Believing in India again

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It is a matter of confidence, credibility and trust. Whatever be the political hue of the next government and whoever its leader, the challenge will be to reinvigorate investor confidence in the political stewardship of the economy, restore the credibility of the executive and rebuild trust in the sanctity of policy and contracts. Else, the much-needed investment in infrastructure and manufacturing will not be forthcoming and the numbers of un- and underemployed will continue to mount. The social consequences will most likely limit the new government to one term.

Corruption scandals have hogged the headlines, but arguably the most damaging effect on investor sentiment over the past several years has been the activism of the tax authorities and the twists and turns in the interpretation of policies and contracts. A fly on the wall of the board rooms of Vodafone, Nokia, Microsoft, BP, Shell, Posco, Tesco, Walmart and many more would be struck by the paradoxical tenor of conversation. The directors would be in agreement about the potential of the country. All would accept that notwithstanding the slowdown in growth and the lacklustre leadership over the past three years, the fundamentals remain intact and India remains on track to be an economic giant. They would endorse the view that relative to opportunities elsewhere, India is an attractive destination and that it would be imprudent to push it off their agenda. That said, they would collectively hesitate to put their signature on further new investments, other than perhaps for amounts required to sustain existing activities. They would substantiate their hesitation by allusions to the arbitrariness of the tax charges on MNCs, the announcement by the BJP to reverse the UPA government’s policy on multi-brand retail, the unilateral tightening of contractual conditions that assured petroleum companies market-related prices for gas and the right to market it freely, the labyrinthine approval procedures that have bogged down major mining and power sector projects, the reluctance of the bureaucracy to take decisions for fear of attracting a vigilance enquiry and the long lead times in judicial decisions. The thread linking all such conversations would be the loss
of confidence and trust in public institutions.

Cornell Professor Eswar Prasad’s wonderfully written book, The Dollar Trap: How the US Dollar Tightened its Grip on Global Finance, brings into sharp relief the positive impact that confidence and trust in public institutions has had on the direction of capital flows in our globalised and connected world. And, by implication, the negative consequences of loss of confidence and trust. Prasad writes that, notwithstanding recurring bouts of financial crisis in America that should have led to an outflow of capital, rising interest rates and a falling dollar, US treasury securities and dollar denominated assets have continued to be a favourite haven for investors. In September 2008, for instance, following the collapse of Lehman Brothers, US financial markets went into a downward spiral, the credit markets froze and Dow Jones was on the skids. Economic fundamentals suggested there would be a run on the dollar. What happened was just the opposite. There was a net inflow of half a trillion dollars into US treasury securities, nearly all of it from private investors and the dollar rose in value against all other currencies. In July 2011, the government came within a day of declaring a technical default on its debt. The credit rating agency Standard and Poors did, in fact, downgrade US government debt from AAA to AA+ on August 2. There should have been a flight of capital away from dollar assets. Instead there was an inflow of nearly $180 billion in August and September, and again mostly from the private sector. In December 2012, the economy once more headed towards a “fiscal cliff”. The US Congress was at an impasse over the government’s borrowing limits. Economists wondered whether this would push the dollar off its perch and deliberated on the extent of the spike in interest rates. The dollar remained steady and the yield on US treasury bills continued to range around 2 per cent.

Prasad’s message is that economic logic and fundamentals are not the only determinants of capital flows. There are “softer” factors with strong explanatory force. Investors moved money into dollar assets, even though they at times received a negative real return, because they had confidence and trust in the fairness and transparency of US public institutions and because the dollar was the safest relative bet. As he put it, “if not the dollar what else”, in a market roiled by volatility.,

This message should be absorbed by the leaders of our new government. Private capital will not flow towards India until and unless confidence and trust in its public institutions have been restored. Investors did at one time regard India as a relatively “good bet” because of its strong fundamentals and the integrity of its institutions. They did fret about the bureaucracy, red tape and corruption, but they felt assured that once these entry hurdles had been scaled, the playing field would be kept even and that they would be treated fairly. Today, however, their views have altered. They are no longer confident about contract sanctity and worry they may be subject to the exercise of discretionary and whimsical authority.

The new government must change this perception. This will not be easy. It will require many policy changes and the executive will have to untangle projects from red tape. But more than that, it will require the new leadership to engage in a personal “charm” offensive. Every company, irrespective of size, geography or ownership, is ultimately run by a small handful of people. It is this group that determines when, where and how the company’s money is to be spent. Their subjective predilections are a major determinant of investment decisions and often more important than sophisticated, process driven and quantitatively rigorous project analysis. A frictionless first step would be for the new prime minister to invite the top leadership of major companies involved in the sectors most important to us, like energy, infrastructure and mining, for a personal tete a tete with him and his key cabinet officials. His personal commitment to due process and the framework of law would go a long way to allay the “gut” concerns of this corporate elite.

This column first appeared in The Indian Express, on May 5, 2014.