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India's corporate economy -- Fallen between two stools

G. Ramachandran

V. Sankar

GROWTH is uniquely dependent on household savings. Long-term investments are aggregated from household savings that flow in trickles. Financial market components such as stock markets; investment institutions such as mutual funds and insurance companies; and depository institutions such as commercial banks play a pivotal role in fuelling growth by feeding voraciously on household savings and then investing them responsibly in corporate resourcefulness. The global financial sector makes mountains out of molehills.

The financial sector comprises banks, retail and institutional investors, debt and equity markets, and regulatory institutions. It enables investments of a large magnitude in the corporate sector by accumulating trickles and then channelling them into co rporate equity, bonds, debentures and loans. The breathtaking growth of the global manufacturing and services industry since 1968 can be attributed to their pivotal role.

Corporate output and incomes have grown in torrents wherever household savings have been garnered assiduously and managed responsibly. The success of the economies that belong to the Organisation for Economic Co-operation and Development (OECD) in achiev ing lasting mutuality between the real and the financial sectors has for long been envied by resource-rich but poor economies such as India. Such mutuality between the real and the financial sectors has been inclusive in scope and expansive in purpose. T he real sector and the non-financial components of the services sector have provided employment, incomes and savings. The financial sector has aggregated and managed savings. The mutuality has made household investments in corporate assets the core of th e OECD economies.

Molehills from mountains

Household savings in corporate assets do not constitute the core of the Indian economy. The financial sector has not risen in content and character to become the key determinant of economic growth. Rising corporate defaults have undermined banks' corpora te assets. Therefore, banks invested more in government securities in 2000-01 than in agriculture, industry, and trade and services by a factor of three. Rising investments by banks in government securities show that households save primarily to support government's consumption expenditure than to support diffuse growth of the national economy.

Financial economics offers at least one unassailable principle. High risk should be rewarded with high returns; low risk does not require high returns. There has been an adverse combination in India. Investments in corporate assets have produced meagre r eturns but have involved high risks. Therefore, the financial sector has failed to spread risk efficiently across households. It has trashed savings and expectations; it has imposed unwarranted costs on households. It is a pity that the financial sector has made inconsequential molehills out of mountains.

A large number of companies do not stir confidence among banks and lenders. Many do not stir confidence among equity investors. Only a few companies stir confidence among lenders and equity investors. Lenders and equity investors invested Rs 5,013 crore in corporate debt and equity issued in 1998-99. They invested Rs 3,606 crore in 2000-01. They invested Rs 4,312 crore in 1990-91; Rs 26,417 crore in 1994-95 and Rs 10,424 crore in 1996-97. Surely, these do not indicate growing confidence.

Has India exploited every possible investment opportunity? No, it has merely exploited as many investors as possible. There are too many important investment opportunities, but there are too few investors. Confidence has been drained comprehensively. The refore, most companies have to make do with their periodic surpluses or internal accruals for growth into the future. Our empirical analysis of corporate cash flows shows that these companies may not produce enough earnings to grow into the future.

A large part of India's corporate economy is not at the summit of any accomplishment. There are no pinnacles; there are many pinpricks. There is no safety in debt for retail investors and banks. There is little optimism that steady cash flows would resto re sanity in the corporate loans and debt market. Companies would love to raise more equity because it would be 'free' and companies could pursue good governance and performance at their own discretion. However, retail and institutional investors have li ttle appetite for charity. Many companies cannot access the debt market and the equity market. It is a pity they have fallen between two stools -- debt and equity.

Left-right balance

The breathtaking growth of the modern manufacturing and services industry in the advanced economies since 1968 can be attributed to the pivotal role of corporate equity, bonds, debentures and loans. Manufacturing and services have become engines for grow th in the OECD economies because of their efforts aimed at nurturing financial markets, intermediaries, regulatory institutions and innovative human resource in the financial sector.

The flow of household savings into manufacturing and services as capital has enabled the migration of their workforces from agriculture into corporate activities. The OECD economies employ a very large percentage of their workforce in manufacturing and s ervices and derive a very large part of gross domestic product (GDP) from them. Manufacturing and services account for over 95 per cent of GDP and have become the key determinants of per capita GDP and prosperity.

The success of the corporate sector in the OECD economies has pleased and inspired both the political left and the right. The acceptance of the suitability and the merits of the corporate sector was in doubt in many economies that have had a history of s tate ownership. The adverse disposition was driven by the horror stories that had emerged from firms that were owned solely by a few families and influential investors. Such firms and their owners were not regarded as friends of consumers and employees. Things have changed in favour of private capital.

Contemporary capital needs are too big to be met by a few families and influential investors. The financial sector has inspired confidence among households. They have invested in corporate assets directly and indirectly. Households own a very large part of the corporate sector in the OECD economies. Households have become the focal point of employment, effort at the workplace, incomes, savings and investment in corporate assets.

The financial sector has struck an excellent balance with ideas, notions and principles from every segment of the polity. It has gone beyond striking a balance 'between' opposing views. It has assimilated the best from every shade of the political spectr um. Everyone owns the corporate sector, but companies are run in compliance with the best practices advocated by die-hard private capitalists. Addicts of state-ownership are not frothing at the mouth. They have come to love the power of household savings and private capital. The employees, consumers, investors and capitalists of the new corporate economy are the women and the men in the shopping malls. They vote on both sides of the centre.

Restoring sanity

The women and the men on the streets and the small grocery shops in India are unlikely to be the employees, the investors and the capitalists of corporate India. If they had been investors, they are more likely to have incurred big losses. They are more likely to be modest consumers of corporate output. They are as far removed from the corporate sector and the capital market as the earth was from the moon three decades ago.

There has been an outrageous imbalance of interests in the Indian economy. A few companies practise corporate governance that complies with the policies of die-hard private capitalists. The political environment in which companies operate has rejected th e fact that employees are consumers and savers too. Though there are 16 consumers for every corporate employee in India, consumers are subordinate to producers. Because producers have to be protected, it has become increasingly difficult for banks and ot her institutions to reclaim their investments. Such difficulty has trashed household savings. It is impossible to evade feedback. Everyone reaps what is sown.

Household savings and the financial sector have been sapped comprehensively. But the irony is there for all to see. Indian households save a larger part of incomes than most other households in the world do. India's financial markets are better developed than that of other economies. The market employs some of the world's better-trained analysts, economists, investment managers, regulators and marketplace administrators, and information and communication technologists.

It would be a miracle if the outrageous imbalance can be sustained. The frittering away of savings and talent is not in India's interests. A summit aimed at restoring balance and sanity in the corporate sector is required. India Inc has to relearn capita lism. Die-hard addicts of state-ownership should be presented with evidence that shows how and how much households gain when their savings, private capital and prodigious talent are assiduously aggregated in India's interests.

India's companies cannot live on air. They need financial capital. Global investors are not too keen to invest here. Equity derivatives, depositories and electronic trading will not pull the corporate economy from between the two stools. Households can. They can make mountains out of molehills because they are the principal stakeholders in the economy. They will if India's legal, political and economic environment strikes a new balance that reckons with them as consumers, investors, employers and employ ees.

(G. Ramachandran is a financial analyst and V. Sankar is a stockbroker.)