COMMENTARY
INTERVIEW
SPECIALS
CHAT
ARCHIVES

Guest Column/S H Khan

Domestic sources will have to fund most of India's growth

The Industrial Development Bank of India chairman and managing director,
S H Khan, gave the inaugural speech at a conference last week on 'Fingrowth: Financing India's Growth'. Excerpts from the talk:

India has chosen liberalisation and globalisation of its economy as a means to achieve growth. We are in the sixth year since these measures were initiated in June 1991. The key performance indicators of Indian economy over the last five years by and large exhibit the visible and distinct gains of deregulation and increased external openness.

Growth in real gross domestic product at factor cost, which had fallen to 0.8 per cent in 1991-92, regained its buoyancy soon after and the economy recorded an annual growth rate in the region of 7 per cent in each of the last three years. India's forex reserves, which were of the order of $5.8 billion in March 1991, have reached $26.4 billion by March 1997. At sectorally disaggregated levels, growth in the post-reform era till last year had been primarily led by industry -- particularly manufacturing -- and buoyancy in select service sectors. However, during 1996-97, while there was an impressive rebound in agricultural output from a slump in the immediately preceding year, there was a broad-based deceleration in industrial growth. Thus, while GDP growth at 6.8 per cent continued to exude strength, it was marginally lower than the impressive growth rates achieved in the preceding two years.

Based on available indications, economic prospects for 1997-98 are favourable and conducive to a growth rate of between 6-7 per cent. While the normal monsoons for the tenth successive year augurs well for agricultural production, achievement of the target growth rate would crucially depend on a sizeable contribution from the industrial sector. There are signs of recovery in the industrial output in recent months and hopefully the year may see growth rate of around 10 per cent.

But for sustaining the momentum of overall economic growth at the targeted 7 per cent level per annum over the Ninth Plan period would call for substantial investment in agriculture, industry, and infrastructure.

As I see it, this would call for a rise in investment rate of around 30 per cent of GDP over the next five years from the current levels of 25-27 per cent. The investment requirements for infrastructure sector alone would be considerable. Going by the estimates made by several agencies, these would be in the region of Rs 4,500 billion up to 2002. To this we must add the financing needs of industry and agriculture. For the purpose of my talk, I would be confining myself to issue connected with funding the needs of industry and infrastructure.

Domestic Financing Options

It is obvious that funds of the above magnitude cannot be met entirely from domestic sources but the fact remains that the bulk of these funds has to be sourced domestically. Domestic financing options would be a combination of debt and equity from both financial institutions and banks, besides the domestic capital market. Fundamentally, however, the mobilisation of savings of requisite magnitude will crucially determine the adequacy of otherwise of domestic fund-flow for meeting planned corporate investments.

Although gross domestic savings have grown from about 22 per cent of GDP in 1991-92 to 25.6 per cent in 1995-96, there is still considerable need and scope for improvement to levels obtaining in East Asian countries, which have consistently managed to save over 30 per cent of their GDP. Attractive tax breaks may have a role to play in energising a still larger complement of household and corporate savings. But the primary onus will be on better fiscal consolidation to significantly improve the government and public sector contribution to overall savings efforts.

Domestic Equity Market

As I mentioned earlier, financing of India's future growth would involve a substantial draft on domestic funds. In this regard, capital markets provide an important complementary source of corporate finance at cost-effective rates. Looking to its importance, the government and the Securities and Exchange Board of India have undertaken broad-based reforms towards developing a deep and vibrant domestic capital market. Resultantly, the domestic market for new issues assumed significant proportions in the initial years of reforms: total fund mobilisation via the market which was around Rs 30 billion only a few years back reached to over Rs 308 billion by 1994-95.

However, this market segment has been depressed for the last two financial years. The amount raised by public and private sector companies, including banks and other public financial institutions, through prospectus and rights issues have sharply declined. The apparent loss of investor faith in the primary market is continuing in the current fiscal year as well which has seen more than 90 per cent fall in fund mobilisation through public issue in the first four months.

It is a matter of concern that primary markets have not yet responded to the series of policy improvements that have been undertaken in the budget and in the slack season credit policy to revitalise the capital market. There is a session on the revival of Indian equity markets and, I am sure, the deliberations would dwell upon what is ailing this particular segment of the market and what still needs to be done to revive it. On the other hand, the secondary market has witnessed a certain measure of buoyancy since December 1996. But it is highly skewed in favour of Sensex scrips and the movements therein have been primarily FII-driven, contributing to its periodic volatility. In my view, there is an urgent need for more proactive efforts by domestic institutions to broad-base secondary market traders. This would impart the desired sustainability to growth in secondary volumes and, in the process, restore investor confidence in the primary segment, leading perhaps to improved support for new issues in the future.

Since there is an exclusive session on this subject, I look forward to more informed suggestions from the eminent speakers on the ways and means to rescue the equity markets from its present morass so that it can perform its designated role in the financial system.

Domestic (Long-term) Debt Market

As I have stated earlier, faster investment in infrastructure related areas will be a key objective behind industrial financing in the next few years. Infrastructure projects, in addition to their capital-intensive and long-gestative attributes, generally have sizeable leverage ratios. Thus, it would be axiomatic if I say that there is a crucial need to deepen and widen the domestic debt market or rather the long-term debt market to meaningful levels if the investment in infrastructure instituents are to be sustained at their targeted levels.

Apart from providing an assured fund-flow for capital-intensive projects, a vibrant debt market would have other beneficial spin-offs like developing smooth term structure of interest rates with more meaningful reference rates and benchmark yields, enabling policy-makers and market players to improve risk management, enhancing liquidity, and reducing intermediation costs. Besides, developed debt markets would facilitate the use of derivative products like futures and options and enable the Reserve Bank of India to undertake effective open market operations. Debt markets also have a crucial role in mobilizing savings and enhancing capital formation.

According to official estimates, the outstanding volume of government securities and corporate debt, including private placements, stood at around Rs 3,500 billion and Rs 1,100 billion respectively at end-March 1997. At this level, it is the third largest bond market in Asia. Nevertheless, the market continues to exhibit a number of inadequacies that need to be expeditiously addressed. To my mind, the most glaring aberration is that the bonds market continues to be overwhelmingly skewed in favour of government and public sector undertaking bonds to the virtual exclusion of corporate debt issuance and trades, particularly the latter.

However, it must be appreciated that the overall debt market has seen quantum improvements in the past few years, mainly from 1994, through serial policy and infrastructural improvements, albeit mostly in the government securities market. They have succeeded in energising a robust growth in liquidity and secondary market turnover and in imparting the desired transparency to the operating environment. Other demonstrable gains to the system have been tapering devolvements on RBI, competitive pricing of securities and development of a market-responsive yield curve. There is also a visible accent towards debt market research and treasury management, hallmarks of developed debt markets.

Continued