Tuesday, September 11, 2012

IPOs - Issues & Alternatives

In a recent blog Prof. J R Varma, quoting a research paper by Adam Pritchard, argues that it is high time we abolish IPOs!  Weird, as it may look, but when one reads Prof. Varma's blog (http://jrvarma.wordpress.com/) as well as the paper by Pritchard (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2103246), one is forced to believe their argument.  Pritchard explains that an IPO does not add value to any stakeholder including the issuer and the investor; and those who make money from IPOs are the people who manage the issue.  These people/agencies are paid a specific percentage of the issue size, which is known as 'floatation costs'.  Pritchard suggests a two-tier market system, where the companies would be first allowed to trade in a market where the participants would be Qualified Institutional Buyers.  Once a company matures in the Tier I market, it would be allowed to move to Tier II, which would be open to retail investors.

Way back in 1997, I was involved in a project to analyse the post-issue performance of the IPOs that flooded Indian markets during 1993-94.  (Incidentally, Indian markets witnessed maximum number of IPOs during this period).  We found that majority of the issues were trading below the issue price and many companies had vanished into thin air.  Compared to 1994, today, Indian markets have matured a lot in terms of regulation, disclosures and compliance.  However, the IPO market continues to be a gambling zone.  On one side we have issues like Vaswani Industries (October 2011-Issue Price Rs.49 & Current Price Rs.4.76) and Indo Thai Securities (July 2011-Issue Price Rs.74 & Current Price Rs.9.75); and on the other side, we also have Onelife Capital (October 2011- Issue Price Rs.110 & Current Price Rs.648.10).  The story is not different in developed countries either.  Take for example the much-hyped IPO of Facebook.  The shares issued at $38 in May this year are currently trading at $18.80 in Nasdaq and the firm is embroiled with more than 40 lawsuits.  If a firm trades at huge discount or at huge premium on listing, it reflects the inefficiency of the primary market.

In the wake of the above, I pray that the Government appoints a committee headed by Prof. J R Varma (who has already been a member as well as Chairman of several committees) to restructure the IPO market; the committee comes up with revolutionary suggestions; and above all, the Government accepts and implements these suggestions.  Are the bosses at the Finance Ministry and SEBI listening....?





Monday, September 3, 2012

Interest Rate, Inflation and the Growth Conundrum..!

The Economic Times of 30th August carried three interesting and related reports.  First one was about a speech that the RBI Governor, Dr. Subba Rao, delivered at Cornell University, where he stated that RBI was not planning to reduce policy rates owing to high levels of inflation.  He said that unless inflation reaches an acceptable level of 5% or below, there is no scope for a rate cut.  The second story dealt with the opinion of Mr. K V Kamath, the chairman of the second largest bank of the country.  He argued in favour of a rate cut by RBI by 1% points to spur economic growth.  He said that keeping rates high may not be doing anything to contain inflation.  However, whether a reduction in rate would propel growth, is something that even Kamath says is worth experimenting!  The third one was a column by Prof. T T Ram Mohan of IIMA, where he says that RBI can not be blamed for the economic slowdown.  Based on the recent statistics, he argues that increase in interest rates and global slowdown can explain only a portion of the economic downturn.  He says, it is not the interest rate than can boost growth, but positive policy measures and public investment in sectors like infrastructure.  It was a pleasure reading these three pieces together, as each one represented a specific angle - a regulator, a banker cum businessman and an academician.

Let me quote few lines from the latest RBI Annual Report: '...even at the current level of the policy rate, the real effective lending rates of the banks are relatively lower in comparison with their pre-crisis levels.  This highlights the fact that policy rate alone cannot explain the sharp growth slowdown.....'.

In a global scenario marred by recession, the only hope for growth is from domestic demand.  If the interest rates are reduced, two simultaneous forces should work in the economy in order to propel growth.  First, with reduced interest rates, people should reduce savings and increase consumption.  Second, in order to meet the increased consumption needs, the business sector should increase their output by borrowing money from the market at lower interest rates and investing it in productive activities.  Here is the catch: what is the guarantee that reduced interest rates would enhance demand?  Another trend that is revealed by the RBI data is that household savings have started drifting more towards physical assets like gold and real estate, which people consider as safe bet during times of high inflation.  But these investments are unproductive in nature and do not help in capital formation.  If this is the case (even with high interest rates), one wonders whether a marginal reduction in rates by RBI would have any impact on growth at all.  In a way, we are continuing with the age-old debate in economics between Keynesians and Monetarists.  Let the debate continue.