk of overzealous taxation!


No other country in the world imposes a CTT, but that is unlikely to cut ice with the Finance Ministry. Similar arguments were made about the STT, but they quickly died down when the tax incidence was lowered significantly. Will the same be done with the CTT? Some senior government officials think the FM will have to roll back at least the quantum of tax; others worry that he is too rigid and haughty to do that.


Name Change


Anil Dhirubhai Ambani group has a penchant for changing corporate names. After demerging with Reliance, the group changed its name several times, almost finalised on ADA Enterprises, before settling for ADAG (Anil Dhirubhai Ambani Group). Then it changed the company names. Reliance Infocomm became Reliance Communications and Reliance Webworld simply became Reliance Shop.


Reliance Energy Limited (REL), earlier BSES Limited, will soon be called Reliance Infrastructure, apparently to “capture the current nature of various business segments it is involved in.” This will create a nice confusion among punters with Reliance Industrial Infrastructure controlled by Mukesh Ambani. Since REL couldn’t stop its major power projects being given away to Reliance Power (RPL), it seems rather pointless to retain ‘energy’ in its name. Reliance Power has also changed its name five times. It was set up as Bawana Power Pvt Ltd, then became Reliance Delhi Power Pvt Ltd, went on to be called Reliance Egen Pvt Ltd, which in turn became Reliance Energy Generation Ltd, and finally Reliance Power Ltd. <p>

Many Indian companies have figured out, through long experience, that a new name is the fastest way to blur previous corporate history.  As things stand, both Reliance Power, and Reliance Energy have plenty that should be forgotten. Reliance Power after its high priced IPO (initial public offering) based on exaggerated valuation, is now trading at a large discount to the offer price. Reliance Energy too has not endeared itself to investors because it became the sacrificial lamb to promote RPL. It was made to forego bonus shares in RPL and had to settle for a part reimbursement by Anil Ambani. ADAG probably hopes to wipe out this memory through a quick name change. But before that happens, Reliance Power itself will have to clean up the post-IPO mess and resolve complaints from 2,261 subscribers who are waiting for refunds after the mega public offering that raised Rs60,000 crore after a 72-times over-subscription. The shares were issued at Rs450 and had sunk to Rs318 on 18th March.


Mixed Math


While on Reliance Power, let’s revisit the math on its strange 3:5 bonus issue. As we know, Reliance Energy Limited and Anil Ambani’s personal companies renounced the bonus to preserve the market-cap of RPL. Ambani then transferred 5.72 crore of his own shares (then worth Rs5,000 crore) to Reliance Energy to maintain its holding in RPL at 45%.  But REL shareholders are still big losers. REL should have received 60.9 crore shares under the proposed bonus, not just 5.72 crore to maintain its 45% stake. It is another matter that this would have increased the capital and significantly decreased the market-cap of RPL and further angered its shareholders.


Since REL shareholders (now Reliance Infrastructure) would still have been better off with their rightful bonus allotment, Anil Ambani hit on another strategy to placate them - he announced a share buy-back at Rs1,600. That too has run into rough weather. The buyback price itself is significantly below the January 2008 high of Rs2,600 and the stock plummeted 13% after the announcement. It was trading even lower at Rs1,228 on 18th March.


If this battering were not enough, there is another capital expansion in the offing if Anil Ambani converts the warrants allotted to him on a preferential basis with a conversion tag of Rs1,800 plus. At the time of going to press, it is not clear if the buyback is on course and whether the promoters will convert the warrants at the agreed price.

-Sucheta Dalal

-- Sucheta Dalal