FROM THE TELEGRAPH OF 8 MARCH 2005
The capital
crunch
In an aside, P Chidambaram said in his
budget speech that when they met recently, the Chinese finance minister told
him that China had received $60 billion in foreign investment last year;
Chidambaram suggested the need for pragmatism. The comment was obviously meant
for his leftist allies, for whom the very talk of foreign investment is a red
rag. Chidambaram has often mentioned a figure for required investment in
telecommunications running into billions; against the left’s protests, the
government pushed up the foreign equity limit in telecommunications to 74 per
cent.
I am all for not
just pushing up foreign equity limits but for abolishing them. For I believe
that the supply of enterprise depends on the returns on it. In the short run,
an entrepreneur may count the returns in terms of the profits on his toils or
on his investment. Even in the long run, he may act like a stupid Indian
promoter and fall in love with his one enterprise. But enterprise is a game of
risk-taking, matching wits with competitors and coming ahead of them. Once an
entrepreneur has done this in one field, once he has beaten the others, once he
is in the home stretch, he will get bored and want to do something else.
Whether he can or not depends on whether he can sell off what he has built up,
and obtain the capital to start afresh. If foreigners are allowed to buy entire
firms, the market for firms will be many times greater than it is with only
Indians being able to buy tnem; and the larger the market for firms, the more
Indian entrepreneurs will venture and the more they will build.
For this it is
necessary that firms – foreign or Indian – should not be able to build up
monopolies and prevent entrepreneurs from entering industries; this is something
that the state may have to ensure. Monopolization is much easier if big firms
find it easier to raise finance. Our entire financial system is dominated by
government ownership, geared towards security and biased towards big firms.
This is a purely indigenous and largely official obstacle to enterprise; the
free entry of foreign firms would weaken it. For foreign firms would have their
own sources of finance abroad; their entry would bring in the competition of
their financiers with home-grown ones like State Bank of India and Small
Industries Development Bank of India. Thus while I see the need for vigilance
against monopolization, I am entirely in favour of unconditional foreign
investment.
But mine is not
the argument that Chidambaram uses for more liberal entry of foreign
investment. His and also Manmohan Singh’s argument is that we need foreign
savings. Our savings rate is 28% even in the exceptional last year; China’s is
40%. So if we want as high an investment ratio as China, we should import
foreign savings to the tune of 12% of GDP. Sitting in the seats of power, they
can see the power of this argument. Telecommunications operators are giving out
over 2 million connections a month; they are having to invest in the
concomitant transmission towers, switching facilities and billing equipment.
They go up to our powerful rulers and say, we will not fulfil your targets of
telephone connectivity unless you let us borrow abroad. And our business is
expanding so fast that we just cannot raise the equity capital for it at home;
we have to bring in more from our overseas partners.
Again I see
nothing wrong in doing so. But I do note that of our savings, something like
two-thirds are what the central statistical office calls household savings;
they are really savings of small businessmen. Our financial markets handle tiny
amounts by comparison with these savings; most of those savings never enter
financial markets, and are never invested in or lent to Bharti and Idea.
Instead, they
are invested in small, unincorporated businesses. And there is nothing wrong
with that. But they are so invested partly because the sources of finance for
such small businesses are few in India; small businessmen are forced to fall
back on their own savings and those of their relatives and friends. And because
they have no other sources of finance, they do not go and invest their savings
in financial instruments. That is why Bharti and Idea cannot raise the money
they need here, and are forced to go and raise it abroad. At one time, when the
Rupee continually depreciated, when high import duties made underinvoicing
profitable, and when the ban on gold imports made its smuggling lucrative,
raising money abroad might have had its special attraction. But today, thanks
to liberalization carried out in an era when the left did not matter, all those
rackets have collapsed, and there is no special attraction to foreign exchange.
Loans from abroad bear less interest; but then they carry exchange risk. So
businesses do not necessarily prefer them.
The reasons why
small savers do not make financial investments are complex; but the basic
answer is that financial intermediaries’ margins are huge. Banks in particular
raise money from depositors at an average cost of perhaps 6-7%. What they earn
on it is at least 5% more. In other words, they siphon off about 40% of their
earnings; and their depositors get a raw deal. The reason on the equity side is
slightly different. With debt-equity ratios of 2-3, and with high profits
available for reinvestment, Indian companies do not need much equity. So they
give poor returns on it. Promoters siphon off profits or reinvest them in the
companies and thereby raise the value of their own equity. So overall, the
returns on financial investment are so low, compared to what intermediaries or
producers earn on it, that anyone who has the brains and the inclination would
prefer to use the savings in his own business. This is why we have the largest
number of retail businesses in the world per consumer.
Why do financial
intermediaries give savers such a bad deal? The basic answer is that they are
protected against competition. Reserve Bank considers it absolutely immoral
that government banks should have to face any competition. Our WTO commitments
are forcing it to give foreign banks a slightly broader entry, but it is doing
its best to delay and minimize it.
Similarly, SEBI
does not allow any entrepreneur to issue shares to the public unless he has
made profits for three years, and unless he can find some Qualified Institutional
Investor to buy most of them. And who are those Qualified Institutional
Investors? They belong to the same tribe as those banks whom Reserve Bank
fattens.
Thus it is a
cozy oligarchy that controls our financial system. It gives savers a rough
deal; that is why savers do not give money to Bharti, but prefer to start their
own Bhartia Daily Tiffins. And that is why Bharti has to go and raise money
from the moneybags in New York. If competition were introduced into our
financial system, companies like Bharti would get much more money within the
country. Savers would get much higher returns on their financial investments,
and businesses would be prepared to raise more money from savers. As a result,
we would save much more – maybe more than the Chinese. And then we would not
need all that foreign money.
