Scandals, uncertainty dent India investment case

Even by standards of emerging economies, the scale and frequency of India's recent scandals borders on the baroque: parliament is frozen and the government is threatening to revoke dozens of licenses for operators in the booming cellphone sector.

An outperformer all year thanks to a record influx of foreign funds, the Indian stock market lost momentum in November and saw outflows at the end of last week as another investigation unfolded -- this one over alleged bribes-for-loans that saw eight executives detained, including top officials from state banks.

While investors tend to shrug off corruption scandals as a risk of emerging markets, anything that adds to regulatory uncertainty threatens to taint India's attractiveness as a destination for foreign firms dazzled by its prospects.

"Normally, I would say it doesn't have an impact," Andrew Holland, chief executive for equities at Ambit Capital in Mumbai, said of the latest scandals.

"But if they did cancel the 2G licences, that could send a very poor signal to foreign companies looking to invest in India and its infrastructure," he said, soon after India's telecoms minister announced a crackdown on recipients of cellular licences at the centre of a government corruption probe.

Regulatory uncertainty often haunts investors in India -- whether or not corruption has been involved.

Direct investors -- companies building factories or power plants or buying local firms -- often have less flexibility and more to lose than fund investors and are especially sensitive to regulatory uncertainty.

Leading global companies such as Wal-Mart Stores (WMT. N), Vodafone and POSCO have been frustrated for years in their efforts to negotiate regulations in a promising but perilous market, and foreign direct investment has suffered.

India is investigating whether ineligible companies received coveted second-generation (2G) mobile licences and has threatened to revoke permits held by carriers including the local ventures of Abu Dhabi's Etisalat ETEL.AD and Norway's Telenor.

EMERGING MARKETS RISK

Corruption is nothing new in emerging markets, but the stakes in India have risen in recent years as the economy modernises and investment surges but the political system remains heavily reliant on patronage, and graft is rife.

India's economy grew nearly 9 percent in the September quarter but the country scores a 3.3 rating on Transparency International's Integrity Score list, where 10 is perceived to have lowest levels of corruption. China came in at 3.5.

The latest scandals follow close on the heels of New Delhi's hosting of the Common wealth Games, preparations for which were chaotic and beset by corruption, according to investigators.

Thus far, corruption outbreaks have done little to dent the enthusiasm of portfolio investors. Domestically-driven growth, corporate profitability and the breadth of India's market continue to command a premium.

"We don't think there is a problem across all sectors, but at present we are cautious and would wait for more information to initiate further action," said Sudhindra Ballal, fund manager in Singapore at Daiwa Capital Markets.

Ballal added that many investors appear to have ignored risks linked to investing in emerging markets, and recent developments act as a reminder to focus on risk.

Foreign funds have poured a record $28.7 billion into Indian stocks this year, but dumped $263.5 million of shares last Thursday and Friday as the bribes-for-loans scandal unfolded.

The BSE Sensex  remains the most expensive major stock index in Asia, trading at 18.23 times forward earnings, compared to 10.25 on China's main stock index.

"India will continue to trade at a premium to markets like China because the strong corporate earnings momentum is likely to continue," said Taina Erajuuri, portfolio manager at FIM India, which owns about $150 million worth of Indian shares in Helsinki.

Still, she said: "corporate governance is a big issue and if the cases like these happen more and more that will make investors very nervous."

FDI UNCERTAINTY

Foreign direct investment, on the other hand, has been sluggish, in part because of delays in regulatory approvals on environmental and other grounds. FDI totalled $13.5 billion in the first six months of the fiscal year through September, and is on track to lag the $37.2 billion of FDI in the previous year.

On Tuesday, shares in UK-based Cairn Energy skidded after India extended its deadline for ruling on whether to allow it to sell control of its Cairn India (CAIL.BO)  arm to Vedanta Resources (VED. L) for up to $9.6 billion.

POSCO's efforts to build a $12 billion steel plant have been stalled for years over environmental approvals. On Monday, India recommended withdrawing the South Korean firm's permits, further delaying what would be India's largest foreign direct investment.

Vodafone, India's biggest foreign direct investor to date, is fighting a 120 billion rupee ($2.6 billion) tax bill in a court battle and has complained about a telecoms regulatory structure that it said allowed too many players into the market.

"The bottom line is that the moving goal post, changing regulations, the whole issue of lack of certainty -- that's not good for any economic investment," Ron Somers, head of the U.S.-India Business Council, told Reuters Inside.