India’s economic growth has been achieved on the back of sustained investment and improved capital allocation in the economy made possible by structural reforms. However, we are once again approaching a scenario where India may be heading into an investment famine, which would then translate into sub-par growth.
But India is being starved for investment just when several domestic institutions have significant investible capital but are barred from deploying this capital in the economy as equity investors. Recently, HDFC chairman Deepak Parekh said that thanks to lack of clarity on the policy front and poor governance, India’s blue chip corporations are all looking to invest abroad. Mr Parekh has also remarked that India is unable to come up with world-beating products because of the paucity of risk capital for investment in innovation.
The fact that the India story is simultaneously losing its sheen both at home and abroad compounds the need for worry - if foreign investors turn sour on the India story and India’s blue-chip companies start focusing on global expansion, how will India find domestic investment needed to sustain economic growth?
Capacity constraints and supply bottlenecks are contributing to rampant and persistent inflation, which is caused by profligate fiscal spending by the government that pushes up interest rates, exacerbating the vicious cycle of spending and inflation. The government is raising ever-increasing sums of money from the market, crowding out private borrowers. Expensive debt financing is making various industrial projects unviable, forcing some businesses to raise private equity.
India’s capital markets are well-regulated, but much more can be done to make them deeper and more liquid. Our religious institutions control at least tens of billions of dollars in assets. There are various legal hurdles that prevent them from transparently investing in risk assets. Their anachronistic and statist governance structures makes it difficult for them to actively manage their assets in ways that are in their own best interest and in the interest of the broader economy. Religious institutional wealth abroad, such as that controlled by the Church of England and the Vatican, is professionally managed according to clearly-defined and laid out policies and guidelines, finding its way into listed equities as well as private companies. Similarly, policy myopia prevents India’s leading educational institutions from tapping their alumni base for building independently-managed endowment funds. Nurturing such domestic institutional capital would create a wider asset base that is genuinely long-term and whose interests are closely tied in with sustaining India’s growth.
Expanding domestic institutional capital will also counter the clout of foreign institutional investors both in the private and public equity segments. India’s stock markets are notorious for their dependence on foreign fund flows, and markets move in sync with these flows. This exaggerates the impact of global economic events on the market, even though the Indian economy is not as dependent on the world economy as some other developing countries. The biggest domestic participant in the equity markets is the state-owned insurance giant Life Insurance Corp - bench strength is weak, and other financial institutions need to step up to bring about balance.
Currently, most of the major domestic financial institutions are at best nominal participants in private equity, with the bulk of the capital base coming out of pension funds and university endowments from abroad, as part of their fractional allocation of their multi-billion dollar assets to emerging markets. Why do investment managers sitting thousands of miles away feel comfortable investing some fraction of their assets in India-focused funds, but the custodians of India’s pension funds and educational and religious endowments find difficult the idea of investing in such asset classes in their own country?
The New Pension Scheme (NPS), for example, is in the danger of being converted from defined contributions to defined benefits because of calls to guarantee minimum returns, potentially beating the entire purpose of the NPS. Both the leading political parties are guilty of hypocrisy and opportunism with regards to this very important reform. The concept of minimum return is not necessarily incompatible with long-term risk investing. But for India to renege so soon on the NPS reform - and that too at a central level where politics can constantly increase the level of guaranteed returns - is ultimately harmful to precisely those low-income organized sector workers for whom ”safe” returns in the their provident funds barely keep up with inflation.
India needs to evolve policies that allow more efficient use of its domestic capital base. With the vast investments needed to sustain and accelerate growth and create opportunity for all, there has never been a better time to do it.