Strategy for boosting markets

By Taponeel Mukherjee

Given the current economic slowdown in India, a renewed focus on the primary conditions towards promoting investment and consumption is essential. At its core, a slowdown in the flow of credit due to a variety of factors has been a significant contributor to the issue at hand. Improvements in the three areas of credit flow through removing information asymmetry, improving contract enforcement, and enhancing secondary market liquidity are the need of the hour.

 

The first fundamental issue that the credit market in India faces is the slowness in the flow of credit information in the financial ecosystem. Essentially, information asymmetry is a primary cause of the credit issues that the Indian economy has faced. While steps such as the Insolvency & Bankruptcy Code (IBC) and bank recapitalisation have helped in the recovery of credit, a move towards creating greater informational availability on credit quality of borrowers is essential. The better the quality of the credit information available regarding the actual credit quality of a borrower, the better the quality of the loans disbursed would be.

The opportunity in creating credit market information symmetry is a business opportunity as well as an area where effective regulations can help. Benchmarking of loans against indices will be essential for going forward. A constant valuation of credit quality, akin to the mark-to-market nature of equity markets will be required to reduce the jump risk that has been prevalent in credit defaults that the country has witnessed over the last few years.

The second vital issue that needs attention from both the central and state governments is improving contract enforcement. Constant changes in long-dated contracts is a factor that can significantly hamper the flow of credit in the economy. Regardless of whether the investors are domestic or international, contracts must be honoured. If there are issues around the valuation of the contracts, then a legal regime needs to be instituted that will help in expediting resolution to matters relating to the enforcement of contracts. We hasten to add that, to begin with, transparent auction mechanisms must ensure that issues around contract enforcement are reduced to the minimum.

Contract enforcement issues will significantly impair the flow of investments, thereby delaying or in some cases stopping the investment and the consequent job creation and the associated revenue generation for the economy. Given the massive capital required by India for developing its infrastructure, investments being done today must be viewed as the core base of the infrastructure development, which when successful will create the multiplier effects critical for attracting larger pools of capital. It may be added that weak contract enforcement not only stops investment flows in the future, but it also drives up risk premium required by investors that translates into a higher cost of capital for the overall investment horizon. A higher cost of capital will render more projects unviable and significantly slow down investments and consumption.

The third essential issue that needs attention is ensuring that tax regulations continue to encourage Foreign Portfolio Investors (FPIs) to be a meaningful part of the capital markets. Policies in India must use the current structural low-rate environment globally to attract the lion's share of much-needed capital. Additionally, since FPIs have structurally different balance sheets and return requirements versus domestic investors, FPIs add the much-needed secondary market liquidity to the capital markets and are therefore even more critical. The liquidity in the secondary market is what lowers the cost of a transaction, that in turn reduces the liquidity premium required by an investor to hold an asset, and therefore reduces the cost of capital in the economy.

The capital markets and real markets are essentially two hands of the economy that must work in tandem to create value and economic growth. India must realise that the three factors mentioned above are interlinked. Information availability, contract enforcement and greater investor participation feed into each other. India needs to create a positive feedback loop between the three. Greater investor participation in Indian equity markets will greatly help increased participation in unlisted Indian businesses and infrastructure projects. On the other hand, robust contract enforcement will help generate better returns, which in turn will improve credit flow in the Indian economy.

Both domestic and international capital have a role to play in boosting Indian growth. A diverse set of investors and balance sheets is what India needs to boost investment and consumption today. Above and beyond improving the flow of credit, "signalling" is vital for any economy. The three issues described above need attention to send the right signals to provide the much-needed animal spirits in the economy.

(The views expressed in this article are personal and that of the author. The author heads Development Tracks, an infrastructure advisory firm. You can contact him at taponeel.mukherjee@development-tracks.com or @Taponeel on Twitter)