1. ‘Protecting society’: Can’t hedge against regulatory risk

‘Protecting society’: Can’t hedge against regulatory risk

There are archaic laws still being implemented and new ones are being imposed under the garb of ‘protecting society’.

By: | Published: May 20, 2017 5:43 AM
Market risk cannot be measured or defined beforehand, and can be in the form of price changes, competition, trade movements, etc. All businessmen are prepared for such a risk.(Reuters)

In any business, there are three kinds of risks—credit, market and operational. Credit risk pertains to any default on payment that is addressed through either buffering this cost in price or in collateral. Market risk cannot be measured or defined beforehand, and can be in the form of price changes, competition, trade movements, etc. All businessmen are prepared for such a risk. Operational risk can be along the value-chain, where there is a breakdown in supply-chains, theft, cyber fraud, insurgency, natural disasters, etc, where one can hedge through insurance. But one risk that has become critical in the last decade or so is the regulatory risk, where the authority in power can upset business plans.

The regulatory risk today is unique as every such action is in accordance with prevalent laws, but has the potential to strike at the edifice of business. At the individual level, the biggest shock has been demonetisation, where there was total chaos caused by an announcement made by the government. People were told that they could exchange or deposit currency till December 31, after which they could go to RBI until March 2017. But then a new law making it a crime to hold currency after January 1 put holders in a fix.

Another shock is the use of Aadhaar, where every benefit/activity has been mandatorily linked—the absence of Aadhaar precludes kids from the mid-day meal programmes as also, increasingly, individuals from holding a bank account. Therefore, individuals are not insulated from regulatory shocks. For an enterprise, it is even more pernicious as it impacts investment and employment considerations. India has improved its ‘ease of doing business’ showing, which actually is not difficult because the parameters tracked by the World Bank are based on rules in fixed locations that can be changed conveniently. For example, one can improve the score on electricity procurement by doing away with some unnecessary rules.

But running a business can be subject to several regulatory shocks, via legislative and judicial actions. These are always defended on grounds of implementation of existing laws, and the clinching argument that whatever is being done is not new. Further, legislative action derives strength from the rule of the legitimacy of the majority. Some of these risks can be enumerated here. First, the meat ban has affected many key business segments, and with a double-whammy—under the guise of ban, suspected meat traders are being subjected to violence. Curiously, the law is strict on the ones in the meat business, but is usually silent on the actions of the self-appointed conscience-keepers. Second, the liquor industry, dealing in a legitimate product, received a major blow with the highway ruling of the Supreme Court, and many liquor shops have had to down shutters.

Third, the hospitality industry has, in turn, been affected by the ban on liquor sales. The proposed move to regulate the quantum of food served in restaurants, which is justified by an emotive appeal of people starving in the country, can push the industry further back as customers would start making comparisons on value for money for various options. Fourth, the pharmaceuticals industry walks the tightrope of price-orders coming in at any point of time, and the recent control on coronary stents is a case where business plans have been seriously upset. This regulatory risk is within the country, and goes beyond the regulation in other countries on patents and other protective measures which companies are aware of and consider being an operational rather than a regulatory risk.

Fifth, the automotive industry has been through tough times with state governments having the discretionary power to pass laws like the ban on the sale of diesel vehicles above certain engine size. Now, as it has never been a crime to use diesel in vehicles, the sudden ban is a shock as companies have already made investments in such technology. Sixth, in the commodity futures market, the regulator, on advice from the government, has banned futures trading in several products where traders with open positions have to close out with accompanying losses. This has been a setback for traders, exchanges and the market as well, with bans based on emotive issues like price rise. In fact, even the arbitrary imposition of stock limits whenever there is a crop-failure could send traders into a tizzy as they have to offload stocks to avoid prosecution.

Seventh, in for the capital market, the government changed the rule of treatment of tax on debt instruments retrospectively a couple of years ago, and all the holders stood to lose. Not to leave aside the equity market, the Budget this time has decided to tax capital gains where Securities Transaction Tax (STT) has not been paid. Eighth, though the concept of the General Anti-Avoidance Rule (GAAR) cannot be contested, or the infamous Vodafone case, but retrospective action is a major cost for any operator in the country. Logically, if there is money being wrongly routed through Mauritius, then such participants need to be penalised. But, by bringing in such laws, potential investors could get nervous.

Ninth, wherever there are natural resources involved, businesses run the risk in the manner in which these are allotted. The coal, 3G, iron-ore controversies are examples where a player ends up in the middle of something it has no control over. Tenth, any industry can run into problems with environment rules being brought in at any time. With a plethora of activist groups waiting to pounce on these companies, projects get into litigation for years, thus upsetting plans. Eleventh, MNCs run the risk of being pilloried for wrongdoings, as was the case with ‘Cadbury worms’ or ‘toxins in Nestle’s Maggi noodles’. The government and enforcement authorities never target the millions of street vendors who sell unhygienic food, but move with alacrity when an MNC is involved.

These examples show that almost any business is open to immense regulatory risk that cannot be hedged beforehand. The reason is often that there are archaic laws which are being implemented or new ones are being imposed under the garb of ‘protecting society’. While we do harp a lot on the ‘doing Business’ and ‘Make in India’, there is little assurance provided to the businessman once operations start. Regulatory capture is quite easy in these conditions by any interest group, which can range from business rivals to the political elite. More importantly, legislative action is justified by virtue of being the majority view, as the party/coalition with more than 272 seats has the legitimacy to voice the choice of 1.3 billion people in a democratic set-up.

Industries like sugar (diabetes), tobacco (cancer), liquor (sin), edible oils (potential coronary problems), gifting (anti-Valentine’s day campaigns), luxury housing (when there are 500 million poor, why should anyone have big houses), garments (customs and tradition), etc, all run the risk of sudden activism, pushing one out of business. Maybe, it is here that the government needs to provide assurance or guarantees to business, as addressing issues on starting a business will not help if players have to operate under a cloud of uncertainty. Otherwise, doing business will be a risky venture in India, and akin to rolling the dice.

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