Chapter 8
1 Since the public sector investment in most of the developing countries is effectively a policy variable, the economists have focused on the private sector investment as being susceptible to extensive analysis. Also contributing to the interest in the private investment activity is the recent research suggesting that the private sector investment has been more directly related to economic growth in the developing countries than has the public sector investment (Khan and Reinhart, 1990).
2 In India, the corporate sector is defined as the non-financial, non-government joint stock companies. The corporate sector consists of the closely held (private limited) and the publicly held (public limited) companies, with approximately 6.19 lakh registered companies as on June 2003, and about slightly less than half of them are engaged in manufacturing. As a percentage of the GDP, the estimated paid-up capital of the non-government companies constitutes 12.1 per cent (Government of India, 2003).
3 These institutions were originally sponsored by the government, and often supported by the World Bank’s participation or the line of credit to give a primary impulse to economic expansion in the important sectors where private enterprise was not forthcoming. See the World Development Report, World Bank (1989b) for details.
4 The 1950s and the 1960s represented a foundation phase with extensive powers for supervision and control of banks vested in the RBI under the banking companies Act, 1949.
5 Such a policy was to ensure that they would support government policies, such as the ‘need to control the commanding heights of the economy and to meet progressively the needs of the development of the economy in conformity with national policy objectives’ (Preamble of the Banking Companies Act of 1969).
6 This was reinforced by the channellizing of public saving by an elaborate banking network to the ‘socially productive’ uses by an elaborate mechanism of directed credit programmes and concessional interest rates for ‘priority sectors’.
7 While the CRR is the proportion of the total deposits the banks have to deposit with the central bank, SLR is the proportion of the deposits the banks are obliged to hold in the government and other approved securities.
8 See Reddy (1999) for more details of the various instruments of money market in India in the liberalization period.
9 Associated with this, many developments have taken place in the securities market in terms of improvements in the market design, electronic trading, innovation at the clearing house to reduce the settlement risk, the institution of depositories to eliminate the operational vulnerabilities associated with the physical share certificates, derivative trading, etc. See Shah (1999) and Shah and Thomas (2001) for complete details of these developments.
10 The market capitalization is the share price times the number of shares outstanding. The turnover ratio is the total value of the shares traded during the period divided by the average market capitalization for the period. The average market capitalization is calculated as the average of the end of period values for the current period and the previous period.
11 India generally adopted a highly regulated regime in the arena of foreign investment. The major policy decision regarding the FDI was made in the New Industrial Policy of 1991. Only after this, the norms and procedures regarding FDI have been declared to liberalize the foreign capital flows.
12 The years 1997–98 and 1998–99 are exceptions. In these years, the foreign capital flows faced an aberration. This may be attributed to the contagion effect in the aftermath of the East Asian Crisis that affected the global capital flows.
13 Still dominated by the state-owned banks, the years after liberalization have seen the emergence of new private sector banks and many foreign banks. The result was the reduction in a much lower concentration ratio in India. The concentration in banking in 2003 is measured as 0.40 as against the World figure 0.69 (Allen et al., 2005). However, the financial market size of the banking sector is much below the world figure. In terms of bank credit to the GDP, it is 0.31, which is much below the world average of 0.50 (Levine, 2002). Over the last many decades, the banking sector has grown rapidly. In terms of deposits it grew at a fairly uniform average annual growth rate of about 18 per cent. There are about 100 commercial banks with 30 state-owned banks, 30 private sector banks and over 40 foreign banks. The total bank deposits account for 50 per cent of GDP in 2003 and constitute three-quarters of the country’s total financial assets. The concentration is measured as the share of the three largest banks in the total assets of all commercial banks. In terms of concentration, India ranks only 9th in the world. Koeva (2003) also showed that the competition has increased using Herfindahl index for advances for measuring the competition. According to him, concentration in the banking sector has dropped from 28 per cent in 1991–92 to 20 per cent in 2001–02.
14 The scope for mobilizing external funds widened with the free market pricing of the domestic capital issues on one hand and a free flow of the direct and the portfolio inflows from abroad on the other. For instance, during the financial liberalization period, the average share of foreign equity capital sharply increased from a negligible share of 0.1 per cent in 1980s, to about 2 per cent in 1990s (RBI, 2005).
15 This is evident from the fact that the ratio of the retained profits to profits after the tax (profit retention ratio) has increased from 62.9 per cent in the 1980s to 70.7 per cent during the period 1988–96 and further to 71.9 per cent in 1996–2003 (calculated from data on corporate sector by CMIE, 2005). There had been a continuous decline in the effective tax rate (ratio of tax provisions to profits before tax) from 48.6 per cent in 1970s to 31.0 per cent in 1980s and further to 22.7 per cent during the period 1988–96. This decline along with high profit retention ratio led to an increase in the retained profits in the private corporate sector in the period 1988–96, thereby contributing more to the internal sources.
16 If we consider all the resources from the capital market, the share of the share premium that was 4.64 per cent in the 1980s increased to 12.64 per cent in 1992–96 (CMIE, 2005).
17 It is pertinent to see that almost all sources of capital markets witnessed a decline. Pal (2000) observed that after a spurt during 1992–94, the importance of the capital market as a source has declined for the Indian firms. He emphasized that there has been a steep decline in the proportion of funds raised through equity-related instruments in the post 1994–95 phase. He concluded that the Indian firms have substituted the external equity by external debt as their most important source of external finance.
18 The factors mainly determining long-term borrowings (FIs) are the average interest paid by the corporate sector on all its borrowings and the comparative returns on equity. The average effective interest rate rose from 11.8 per cent in the 1970s to 13.3 per cent in the 1980s. Interest rates peaked at 14.0 per cent during 1988–92 and then it declined sharply to 12.2 per cent during 1992–96. Effective interest rate indicated is computed from the ICICI’s Financial Performance of Companies Various Issues. But it is clear that the share of the institutional borrowings have not increased even when interest rates fell during the period 1992–98. In this context, one can argue that recourse to institutional borrowings would also depend on the cost and availability of alternative sources of funding including the state of equity markets. In other words, booming equity markets imply easy availability of share premium, which brings down the need to borrow from financial institutions even though interest rates were low during the period 1992–96. The data on institutional borrowings from 2004–05 is not available since they are converted to banks.
19 This was more due to the equity market boom than a fall in the tax rate. In terms of a primary return in the form of dividend and a secondary return in terms of capital appreciation, the Indian companies were in an advantageous position. The former can be captured by the total dividend rate and the latter by changes in share prices. In India, both the dividend rate as well as share prices have risen over the period. For instance, the equity dividend to a net worth ratio of the corporate sector was relatively high at 4.12 per cent from 1991–92 to 1995–96 period. Compared to this, it has come down to 3.5 per cent in the period from 1996–97 to 1999–2000. The relative attractiveness of equity shares to the corporate sector has been enhanced by the fact that it has been able to obtain a premium on such issues; mainly due to the abolition of the CCI in 1992, which facilitated the free pricing of equity issues by companies.
20 In the initial years of financial liberalization, the flow of funds from banks to the corporate sector declined due to the increased flows from other newly emerging domestic and foreign sources.