India does not need FDI!
Our credit system has been choked, equity is expensive. We do not know how to use equity, debt and banking credit effectively. That is why we are reliant on FDI. But that can change.
Financial reporters, finance ministry officials, and state government officials often emphasise the amount of foreign direct investment (FDI) they attract. This relentless pursuit of foreign capital is both dangerous and unnecessary.
What is the purpose of FDI?
FDI was necessary for the following reasons:
Cheap capital and quantum of capital
First, the cost of capital in India has remained high. It reflects the prolonged period of high inflation in which we operated until approximately 2018.
Second, the balance sheet strength of Indian banks, private investors, and lenders was constrained. This limitation made it challenging to finance large projects through debt, given its lower cost of capital compared to equity. Consortium lending was used to finance big-ticket projects.
Third, India has not developed its debt markets very well. It was a pet project of my former super-boss, R Ravi Mohan. Regrettably, following his passing, no one has demonstrated the motivation to advance this. The absence of debt markets hindered smaller investors from supplying more affordable debt capital to corporations.
Fourth, the cost of accessing equity markets is impossibly high and a huge barrier to accessing high-risk capital.
The result of the stock market scams of 1991 and later was that the regulatory cost for accessing equity capital was very high.
Very few corporates could access it. Save for some Reliance companies (Reliance Petroleum Ltd, Reliance Power, RCOM etc.) and some notable others, not many had the muscle to enter the equity markets.
The Reliance ADAG group's mismanagement, Ketan Parekh, the NSE, and various other scams has further increased the cost of accessing equity markets.
Fifth, the seed investing, private equity, and venture capital sectors were not developed, primarily due to a lack of exit opportunities (an indirect consequence of the reasons above).
As a result, Indian corporates were hamstrung when it came to growth or expansion. Capital was not available in the size that made it impactful; it was definitely not available at a cost that was competitive.
FDI provided larger sums at quite competitive rates, bypassing the equity and debt markets. Hence, FDI was essential for the survival of many Indian companies.
Technology or Intellectual Property (IPR)
Developing technology requires high risk and patient capital.
R&D is one of the most high-risk AND highly resource-intensive activities.
As I explained above, with the kind of capital constraints we were operating in, it was impossible to develop high-quality IPRs that could give you bargaining power in international markets.
When we speak of globally competitive IPR, probably Bajaj’s DTSI engine comes to mind. Mahindra’s mHawke CRDE was also innovative but actually European, though Mahindra holds the IPR for it.
IPR builds upon itself.
Once you kickstart the R&D process, you will start accruing benefits gradually.
The research pays off over the longer term. This leads to two issues. Indian companies need to work on R&D for more than 10-20 years before they can develop the momentum for IPR breakthroughs. On the other hand, foreign companies can easily bring new IPR-protected products to the market, increasing the risk for Indian R&D investments.
The R&D risks can be reduced by having high levels of clarity, predictability and future visibility of about 10-15 years in trade and industrial policy. (Old hands are laughing their bums off…)
Imagine that even in the Pharma Industry, where India has significant technical knowledge and companies have big balance sheets, India was not able to deliver a breakthrough drug. It still can’t. The reason is not a lack of talent but that of capital. In an industry where the quantum of capital is a barrier to entry, your large balance sheet players will not pour money into R&D.
Rather, they will be busy milking the low-end, cost-arbitrage business. A similar (but not quite the same) story is that of our super-esteemed IT players.
Even today, most of the IPR created by Indians is for foreign companies.
This chicken-and-egg situation is why we need external technology. And with technology comes money to protect that technology from falling into Indian hands - FDI.
Employment
With corporations keenly focused on wage arbitrage and a lack of financial capacity with the government, there were not many ways to create employment.
The rapidly expanding young Indian population seemed like a potential market for foreign players. With the population in the developed world starting to decline, they were in search of volume growth. Older products and technologies could very well satisfy this population at great profit.
The China model also provided another template for foreign companies to invest in India. They intended to create factories to serve the developed country's market by exploiting wage arbitrage.
Thus, this area was an actual win-win for FDI in India.
FDI is not as beneficial as it is touted to be.
Whenever a foreign company invests in India:
It seeks returns from this company, and the returns are higher than the capital invested. These returns are repatriated to the parent company.
It creates and owns the technology or intellectual property and India does not get access to it.
It can bring in automation to negate the employment potential of the FDI investments.
A combination of these factors means that the foreign company is merely accessing the markets of India and, as such, extracting and exporting the value creation to its parent. I have explained various challenges with Multinational corporations, including regulation-shopping, in my 2010 book Subverting Capitalism and Democracy.
But, there is another factor in this argument.
We do not need FDI today.
Let’s delve into this a bit more.
Imagine if, after totally banning all trade, there is Trump 3.0, where all FDI is banned. In such a scenario, how will the US grow? It will do the very same things it has done since the 1900s. It will open the equity and debt markets to domestic investors and improve bank lending for industrial use. That will kick start US growth within its domestic economy.
Why can’t this work for India too? In fact, it can.
In short, our credit system has been choked, equity is expensive. We do not know how to use equity, debt and banking credit effectively. That is why we are reliant on FDI. But that can change.
The RBI has choked banking liquidity for quite some time under the name of inflation targeting. This is being eased up now.
Bank lending has become unnecessarily centralised.
This removes personal judgment from the lending decision, which is detrimental.
Effective lending relies on both the ability to repay and the intention to repay.
A centralised decision cannot assess the intention to repay.
In fact, when you remove that assessment, those who do not intend to pay have extremely alluring proposals.
The solution is to think of certain employees as loan-portfolio managers. Give them freedom and evaluate them just like you evaluate a portfolio manager. The loans should be tagged with and should follow the loan manager till they are repaid. (I have discussed this solution in certain other fora before).
Easier access to equity markets
In a bid to encourage unqualified investors to invest in equity markets we have made it absolutely impossible for young, dynamic and highly risky companies to access the equity markets.
We must understand business means risks, and equity capital is high-risk capital. It should allow the young dynamic companies to take risks while not letting the fraudsters get away.
Today, thanks to so many regulations, we have made equity markets as exit avenues for private equity. The PE/Venture Caps have also started financing unsustainable companies that can exit into the market with a bang before falling down as duds. This is fraud by other means and defeats the purpose.
It is time to simplify the entry requirements and ease compliance requirements for companies to access equity markets.
Corporate Bond markets
This is another area where debt Mutual Funds, Time Deposits from banks, retirement funds, etc. compete. So, it should be a no-brainer that the simplification of regulations should make it a low-hanging fruit. But it hasn't happened.
The main reason was the ineffective resolution of debt claims in case of disputes. Disputes tend to increase the costs and risks for bonds and debt.
The Insolvency and Bankruptcy Code has the skeletal framework to resolve it. But the courts are a hindrance both in terms of time and quality of resolution. Assets and capital get tied up and cannot be deployed for productive uses.
The way to resolve it is a bit tedious. But if you can free the capital while the claims are being resolved, then you will ease the burden on the economy.
In Sum
India can do without FDI. Yes, FDI is welcome if it is in our interest.
But it is absolutely vital that we unleash the capital we have. IT will allow our capital holders to earn a return and expand our wealth.