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.