India's Supreme Court deals blow to corruption - and foreign investors

India’s Supreme Court has ordered the government to cancel telecommunications licenses awarded in 2008 that are at the center of one of the country’s largest corruption scandals.

India's Supreme Court today issued a landmark decision against government corruption. The move will ultimately raise international confidence in India, but in the short term investors may stay away while the country cleans house.

The court revoked a set of telecom licenses granted in 2008 through a rigged government bid. The “2G scam” – which became India’s largest public corruption scandal – robbed government coffers of about $40 billion. Today’s ruling will strip companies of the underpriced licenses and allow the government to resell them at more competitive rates.

This sudden upheaval in the cellphone market is the sort of volatility caused by a corruption crackdown that has made investors nervous during the past year.

Foreign investors fled India last year for a number of reasons, including uncertainty about what business-as-usual corruption might suddenly be uncovered and punished. In the short-term, the decision spells out more economic woes for the world's fourth-largest economy – which was, until recently, a beacon of hope during the darkest hours of the global recession.

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“This will have a hugely negative impact on future foreign investment because it sends a signal that a license issued by the government of India has no meaning and could be considered null and void because of a judgment two or three years down the line,” said Rishi Sahai, director of the consulting firm Cogence Advicor, according to a roundup of reactions by The New York Times.

As of press time, share prices in one of the license losers, Norway’s Telenor, have fallen nearly 5 percent today.

Foreign institutional investors (FIIs) placed only $8.4 billion in India in 2011, roughly a fifth of the $39.5 billion they invested the previous year. The investor pullout began at the start of 2011 and the trend was flagged early by Espirito Santo Investment Bank. 

“In all our interactions with FIIs the tone has changed and corruption and ensuing political risk has without question become a major concern,” reads a January 2011 assessment from Espirito Santo.

The bank noted at the time that the number of articles in print media about India’s corruption soared in the final quarter of 2010, according to a Factiva analysis. Espirito Santo's India chief, Nick Paulson-Ellis, told the Monitor at the time that if the media pressure on the government were to trigger a crackdown on corruption, investors in some sectors might be at risk.

For investors in companies like Telenor, Abu Dhabi’s Eisalat, and Russia’s Sistema, that day has arrived.

Telenor reacted angrily.

"We have been unfairly treated as we simply followed the government process we were asked to," read a statement from Telenor’s joint venture in India called Uninor. "We are shocked to see that Uninor is being penalised for faults the court has found in the government process.”

While the court decision confirms that the anticorruption fervor will result in some regulatory changes, it is still unclear how thorough the cleanup will be and how long it will take.

The government has managed to drag out the process, rather than make reforms quickly to stabilize the situation and reassure investors. Weeks of mass street protests this past summer forced the government to consider a tougher version of an anti-corruption bill in parliament, but the bill remains a matter of contention.

Today’s court ruling also adds uncertainty surrounding a key figure in Prime Minister Manmohan Singh’s government. The judges ordered a court to rule on whether Home Minister P. Chidambaram should be investigated for any role in the 2G scam.

Two ministers have already resigned over the scandal, one of whom sits in jail awaiting trial. There is concern that if Mr. Chidambaram falls too that Mr. Singh would be severely weakened.

The court’s decision sends a signal that such flagrant corruption in government will not be tolerated, which, in the long term, will help firms trying to do business in India cleanly. Most investors welcome such reforms even if they would want to sit out the time period when they are made, Mr. Paulson-Ellis told the Monitor last year.

"This is one step closer to transparency in policymaking," Kamlesh Bhatia, research director at Gartner in Mumbai told Reuters.