Over the last few days there has been lot of debate going on regarding the moves by some countries in trying to control capital inflows. The top most and largest country to do this at this point of time being Brazil. There has also been debate on this issue in India and a number of policy makers have been openly debating this in public forums. Thankfully, the view of all of them is that there is no sense in putting any sort of artificial barriers or taxes to control capital flows.
India has traditionally been a capital starved country and in the earlier era where there were a large number of restrictions on all kind of capital flows and the country lived in the License Raj the availability of capital for growth was the biggest constraint. As the economy slowly opened up since 1991 we have seen capital flows picking up in India, however they remain extremely low as compared to flows into most other large emerging economies. Traditionally FII flows have dominated in India. Although in terms of FII flows India compares well with most other emerging economies in terms of FDI India has significantly lagged behind. The reasons for this have been several which include limited currency convertibility, Red Tapism in granting approvals for investments, Sector specific FDI restrictions, Poor infrastructure and lack of competitiveness etc.
Even if we look at the composition of the Indian economy today more than 60% comprises Services, 25% manufacturing and 15% agriculture. Strong consumption and sectors where capital requirements were lower dominated the growth in India in the years preceding the last boom of 2003-2007. Due to the scarcity of capital availability the sectors that required lower capital for growth started dominating the Indian GDP thus leading to the current composition which is very different from most emerging economies.
Today we live in a world where liquidity is ample and interest rates are expected to remain low for a prolonged period of time. Credit spreads have also started to come down and are expected to trend lower as there is more conviction in the global economy. Given the fact that the Indian economy is likely to go back to a 8-10% growth trajectory over the next few years a huge amount of capital will flow into India looking at higher returns. As a historically capital starved economy we should welcome this and in fact create absorptive capacity in the economy so that these flows go into productive uses and contribute to the growth in the economy rather than add to inflation.
There is a huge need in India to develop all kind of infrastructure, be it roads, power plants, airports etc. Urban infrastructure in India is in shambles and requires huge investments. It is estimated that investment requirements over the next five years will be upwards of USD 600 billion which is nearly 60% of the current GDP. Under the circumstances the current scenario of ample and low cost global liquidity is a godsend for India. The current savings rate in India is around 35% and the current ICOR (a measure of capital formation) is aorund 4.2 to 4.5. As such the domestic savings rate itself can sustain a growth rate of around 7.5-8%. In order to move up the ladder to a 10% growth we need to get in around USD 80 billion every year on a net basis. The current inflows comprising various capital flows would be in the region of half of this.
It is important that flows come in the form of equity capital and there is need to set up models to provide reasonable returns on these investments in various infrastructure sectors. Capital flows will be of two kinds Risk capital and that looking for fixed returns. It is important for the policy makers to have models to attract both kind of capital.
For models where investors would not like to take a risk beyond the currency risk annuity linked models as were existing earlier in highway projects would attract lot of capital. Given the fact that borrowing costs are extremely low today (even with higher spreads) with LIBOR rates being nearly 0.3%, if the government can come out with models where the risk premium for investing in India is taken care of a large number of global infrastructure funds as well as utility companies might look at putting capital in such models. A reasonable return for them would still be a reasonable cost for India.
The second model is in the form of risk capital where investors can come into projects in form of BOT projects. Here the regulatory regime has to be clear and clarity will need to be there for having lot of relevant data which can be analyzed by potential investors. For example in case of road and port projects traffic projections have to be realistic and in case of Power projects there is need for clarity of long term power tariffs that the utilities can charge etc.
In conclusion I believe that there really should not be any debate on controlling capital flows and the aim should be to channel them into productive asset creation.
Industrial Production growth for September
The IIP growth for the month of September came out to be much higher than expectations at 9.1%. Over the next one year we should see a continuous improvement in these numbers and we should have an average of 10% plus IIP growth for the first 9 months of 2010. The good part is that the growth is well spread out and is across industry segments. GDP growth forecasts for next financial year which currently stand at around 7% should see upgrades over the next few months.
Markets are looking extremely good in the short run and I expect a 8-10% upmove from now on till January 2010.
“Its not whether you are right or wrong that’s important, but how much money you make when you are right and how much you lose when you are wrong – S. Druckenmiller“