Political Connections Hold Diminishing Sway for India Inc

Being politically connected isn't what it used to be for corporate India.

When G. Janardhana Reddy, a prominent politician and mining baron, was arrested at dawn this week, with the police seizing $1 million in cash and 66 pounds of gold bars, it was another sign of just how perilous the mix of politics and business has become.

In the eyes of a growing number of investors, being connected is a liability, as the ongoing fallout from a spree of corruption cases makes it harder for companies that benefit from knowing the right people in New Delhi or state capitals.

The scandals, including an investigation into the award of telecom licenses that may have cost the government up to $39 billion, have seen the jailing of executives and politicians once viewed as untouchable in Asia's third-largest economy.

If the competitive advantage of a business largely rests on political access, then it's a red flag, said Saurabh Mukherjea, head of equities at Ambit Capital, a brokerage that has researched the link between the stock market performance of firms and the strength of their political connections.

We're doing this because investors are trying to actively de-risk their portfolios from political risk.

While lobbying is perfectly legal, many stocks in sectors where political connectivity is most pronounced are among the worst performers in the past year, partly due to policy paralysis after scandals have stalled project approvals.

Ambit Capital found that of 360 firms, 25 have strong connectivity and 50 have medium connectivity.

It did not name any of the firms but said in a June report that strongly connected companies substantially outperformed the market during India's last bull run, which ended in 2008, but underperformed the market by 14 percent in the past year.

Stocks with strong or medium connectivity came mostly from the capital goods, infrastructure and construction sector, as well as real estate, technology, and power.

Companies that do not rely on connections, meanwhile, are being rewarded by investors and are less prone to the sorts of nasty surprises that have battered the stocks of numerous firms and industries caught up in the whirlwind of scandals.

We try and avoid companies where we think there's excessive government regulation, interference, or where promoters may have in the past or even today have strong links to the political process, said David Cornell, Mumbai-based director at fund manager India Advisory Partners.

The past year's scandals range from the organising of the Commonwealth Games to the award of 2G mobile licences to a crackdown on illegal mining in Karnataka, which resulted in Monday's arrest of tycoon Reddy.

Shares in firms whose operations have been crimped by mining bans in parts of Karnataka have taken hits, including JSW Steel, in which Japan's JFE Holdings has a stake, and Sesa Goa, a unit of Vedanta Resources.

A popular backlash against corruption came to a head last month, when Anna Hazare, a 74-year-old Gandhian activist, used a 13-day hunger strike to force the government to adopt a tough anti-graft Lokpal law and touched a nerve among millions of Indians.

Getting companies and officials to change their behaviour, however, is expected to take time in a country that ranks 87th on Transparency International's corruption perception index.

I think this thing is not yet over. Once the (anti-graft) bill is passed and it comes into effect then things will change. But I think the society as a whole and the people are more aware of corruption, said Rupen Patel, managing director of road-builder Patel Engineering.

BUSINESS MEETS POLITICS

Corporate and political India have long benefited from each other, combining in a symbiotic relationship to manage a business climate plagued by cumbersome bureaucracy, with deep-rooted patronage systems.

In India, the intersection of commerce and politics often takes place in the open.

For example, several prominent businessmen are lawmakers, including Jindal Steel and Power Managing Director Naveen Jindal, and Vijay Mallya, who controls Kingfisher Airlines and United Spirits.

It is not uncommon for a lawmaker to have a business card with his parliamentary details on one side and his business details on the other.

Lobbying is a standard global practice for companies, industries and others to make themselves heard above the din of competing demands on government.

If you have a choice of having access to the political patriarchs and choice of not having access to them, you'd rather have access to them, said Ankit Miglani, deputy managing director at Uttam Galva Steels in Mumbai.

That doesn't mean that everyone who has access to the upper echelons of politics is doing something wrong, he said.

RED TAPE

The more red tape that needs to be cleared in a given industry, the more connections can come into play, especially in an emerging market.

At one point in time ... investors assumed that companies who had these advantages were in a better position to participate in some sectors where you see a lot of government influence or government role, said Sanjeev Prasad, executive director and co-head of institutional equities at Kotak Securities.

Prasad, whose firm publishes an annual report on corporate governance in India, said such investor sentiment was especially pronounced during the bull market years of 2005-2007.

Investors were willing to bet on these companies assuming that these sources of advantage would continue forever, but clearly that has changed a lot, he said.

Now, people are questioning whether these companies have any other competitive advantage, apart from political affiliation, Prasad said.

Taina Erajuuri, a Helsinki-based portfolio manager at FIM India, whose clients at Scandinavian pension funds demand high standards of governance, said stocks she avoids include those controlled by Mumbai billionaire Anil Ambani, a former member of parliament who makes a weekly visit to the Indian capital.

I just don't feel very comfortable with the information I get from there, she said by phone from Helsinki.

Ambani resigned from parliament in 2006, as did Congress party leader Sonia Gandhi, in a controversy over lawmakers holding profit-making positions, citing the need to uphold propriety in public life. Gandhi has since returned to parliament.

Three executives of his Reliance ADA Group are among several people, including the former telecoms minister, jailed in the ongoing probe of 2G cellular licences.

Erajuuri, whose firm manages about 1 billion euros ($1.4 billion) in emerging markets, said her India holdings include outsourcers Infosys and Tata Consultancy Services, HDFC Bank, utility vehicle maker Mahindra & Mahindra, and cellular firm Bharti Airtel.

She also holds a stake in Reliance Industries, the huge conglomerate controlled by Anil's brother, Mukesh Ambani, India's richest person.

SLOW CHANGE

While some investors are voting with their money, changing corporate and political behaviour in India is likely to be a slow and messy process, as recent months have shown, with shares in numerous companies battered by crackdowns on alleged wrongdoing.

We'll probably have to go through some pain in the short term when more revelations happen, said Ho Yin Pong, a fund manager at RCM in Hong Kong.

Scandals and the resulting policy paralysis, with the ruling Congress party government on the back foot and delays in project awards, have deterred investors.

I think the old way of doing business is changing, and that's a positive, but it's not going to happen overnight, said IAP's Cornell.

If you are a politician now, you are going to think very carefully about how you are perceived and how you behave ... That's got to be positive for the long-term performance of the market, or the development of the economy, he said.

The shares are down 20 percent in 2011, underperforming the nearly 12 percent drop in the MSCI Asia Pacific ex-Japan index. Foreign institutions have pulled a net $148 million from Indian stocks this year.

Things have gradually started changing and the feeling is sinking in in the corporate world that it cannot continue the same way, the way it has been in the past, said Arvind Parakh, director at New Delhi-based JSL Stainless, India's largest stainless steel maker.