Forget foreign investors knocking at India's doors. It is time for policymakers to start worrying about foreign firms which are queuing up to exit the country's financial sector. In the last one year, instances of foreign firms selling out their stakes in their Indian ventures, particularly in financial services, have ballooned.
Fidelity's decision to sell its Indian mutual fund operations this March followed exits by many other foreign firms (AIG, Aegon, Temasek, Merrill Lynch) since 2008. Taking stock of mutual fund houses with foreign sponsors in India today, one would hardly find one or two who have stayed on from the nineties.
A similar exodus is on in the banking sector. In the past year alone, foreign investors — be they banks, private equity funds or portfolio investors — have reduced their equity stakes in over 25 listed Indian banks.
A decade into privatisation, the insurance sector today has over two dozen players. But foreign partners in these firms are getting restive too. Last month, New York Life sold its 26 per cent stake in Max New York Life to Mitsui Sumitomo.
Other firms such as Aegon and HSBC are rumoured to be scouting for buyers. It is convenient, of course, to dismiss all these instances as the spill-over of the 2008 credit crisis. And the turmoil has had a role to play in the current churn.
Stake sales by AIG, Merrill Lynch or Fortis in their Indian mutual fund arms, for instance, were prompted by the parent's decision to restructure their own operations.
Citigroup's recent decision to cash out from HDFC was intended to unlock capital for its parent, in preparation for Basel-III norms. Stake sales by foreign institutional investors in private banks could also be the result of a routine portfolio rejig.
But even leaving out such cases, there are still instances that suggest that foreign firms may be shedding their blind optimism about the India story.
The size problem
One key issue is with market size. When Fidelity decided to throw in the towel after a seven-year stint in India, it managed just Rs 8,800 crore in assets. This is an inconsequential sum by global standards. In fact, a single global fund of Fidelity's manages Rs 3 lakh crore!
In a recent visit to India to review the BRICs story, Goldman Sachs lamented that the total fee pool for investment bankers in India was $810 million in 2011. This compared to over $4.3 billion in China and $1.5 billion in Brazil.
Private equity and venture capital funds investing in India are chafing too. A large private equity firm told this paper that the problem with India was not about opportunity, but the ability of the market to absorb investments.
Global private equity firms raise $1 trillion in assets annually. Even deploying 5 per cent of these assets in India would entail a $50-billion bet, impossible in Indian equity markets. The minuscule pie creates problems for private investors who are already here too. 2007 was a record year for Indian PE deals with $17 billion sewn up.
These investors are now chafing as a moribund stock market has made exits difficult. These deals are set to complete five years in 2012, when investors typically get restive.
We need capital
The other key constraint, particularly for banks and insurance companies, is capital. With new businesses drying up, costs reduced by regulations and poor investor appetite, nearly half the Indian insurers are making losses.
Capital infusion, amounting to $7.5 billion in these ventures over a decade, has gone largely to fund accumulated losses. Now, the industry needs a fresh infusion of money to sustain operations. Primary markets in their current state offer no way out.
But with the government deferring a decision to raise the foreign direct investment cap from 26 to 49 per cent, foreign venture partners in insurance are beginning to have second thoughts.
Solutions
One can argue that some of these are temporary problems that could be set right by a revival in the capital markets worldwide. But India has not enjoyed great liquidity or market depth even in the best of times. If you expect big fish to come to Indian markets, you cannot expect them to make do with a paddle pool.
This suggests that policymakers need to take specific steps to address market depth and liquidity. These can only come from measures such as unlocking household savings from gold, re-directing a small portion of pension savings into equity and incentivising long-term holdings in stocks.
The problem with the mutual fund and insurance sectors is one of unviable scale. Both sectors rely heavily on a field force for retail penetration.
Piecemeal regulations in the last two years have put the agent force in disarray. Here, the regulators will need to collaborate to come up with a uniform regime that will incentivise distributors, without hurting consumer interest. sGiven that capital is going to be in short supply the world over, the government may in fact need to change its entire mindset on foreign investments in India's financial sector.
The question now is, not whether India will ‘allow' foreign capital to come in; it is about what we can do to attract that capital, when there is so much demand for it!
This fortnightly column will take a fresh look at issues in policymaking in financial markets and flag the ones that merit a rethink.