An economy characterised by a young population, falling dependency ratio, growing income, improving literacy and rising aspirations has the key ingredients to sustain high economic growth for decades. However, growth prospects can be substantially dampened if the economy fails to address supply-constraints.
While India's consumption quickly recovered post the global financial crisis, investment continues to disappoint, with growth in gross fixed capital formation declining sharply to 0.4 per cent year-on-year in the fourth quarter of 2010-11. During FY11, its share in Gross Domestic Product (GDP) fell to 34.8 per cent from 38.2 per cent.
Buoyant consumption in the absence of investments can lead to a vicious cycle of spiralling prices, resulting in rising interest rates which will disincentivise investments and further hike inflation to a level where erosion in purchasing power may mar consumption, and therefore economic growth.
While domestic investment has stalled, India Inc. has been on a shopping spree abroad, buying foreign assets like never before. They have done outbound Mergers and Acquisitions (M&As) worth $30 billion in 2010, the highest ever in a year.
OUTBOUND M&A UP
During 2006-2010, cumulative overseas acquisition amounted to around $90 billion. The attractive valuations of foreign assets due to the global crisis made such acquisitions lucrative. Although outbound M&As give the advantage of scale and provide access to new markets and technology, given that India is a supply-constrained economy, they deprive us of our own capital which could have been deployed to build capacities, create infrastructure and enhance our competitiveness.
Despite high capacity utilisation, buoyant demand, high savings and easier access to global capital, investments are still not picking up. Rising interest rates and commodity prices may be blamed for this.
However, since India Inc. is extremely underleveraged (Debt/Equity of Top 100 companies is around 0.5 times) and enjoys a high return on equity of 15 per cent, it makes financial sense to build capex even if it means increasing leverage, since debt funding is available at around 10-11 per cent.
Another important factor influencing capex is policy hurdles. Ease of starting, running and closing business elsewhere vis-à-vis India may also be driving Indian capital abroad. For instance, it takes 1,420 days in India to enforce a contract, against 150 days in Singapore, against 0.6 years in Japan.
INVESTMENT INCENTIVES
A full-fledged pick-up in capex seems unlikely unless structural issues are addressed and investment-friendly reforms see the light of day — land acquisition reforms, consistent policy regarding environment, mining reforms, continued boost to public-private partnership, further foreign direct investment (FDI) liberalisation and targeted incentive packages with subsidised interest rate and tax structures.
For example, in the late 1980s, the US state of Kentucky offered Toyota an incentive package worth (present value) $125-147 million, for setting up a plant which planned to employ 3,000 workers. All these can be instrumental in attracting long-term, growth-oriented FDI, boosting employment opportunities and promoting balanced regional growth.
Despite being a more diversified, self-reliant, transparent and fundamentally stronger economy, we lag behind China in FDI inflows. China received FDI to the tune of $105 billion in 2010, five times higher than India which actually saw over 20 per cent de-growth in such flows in 2010. In the past, China has offered preferential tax treatment for foreign joint ventures and recently allowed foreign investors to use the partnership structure. Initially, it promoted FDI in manufacturing and infrastructure.
Later, having become an economic superpower and a favoured FDI destination, it gradually shifted emphasis towards higher-value-added sectors and withdrew tax privileges for FDI (2007).
India had a successful experience with the Technology Upgradation Fund (TUF) for the textile industry, Special Economic Zones (SEZs) for manufacturing and tax exemption for IT Enabled Services (ITES). We need more such incentive packages in targeted areas commensurate with our demographic profile.
It is worth noting that over the past three decades, consumption growth has exceeded real GDP growth in only seven years, while growth in investment has more often than not exceeded real GDP growth. So, with other growth ingredients well in place, it is time to boost investments to ensure that India is able to sustain a high growth rate for decades to come and further strengthen its foothold in the global landscape.
(The author is Chief Investment Officer with Birla Sun Life Insurance.)