What deters investment in India today?

Sunanda Sen Zico Dasgupta
September 10, 2014 

Stagnation in the Indian industry cannot be explained only in terms of risk-aversion unless one looks at the pattern of corporate investments in the financial sector

An explanation for the slow growth rate of manufacturing in India, as recently offered by the Governor of the Reserve Bank of India (RBI), runs in terms of the ‘poor risk-appetite’ of the country’s industrial sector. This not only overlooks the cost of credit, considered very high even by the Ministry of Finance, but also aspects concerning the portfolio balance of firms in the corporate sector.

Looking at the balance sheets of Indian corporates, as per RBI estimates, one notices a decline in the share of industrial securities as a proportion of investments in non-financial public limited companies. The share dropped from around 40 per cent in 2002-03 to around 15 per cent or even less by 2011-12 and the following years. As opposed to this, the share of financial securities rose from less than 60 per cent to 70 per cent.

The RBI’s figures tally with those available in the Prowess database — which covers nearly 28,000 companies in India — and relate to the changing composition of the stock of assets held by the corporate sector.

Asset base of Indian corporates

The tendency of Indian corporates to invest a greater proportion of their investment in the financial sector makes it vital to look at the composition of financial assets. The share of equities as part of the total financial assets has fallen from 72.5 per cent in 2001 to 63 per cent in 2013, with respective shares of mutual funds (at 18.9 per cent) debt instruments (6.5 per cent) and other categories like approved securities and preference shares providing for the rest. Evidently, the ongoing pace of financialisation has played a role in enticing Indian corporates to seek the high-return short term financial assets.

However, despite these moves, corporate assets have been subject to a sharp decline. Asset growth rate, according to Prowess data, has dropped from a 3.1 per cent rate in 2011 to zero per cent in 2012 and further down to (-)6 per cent in 2013.

Prowess data shows that equities have failed to account for much of the resources over the past decade, and their share in outstanding liabilities has declined from 16.2 per cent in 2001 to 5.9 per cent in 2013.

While reserves (internal) have been a major source, providing 30 per cent of total corporate liabilities in 2013, the two have been inadequate to meet other outstanding liabilities like dividends and interest payments. Thus, stock of borrowings, ranging between 43.6 per cent in 2001 to 39.6 per cent of total liabilities in 2013, seems to have provided an easier option for corporates to meet up with their liabilities. Evidently, such moves were facilitated by liberalised norms for external borrowings, as can be viewed from the rising values of both external commercial borrowings and supplier credits. It is thus not a surprise that growth rates for bank credits to industry, as reported by the RBI, have steadily fallen from 24.4 per cent in 2009-10 to 14.9 per cent in 2012-13.

Industrial growth stagnation

The proclivity on the part of Indian corporates to move away from investments in physical terms to some financial assets largely explains the stagnation in industrial growth. With borrowings making up a large part of the liabilities, one can observe a pattern where corporates today are following a ‘ponzi scheme’ mode, with borrowings used to meet current liabilities both as interest payments on past loans and as dividends on sales of shares.

“The current strategy to get embroiled in the high-profit, high-risk world of finance may turn out to be a dangerous game for the economy”

Physical assets have hovered at around 35 per cent or less of total assets held by the corporates over the decade ending 2013 and it is not surprising that a major part of investments by the corporates is being directed to formation of financial assets rather than physical assets.

Relative profitability

What then deters investments in Indian industry? A tendency to prefer financial assets as compared to those backed by real investments relate to their relative profitability. A major factor behind this has been the wide-ranging ‘financialisation’ of the economy, providing easier options for speculation in various forms.

Financialisation, by facilitating operations that make real investments less remunerative, generates a climate of short-termism in the economy. This heralds the advent of a ‘new capital’ which by and large de-links and distances itself from the real economy and from investments in long-term physical projects.

As for corporates, ‘short-termism’ reflects itself in shareholder preference for quick profits, bypassing long-term growth. This ‘growth-profit trade-off’ in business decisions at the firm level generates a climate where a long-term ‘retain and invest’ strategy is replaced by a shareholder-oriented ‘downsize and distribute.’

In such a scenario, managers often align themselves to shareholder preferences, with offers of ‘market-oriented remuneration schemes,’ linking bonuses — or Employee Stock Ownership Plans — to the balance-sheet performance of firms where they are employed.

Stagnation in Indian industry today cannot be explained only in terms of risk-aversion unless one looks at its financial sector, where the rates of returns are far more attractive. The current strategy of corporate India to get embroiled in the high-profit, high-risk world of finance may eventually turn out to be a dangerous game for the economy as a whole.

(Sunanda Sen is a former professor, Jawaharlal Nehru University; Zico Dasgupta is a research student at the same institution.)

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