This promises to be a very busy year for capital issuance. A senior investment banker recently told me that he has enough time to consider just one out of every two corporate proposals that come his way these days for raising money from the capital markets. He has no option but to turn his back on the other proposals because of a lack of time.
One commonly cited figure is that Indian companies are expected to soak up around $35 billion of capital this year to fund new capacity, takeovers and balance sheet repair, with a few privatizations thrown in for good measure.
India is in the early stages of a long economic boom and companies will need growth capital. Even after taking into account their strong internal free cash flows, Indian companies will have to keep raising money from shareholders to fund growth, new companies will go public and the government will sell shares in public sector units. “If you look at markets like China, Korea and Taiwan, in the last decade, the amount of new issuances as a percentage of market capitalization ranged between 3% and 5%. Given this number of $35 billion and $1.3 trillion of market capitalization, we are talking about something like 2.6-2.7% of market capitalization,” Kalpana Morparia, chief executive officer of the Indian operations of JPMorgan Chase and Co., told CNBC-TV18 in an April interview.
The supply of new paper is likely to be very strong in the coming years— around 3% of market capitalization, going by the estimates provided by Morparia. The obvious question is whether there will be enough demand for such issuance from investors, especially domestic investors in case the world sails into another round of financial turbulence. In addition to the usual issues such as the pricing of issues or how well they are distributed, there are certain broader macro challenges that will have to be met if Indian companies are to successfully raise capital from domestic investors.
The numbers are not encouraging. Household savings constitute around one-fourth of India’s $1.2 trillion economy, or around $300 billion. That number is equally split between investments in physical assets and financial assets. So the total amount of financial savings by Indian households is around $150 billion. Indian households have traditionally steered clear of investing in shares and equity mutual funds, preferring the safety of bank deposits and distortionary government schemes such as the public provident fund.
Data released by the Reserve Bank of India in its annual reports show that investments in shares and debentures as a percentage of total household financial savings fluctuate widely— from 2% in bad years to around 12% in good years. That means savings behaviour over the past two decades shows Indian households are unlikely to invest more than 12% of the $150 billion of annual financial savings in equity or equity-linked instruments. That means the best-case scenario is that $18 billion of the $35 billion that Indian companies hope to raise this year will come from Indian family savings. The rest has to come from either corporate savings or (more importantly) foreign investors.
This is not a pretty picture at all. India is one of the world’s great long-term growth stories, but local investors do not seem keen to participate in this growth. It is easy to fault the chronic risk aversion of Indian investors, but such finger-pointing has little practical value. Overpriced public issues, scams and mis-selling of various financial products since the advent of economic reforms have not done much to convince ordinary Indian savers that they would be better off buying equity rather than parking money in instruments such as bank deposits that often yield negative real rates of return.
One set of challenges is regulatory. Ordinary investors need to be convinced that the Indian capital market is indeed well regulated rather than being a stomping ground for con artistes. Another set of challenges concerns market infrastructure, the ease with which investors can buy and sell shares and mutual funds. There have been huge strides made in these two areas over the past decade.
My view is that the third challenge has not been adequately appreciated. Risk-averse Indian investors need to bridge from the safety of bank deposits to the volatility of equity returns. They may not be ready to leap from one to another. Nothing has quite replaced the units that the Unit Trust of India sold to middle-class investors till the institution went belly up at the end of the 1990s. I sometimes wonder whether this is why so many Indian middle-class families embraced unit-linked insurance plans, or Ulips, that for all their obvious flaws—I could never get myself to invest in them—blended the promise of higher returns with the safety of an insurance policy.
Indian policymakers will have to think hard on how to get more Indian families to participate in the Indian growth story.
Niranjan Rajadhyaksha is managing editor of Mint. Your comments are welcome at firstname.lastname@example.org