For The Indian Capital Market To Lead The Country's Growth?
By Rakesh Jhunjhunwala
The role of markets in the development of economies and societies is significantly under-appreciated and misunderstood. The general impression is that markets are only for the rich, and hit the vulnerable sections of the society adversely. In my opinion, to the contrary, markets are an essential institution for development and the longevity of that development. This has been vindicated across generations and across geographies-the countries with the highest GDPs and highest per capita GDPs have well-developed markets and well-developed regulations. Even resource-rich countries without developed markets have ended up with poor economic fundamentals in the long run as witnessed in West Asia until recently. This is now well recognised the world over, and, hence, barriers to trade, capital and skills are coming down in this new era of globalisation, which has resulted in higher productivity, higher consumption, higher prosperity, lower poverty; and has controlled inflation in a benign range-much to the relief of the poor sections of society.
Markets bring about structural changes in the economy. One of the reasons that Communism did not sustain was the absence of free market mechanism to achieve efficient allocation of capital. Markets empower creative destruction, whereby the inefficient units are destroyed by the advent of more efficient and innovative units. Markets enhance competitiveness in an economy by reducing barriers to entry and by allowing better price discovery. Markets make sharing of risks, pricing of risks and transfer of risks possible. Markets empower entrepreneurship by providing capital and risk taking ability.
The oft discussed and debated economic liberalisation programme in India to me means:
- Customer is King; Achieved by competition and adequate supply
- Efficient allocation of capital; The primary function of the capital markets
- Government to exit the business of running businesses; The elusive phenomenon of privatisation.
To my mind, the crux and heart of the liberalisation programme is the development and the supreme role of markets achieved either by having formal markets, or the supremacy of the market mechanism. As a corollary, the term markets should include not only the organised markets, but encompass a wider perspective of markets, a laissez-faire environment without government interference. Even in the absence of a formal market, government participation in business leads to sub-optimal business environment.
A relevant example of futile government interference in the market mechanism was its attempt to revive the sick textile mills in the country under the banner of National Textiles Corporation (NTC). Twenty-five years and Rs 5,000 crore later, we have not only not succeeded in reviving the sick mills, but have also offered unfair competition to the healthy mills; in the process damaging the entire industry. "NTC has no future unless the government gets out of it completely," says T.S.R. Subramanium, former Cabinet and Textile Secretary. We have not only been unable to protect jobs, but I think we have stifled the prospects of one of India's largest industries and destroyed many job creation opportunities. This is a prime example of interference with the market mechanism of creative destruction. The same can be said of the jute industry, too.
Markets can be efficient only when we realise their importance and consciously make them an institution. Institutional frameworks for markets enhance the longevity of the wealth creation process. In their absence, we breed complacency, inefficiency and wastage. For example, we all know the challenges to the consumer and the stunted growth in the telecom sector till the state had a monopoly. But once a fair policy framework and regulation by TRAI (Telecom Regulatory Authority of India) were in place, we are now adding more mobile subscribers per month than China.
India's growth and growth potential are also influenced by its markets. All barriers and constraints to markets have resulted in wrong allocation of resources, inefficiency, lost opportunities and incentives to vested interests. We have seen dramatic improvements in areas where markets have developed and are transparent, efficient and have effective regulation.
Finance is the fuel that fires all furnaces. Financial markets and financial eco-systems are the most crucial markets for an economy, though the least understood and appreciated. Most people have an adverse bias towards equity markets as being speculative and a gambling den. Little are they aware that they are desecrating the temples of capitalism that ensure efficient allocation of capital and provide risk capital for entrepreneurs. One of the primary reasons for the cutting-edge innovation and scalability of us corporations is the availability of risk capital and an environment for exits for those who fund the risk capital primarily because of the development of equity markets.
Take the case of India's equity markets. There is a sea change over the last decade. With electronic anonymous order book trading, dematerialisation, enhanced corporate governance and robust, but fair regulation, the liquidity, breadth and scalability of Indian equity markets have leapfrogged. This change in the markets has enabled India to attract more than $9 billion (Rs 40,500 crore) of net FII (foreign institutional investor) investments in 2005. Moreover, the effective distribution of mutual funds has started playing a vital role in helping to channel incremental domestic savings into equities. Today, India has a culture of and environment for providing risk capital, especially as Indian markets can provide exit opportunities for sizeable capital, which encourages private equity and venture capital investments. This has laid an effective foundation for the provision of capital to Indian entrepreneurs-so vital for the secular growth of India.
On the other hand, where markets have failed to develop well, the respective economies have borne a high cost for the same. India has a very thin and illiquid debt market for government securities as well as bonds. This has led to an implicit illiquidity premium being embedded in the yields. The futile attempt to prop the Japanese banking sector has resulted in a prolonged quagmire in the country's economy, as its banking system's weakness has been transmitted to the rest of the economy. In Japan, the process of creative destruction was stifled and, hence, the economic weakness persisted for nearly two decades.
Steel prices in India had skyrocketed, but since no artificial controls were enforced, increased supply by imports and by domestic capacity expansion has resulted in bringing down the prices subsequently. It is true that increase in prices hurt, but the hike also attracts fresh supply, which eventually brings down prices. Banning of short-selling has made equity markets more vulnerable. The futile attempts of pricing kerosene at a subsidised rate is unfortunately leading to adulteration of fuels across the country by mixing kerosene with diesel.
Lack of labour reform, which will bring about labour flexibility, may act as a protector of labour that is already employed, but acts as a deterrent for further employment and, hence, leads to lesser opportunities for the poorest sections of the economy. One of the reasons that the US has one of the lowest unemployment rates in the world is the laissez-faire nature of its labour markets. We Indians need to really think about this aspect and arrive at a consensus as to how we can make labour more mobile and productive by not unnecessarily protecting jobs. This is the most vital requirement for India to achieve double-digit economic growth, manufacturing competitiveness and for providing jobs to the crores of young Indians ready to enter the job market.
One of the most vital reasons for the lack of a second Green Revolution in India is the constant government interference in all aspects of agriculture, be it land supply, agricultural inputs, pricing/selling mechanisms etc. Lack of organised markets restricts opportunities. Artificial price setting distorts the free market mechanism and leads to inefficient resource allocation. The minimum support price (MSP) for wheat and rice results in imbalance of cropping area patterns to the detriment of other vital crops. Fertiliser subsidies result in imbalanced use of urea compared to other fertilisers and, hence, lead to structural deterioration of soil. The APMC (Agriculture Produce Market Committee) markets result in prejudicial pricing and lead to throttling of the price discovery process. The regulatory inhibitions of allowing corporates to participate in primary agriculture has led to a paucity of value-added downstream agricultural output in spite of being one of the largest producers of fruits and vegetables. Due to unavailability of market mechanism for movement of agricultural output, appropriate supply-chains have not been built. In spite of the Ricardian Theory of International Trade, the US and the EU are inflexible on agricultural subsidies, which are restricting global agreements on free trade.
If one has to conceive a utopian situation, where there is great faith in the free market mechanism and a commitment to ensure longevity to the wealth creation process in an economy, the following factors are a condition precedent to the stated goal of efficient markets:
- Free markets with low entry barriers and low exit barriers;
- Homogeneous/standardised tradable products/units;
- Efficient information dissemination;
- Effective price discovery mechanism;
- Suitable financing mechanisms for market participants;
- Systems for risk management, and prevention of malpractices;
- Effective Multi-dimensional Regulation; and
- Crisis Management plans.
We must remember what Raghuram Rajan says in his book Saving Capitalism from the Capitalists: "Markets are not just a tool for the rich, they make opportunities available to all sections of the society." He gives a powerful example of the difference micro-credit makes to a labour woman in Bangladesh, and how, in the absence of a free market mechanism to deliver micro-credit, she is exploited. Contrast this with the example of easy access of funds to a student in the US from a search fund that enables him to create significant wealth for himself. If India can create an efficient model for delivery of micro-credit at market-determined rates, we will see a revolution in India.
In summary, we as a society, and especially our polity, have to realise that markets are like the weather-we may not like them, but we have to bear them. The liberalisation of the 1990s is now bearing fruit, and we must continue on the path to reforms. Markets are the ultimate levellers, and always have self-correcting mechanisms. The development of markets and market mechanisms is the primary manner by which the spirit of enterprise of India's talented and skilled people will be unleashed. This, in my opinion, is the paramount need for India to win the war against poverty and for the country to be an economic superpower. We must appreciate and respect the market mechanism.
The author is Partner of Rare Enterprises Ltd and a stock market investor