Abheek Barua: Too big to de-allocate?

The coal cancellation brings back unpleasant memories to investors of earlier 'retrospective' actions

I have had a flurry of calls (anguished monologues in most cases) and noticed copious Facebook posts from fund manager friends from abroad expressing their concern over the Supreme Court's cancellation of coal-block allocations. I suspect that much of what they are saying is merely repetition of what editorials and op-ed columns have already said. However, I thought it might be a good idea to give readers a flavour of how the world outside (albeit based on a remarkably small sample) views this.

One of the problems is that the verdict comes at the beginning of what is likely to be a prolonged phase of uncertainty for financial markets, the upgrade in India's ratings outlook by Standard & Poor's notwithstanding. Thus, the sell-off in the stock markets on Thursday, after Wednesday's verdict, merely built on the negative sentiment that things like the uncertainty over when the United States Federal Reserve will hike rates has triggered. There is also a growing sense that, despite the government's best efforts, the economy will take time to heal. This is driving a rotation of funds away from cyclical stocks to defensives, such as consumer staples, and these rotations are typically a period of consolidation for the headline market indices. Thus, the untrammelled upward momentum in the markets could have been broken. The markets await the decision on natural gas prices, and any hiccup there could provide negative reinforcement.

It might be useful to put together a list of complaints or concerns that centre around the verdict. To start with, the court's decision has brought back distinctly unpleasant memories of both the retrospective taxation (and the announcement of the General Anti-Avoidance Rules in the February 2012 Budget) and the cancellation of 2G licences. The problem, as with the 2G verdict, is the business of "retrospective action" - trying to change the past instead of trying to do better in the future. Some have noted the curious irony of the highest court in the land seeming to violate the very sanctity of the contract between the executive and the firm, a contract that they believe should have been carved in stone.

Minority shareholders of the miners feel particularly peeved, as they were not part of the negotiation between the management of the de-allocated miners and the government. No amount of due diligence, they claim, would have alerted them to these regulatory risks. There are two implications of this. There could be a general aversion to sectors where there is even the mildest whiff of regulatory or policy uncertainty. Second, the repercussions are unlikely to be confined to portfolio investments alone. An increase in political risk premium will get built into direct investments as well. For a country that finds itself close to the bottom of the pile when it comes to the ease of doing business, this is unlikely to augur well.

While "retrospective action" is a general point of concern, there are more nuanced issues as well. Fund managers are hardly legal experts, but one point they all seem to be united on is the fact that the judiciary should pass judgment on the impropriety or malfeasance of individuals, groups of individuals, or companies, and not on a process or a policy. One implication of indicting the policy as a whole is that it tars all players (in this case the mine licensees) with the same brush. Thus, a somewhat extreme way to view this judgment is that it depicts all companies that wanted to mine coal as part of a cabal that worked with corrupt bureaucrats to perpetrate one of the biggest land grabs in India's history. This is patently unfair to bona fide miners who thought they were entering a legitimate business. Not only do they lose their licences, they need to pay the government for their efforts.

While accepting that the system was rotten and had pushed the limits of forbearance, some contributors to the "debate" claim that judgments that have major implications for the economy should invoke a principle similar to the "too big to fail" argument applied to troubled financial institutions. Clearly, there are ethical issues in bailing out large banks when they face the possibility of comeuppance for irresponsible risk-taking accompanied by the moral hazard of encouraging similar behaviour in the future by appearing to condone their action. Yet they are bailed out keeping in mind the system-wide repercussions. In the coal-mine case, a compromise that draws on this principle would have been to exempt the 46 operational coal blocks and the six that are likely to come on stream. There should be very little doubt that the judgment will indeed cause significant disruption in the economy. I find stakeholders in the coal economy, such as the banks (who could see a bulge in non-performing loans), putting on too brave a face on the consequences of this at least in the public domain. Instead, we could have done with a clearer picture of what the damage will be.

This action comes at a time when little regulatory niggles abound. The Uber case (that involves a taxi company and the Reserve Bank of India), however insignificant in the larger scheme of things, seems to have attracted a fair bit of attention as an example of regulation that is both anti-competitive and chooses to go strictly by the book rather than consider consumer interest. There is a face-off between the department of telecom and telcos on intra-circle roaming, a facility that was built explicitly into the licensing agreement. The debate on whether a "strictly by the book" approach to laws and regulations or whether more "sensitive" and flexible interpretation is needed for our state and economy needs to be resolved urgently.

The writer is with ICRIER. These views are his own