Presentation

Impact of Economic Liberalisation on Indian Corporate Sector Financing?

by Sankar De Centre for Analytical Finance, ISB

Conference on Indian Economic Reforms: Current Status

December 19, 2005 ISB campus

Outline

Performance of public and private sector companies in post liberalisation period

Capital market objectives of Indian libralisation drive

Financing pattern of non-fianncial Indian corporations in pre and postliberalisation eras Performance of Indian stock markets in postliberalisation period Special situation of SME sector

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Indian Economic Sector Reforms Conference

Performance of private & public sectors post-liberalisation

Growth of private sector companies has far exceeded public sector companies in important dimensions in the post-liberalisation period:
Private Public 0.6%

Number of units: CAGR 1993-02

7.9%

Paid-up capital:

CAGR 1993-02

23.8%
35.2% 71.6% 75.9% 73.9%

6.2%
64.8% 28.4% 24.1% 26.1%

Share of paid-up capital 1993 Share of paid-up capital 2002 Share of GDP 2002 Share of GDI 2002

A lot of this is due to privatisation drive post-liberalization.

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Fig. 1.A : Annual growth in number of companies

18.00% 16.00%

14.00% 12.00%

Year to year growth

10.00% 8.00% 6.00%

Government Companies Non-Government Companies

4.00% 2.00%

0.00% -2.00%

1993-94

1995-96

1996-97

1997-98

1998-99 Year

1999-00

2000-01

2001-02

2002-03

Source: Central Statistical Organization, National Accounts Statistics

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Fig. 1.B : Paid-up Capital

300000

250000

200000

Rupees crores

150000

Government Companies Non-Government Companies

100000

50000

1993

1994

1995

1996

1997 Year

1998

1999

2000*

2001*

2002*

Source: Central Statistical Organization, National Accounts Statistics

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Fig. 1.C : Contribution to GDP

1800000

1600000

1400000

1200000
Rupees crores

1000000

Government Companies
800000

Non-Government Companies

600000

400000

200000

1993

1994

1995

1996

1997 Year

1998

1999

2000*

2001*

2002*

Source: Central Statistical Organization, National Accounts Statistics

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Fig. 1.D : Gross Domestic Investments

400000

350000

300000

Rupees crores

250000

200000

Government Companies Non-Government Companies

150000

100000

50000

0 1993 1994 1995 1996 1997 1998 1999 2000* 2001* 2002*

Source: Central Statistical Organization, National Accounts Statistics

Year

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Performance of private & public sectors post-liberalisation

However, the performance of private sector companies post liberalisation has not been an unmixed success. The growth rate of private sector companies decelerated during 1996-97 through 2002-3. It has picked up again only recently.

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Fig. 2: Growth rates in sales and profits of private sector companies

35.0% 31.7% 30.0% 31.0%

25.0% 22.2% 22.5% 20.0%

23.7% 20.5% 19.0% 15.4% 12.1% 10.4% 7.5% 6.1% 3.7% 11.2% 9.0% 9.9% 8.5% 5.8% 3.0% -1.3% -1.9% -2.8% -3.2% 7.8%

Growth Rate

15.0% 10.0% 5.0%

0.0% -5.0%

1991-92

1992-93

1993-94

1994-95

1995-96

1996-97

1997-98

1998-99

1999-00

2000-01

2001-02

Year

Sales

Gross Profits

Source: RBI Bulletin, November 2005

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2002-03

Performance of private & public sectors post-liberalisation

Besides, the bigger companies in the private sector have grown much faster than smaller companies in all important respects, including sales, profits, and assets.

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Fig. 3: Average annual growth rates in size groups

18.0 16.0

Avg Annual Growth Rate (%)

14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0

Below Rs. 1 crore Rs. 1 crore - Rs. 5 crore Rs. 5 crore - Rs. 25 crore Rs. 25 crore and above

Sales

Gross Profits

Bank Borrowings

Gross Fixed Assets

Inventories

Total Net Assets

Indicators

Source: RBI Bulletin, November 2005

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Capital market objectives of liberalisation SEBIs capital market objectives :

promote, develop, and regulate the securities market by such measures as it thinks fit (SEBI Act 92/00, chapter IV)

Pre-budget Economic Survey (93), Ministry of Finance

The corporate sector will have to be encouraged to raise resources increasingly from the market

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Financing pattern of non-financial companies in private sector

Type of funding
Internal

89-92
32.2.%

92-04
33.3%
21.9% 18.2% 25.9%

sources

External sources
Capital markets 17.8% Banks and other financial 22.1% institutions Other sources (including 27.8% trade credit and provisions)

Note: the numbers for both periods are averages across the years

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Financing pattern of non-financial companies in private sector

Financing pattern of private sector companies appears to have changed little over the first ten years of liberalisation. Proportion of funds raised from the market increased only marginally. Almost to the same extent, the proportion of funds raised from banks/FIs declined. Actually, the financial institutions themselves absorbed capital market financing.
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Fig. 4 : Sources of funds for nongovernment companies in India

35.00%

30.00%

25.00%

Contribution

20.00%

1989-90 to 1991-92 1992-93 to 2003-04

15.00%

10.00%

5.00%

0.00%

Internal Sources

Capital markets

Banks / Financial Institutions Source

Group Companies / Promoters / Directors

Source: Centre for Monitoring Indian Economy (CMIE)

Others (including current liabilities & provisions)

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Stock market performance since liberalisation

Interestingly, though Indian capital markets have not become more important as a primary source of funds for the private sector, over the same period the stock markets have experienced much more volume of trading. At the end of 2004, BSE and NSE combined was the 14th largest stock market in the world (in terms of total market capitalisation), significantly ahead of China (15th).

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Table 1: Largest stock markets in the world

Rank 1 2 3 4 5 6 Stock Market NYSE Tokyo SE Nasdaq London SE Euronext Osaka SE Total Market Cap (US$ billion) 12,707,578.3 3,557,674.4 3,532,912.0 2,865,243.2 2,441,261.4 2,287,047.8 Concentration (%) 55.8 56.9 59.3 82.2 68.8 56.7 Turnover Velocity (%) 89.8 97.1 249.5* 116.6 115.0 5.9

7
8 9 10 11 12 13 14 15

Deutsche Brse
TSX Group BME Spanish Exchanges Hong Kong Exchanges Swiss Exchange Borsa Italiana Australian SE India (BSE+NSE) China (Shanghai+Shenzen)

1,194,516.8
1,177,517.6 940,672.9 861,462.9 826,040.8 789,562.6 776,402.8 749,597.1 447,720.3

73.2
63.1 NA 78.6 76.0 61.9 79.8 78.4 40.5

67.9
66.2 57.7 39.7 100.5 134.9 81.1 70.9 97.0

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Stock market performance since liberalisation

A dollar invested in the BSE index during 1992-05 would have earned a higher (buy and hold) return than the S&P 500 and the indices in UK, China, and Japan. At the end of March 2005, market cap of BSE index was 55% of GDP (3.5% in early 80s). India boasts the largest number of listed companies in the world: well over 10,000. All of this has captured popular press as well as public forums, somewhat to the neglect of corporate financing.

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Fig. 5: Return on Stock Indexes around the World

Return on Stock Indexes around the World

Value of $1 investment, ($)

4 3 2 1 0
19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05

SBE-India SSE-China S&P 500 FTSE-London Nikkei -Japan

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Banks and financial institutions as a financing source

The banking sector in India has grown steadily in size (total deposits) at a fairly uniform annual rate of 18% since the 1980s. With deposits of over $385 billion dollars in 2003, the sector accounted for 75% of the countrys financial assets. The NPL problem is not serious: could be partly due to under-lending.

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Banks and financial institutions as a financing source

On the other hand, the proportion of funds provided by banks and financial institutions actually declined for private sector companies over 1993 2002. There is evidence of under-lending by banks (Banerjee and Duflo; 2002). While they shied away from corporate loans, financial institutions invested heavily in government and other kinds of securities.

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Reasons for under - lending

Among may reasons cited, Inadequate lender protection before SARFEISI Act, 2002. Not enforced until the other day. Lack of right incentives for public sector bankers to make risky corporate loans (Banerjee, Cole and Duflo; 2004)

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Other sources of financing

Mostly short-term trade credit Close to a third of all sources The second most important source (after internal sources) before as well as since liberalisation Importance increases dramatically for the small and medium sector (SME) sector

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The SME sector

A very important sector of the economy: accounts for

40% of value added in manufacturing USD 188 billion annual output (6.75% of GDP) 20 million employment 95% of total industrial units Managed faster growth rate than industrial production as a whole in the 90s

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Fig. 6: Growth of the SME sector in India

Growth of the SME sector in India
25 Units Employment Production 20 160 180 200

Units and Employment (millions)

140

15

120

100

10

80

60

40

20

0 1994-95 1995-96 1996-97 1997-98 1998-99 Years Source: CII website 1999-00 2000-01 2001-02 2002-03

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Output (billions of USD)

Figure 7 : Growth rates of the SME sector and Industrial Production

Growth Rates of the SME sector and Industrial Production
14 SSI Sector Industrial Sector 12

10

Annual Growth Rates (%)

0 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 Years

Source: CII website

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The SME sector

No official definition of SME exists

Two subsets of SME are

Small Scale Industry (SSI): less than Rs. 1 crore in plant and machinery Small Scale Service and Business Enterprises (SSSBE): less than Rs. 10 lakh in plant and machinery

SME sector is important in other high-growth economies as well: importance hardly unique to India

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Financing sources for SME sector

Severely credit-constrained: In an NSSO survey: faced an acute shortage of capital mean loan outstanding was less than 3% of GFA 93% had no bank/FI loan outstanding About 50% of the loans were from SIDBI/SFCs Depends heavily on other sources (close to 50%) Similar, though less extreme, situation for SMEs in other countries

Anecdotal evidence indicates high bankruptcy

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Survey findings of SSI units in Hyderabad

The findings of a survey of SSI units in Hyderabad( in Allen, Chakrabarti, De, and Qian; 2005) indicate that
During the start-up phase, friends and family comprise the most important (over 50%) source of financing for an overwhelming majority of respondents (70%)
During the growth phase too, friends and family remain the best source of financing for 70% of respondents. Bank financing is the second preferred source. Bank financing seems to be extremely relationship-driven. 20% respondents had no bank credit. 63% had credit from only one institution.

Dependence on friends and family financing avoids independent scrutiny on the one hand and limits growth on the other.
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Fig. 7.A : Importance of various sources of funds at start - up

Importance of various sources of funds at start-up
80% Extremely important (above 50%) 70% Very Important (25-50%) Somewhat important (10-25%) 60% Of Little Importance (<10%)

Percentage of respondents

50%

40%

30%

20%

10%

0%

Family

State Budget / Local Government

Venture Capital

Private credit agencies and individuals

State-owned banks

Sources of funds

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NRI Investment

Foreign Direct Investment

Close Friends

Trade Credits

Fig. 7.B : Ease of obtaining funds during growth stage

Ease of obtaining funds during growth stage
80% Very easy and low cost 70% Relatively easy and moderate costs Difficult and costly 60% Extremely difficult and costly

Percentage of respondents

50%

40%

30%

20%

10%

0% Family and close friends Short-term bank loans Long-term bank loans Loans from special institutions such as SIDBI and SFCs Trade credits Private equity/debt from investors within India NRI Foreign direct Issue public Investments investment stock and (non-NRI) bonds in the stock markets

Years

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Concluding observations

Capital markets financing has become only marginally more important. Financing from the banking sector actually declined over 1993 2002. Heavy dependence on other sources External financing for the SME sector is scarce.

Overall, the picture is sobering.

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Q&A

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Thank You

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