The Telegraph
Since 1st March, 1999
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- Improved private investment in India is still not encouraging enough of development

At the World Bank annual development economics conference in Bangalore in May 2003 on “Accelerating Development”, the private sector and its role in development was discussed.

Innovation is through new product development. Financing innovation requires venture capital financing, which is different from usual investment financing. Venture capital finances new and untried ideas, expects higher returns, helps early commercialization of ideas through strict screening and careful monitoring of projects. Open economies add to innovation. Investment finance depends on the investment climate and the business environment. World Bank surveys show that investors favour pro-employer climates, with other research showing that poverty declines in pro-growth environments.

India has seen declining rates of investment over the last eight years. The fall has been in public investment, and more in agriculture. Subsidies on infrastructure services to the poor will continue and therefore keep infrastructure predominantly in the public sector. Public-private partnerships, commercial viability and payment security are necessary to promote investment in infrastructure.

Sri Lanka, like India, liberalized on broad macro issues. Micro and institutional issues like government red tape, corruption, bureaucratic resistance to deregulation, rigid labour laws, ill-defined property rights, the limited scope for land market transactions, the structurally weak fiscal situation and reduced public investment got little attention. Low tax and non-tax revenues in the gross domestic product hold back public investment.

A World Bank survey compares the investment climate in south Asia and China. The comparisons are in infrastructure, bureaucratic harassment/corruption and financial services. The quality and responsiveness of the administration, governance and leadership also affect the investment climate. India rated poor on power and better on financial markets and not very different on corruption and red tape.

Customs take excessive time to clear goods in Pakistan, like India and Bangladesh. China takes the least time. India has additional high costs due to inability of ports to handle very large sized vessels, low levels of containerization and powerful dockworkers’ unions preventing productivity improvements. India’s investment climate is also vitiated by the variations in sales and entry tax rates between states and municipalities and the time lost by trucks waiting for clearance at state and municipal boundaries. The survey shows that operating in states with poorer investment climates adds significantly to costs.

The business environment in India in financial markets is a little more advanced than in China. India has greater reliance on equity markets. China depends mostly on retained earnings and much less even on bank loans. However, the survey neglects to note that even in India the equity cult has been declining. Indian industrial growth is hampered by the lack of adequate primary equity. This adversely affects the overall levels of investment.

Much foreign direct investment seems to have financed buyouts of existing businesses or buybacks of shares in their own companies, not added new capacity. Indians who sold to the multinational corporations may not have invested back. If fresh equity is a bottleneck to investment in India, how will Chinese businesses in the future finance growth' Can their operating margins be so high that retained earnings are adequate for continuing high investment'

The loss of confidence of Indian investors in primary equity markets began when liberalization allowed companies to determine prices of their equity issues. Many instances of rigging share prices, attracting new investors hoping for windfall gains, and the collapse of share values after the new issues were subscribed, left investors with large losses. Only moderating the greed of company promoters will make them price capital issues at levels that could leave a possibility of profit for the investor.

The argument that low levels of discretionary savings with the Indian masses would limit growth of equity markets is weak. The declining interest rates in recent years make equity the best option for better returns on savings. But investors still prefer the relative safety of government securities, bank and post office savings deposits. If equities were safer, more investment funds would go to equity. Properly leveraged, this could provide funds for building new production capacities.

Corporate governance, its transparency and full corporate disclosure are vital to improving investor confidence. The new laws for ensuring better corporate governance will not change matters unless there is a change in promoter mindsets, the quality of market regulation, the speed with which regulators detect wrongdoings and punish offenders and the severity of the punishment. Punishment must be commensurate with white-collar crimes like rigging share values, inadequate disclosure, giving unfair advantage to insiders over investors outside the company. Competition could moderate greed, as in telecommunications. Ways to stimulate competition in every sector must be encouraged.

Independent regulators must not blindly enforce implementation of contracts, nor merely settle disputes. When contracts are entered into by unfair means, with poor disclosure, with government negotiators who are incompetent or worse, such contracts cannot be treated as sacred. Electricity regulators have trashed the Enron investment in Dabhol and other power purchase agreements because of high costs. Regulators must set out clear rules for markets and enforce them. Lack of strict enforcement makes the functioning of regulators non-transparent. The Indian system (and others at our stage of development) is slow to identify and prosecute violations and weak in punishing them.

There is a multitude in the institutional mechanism of financial markets: chartered accountants, credit rating agencies, merchant bankers, brokers, management consultants, and investment advisors on the media. They are either self-regulated, a euphemism for weak regulation in most cases, or unregulated, poorly disciplined and never punished for their wrong actions that lose capital for many investors.

Private funding of infrastructure may progress for services like railways, maritime transport, civil aviation and telecom that can fix user charges to cover costs and leave a reasonable margin after efficiency gains. But even they have political interference in rebalancing ruling tariffs. With power and water, for which the poor and vulnerable groups like farmers are consumers, the difficulties in achieving user charges related to costs of service are greater. So long as this imbalance remains these sectors will not become commercially viable. That will tarnish the overall investment climate and hold back private investment generally and in these services.

Private investment in roads would be difficult if it relied only on charging tolls and collecting them even from those who have no alternative to those roads. Exploitation of the rights of way along the roads might help cover costs and returns to investors. The fuel surcharge now used as means for public funding of the “Golden Quadrilateral” could also leverage private funds.

But the real problems in improving infrastructure are with power and water. The new electricity bill, 2003, might help large industrial users but will further impoverish state governments and their distribution companies. The ineffective old style regulation by government in water and the patchy record of new style independent regulation in power must quickly improve. In both there are huge leakages because of theft, inefficiencies, poor metering (where it exists), inefficient billing and collection, poor availability and quality, and lack of equity in supply between socio economic consumer groups. Subsidies are without caps, do not reach those for whom they are meant, thefts are rampant and management is highly unprofessional in both sectors. There is also the lack of payment security to suppliers.

The legal framework must enable lenders to take risks. The Asset Restructuring Act enables banks and financial institutions to seize defaulters’ assets and sell them. But the insolvency laws also need drastic change to give more powers to creditors and less preference to debtors.

The climate for private investment in India today is better than even two years ago. But it is not good enough for accelerating development. Both old-style and new style (independent) regulation of financial markets and of infrastructure services are weak and must be strengthened.

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