India: The pivotal moment
India’s capital markets are approaching a pivotal moment. After Narendra Modi’s landslide election victory earlier this year, initial enthusiasm has begun to give way to lingering doubts that the new regime can deliver on its reform agenda.
What happens next will determine the direction of India’s economy over the next five, or even 10, years. If Modi’s government can follow through on its promises to energise Indian business, the potential is clearly enormous. But India’s bureaucratic red tape is world renowned, and even a powerful public mandate risks becoming bogged down by vested interests and byzantine regulatory structures.
In many ways, the capital markets are on the front line of this intriguing battle. Improving the flow of capital to underdeveloped sectors such as infrastructure will be key to lifting economic growth, but the scale of the challenge is daunting.
India’s banking sector is running dangerously short of capital, with estimates calling for another Rs200bn of Tier 1 equity by 2019 to meet the latest Basel rules. Since committing to the Basel III standard, India has begun to realise that the measures risk starving some sectors of the economy of important growth funding. Given the state of the country’s finances, India needs to bridge that gap without resorting to government handouts for banks or borrowers – no easy task in a financial market so reliant on state support.
The banking sector’s inadequacies pose some immediate problems for Modi’s task force. In particular, bank risk weightings threaten to leave some promising young companies without access to capital as lenders focus on borrowers with higher ratings and longer track records. Dysfunctional debt capital markets also make it hard for banks to lend at the long tenors required by infrastructure developers without facing a dangerous maturity mismatch with their own short-term liabilities.
Many positive steps are already in progress. Indian banks are now allowed to sell long-term senior debt – a simple measure towards solving a problem that previous regimes, unbelievably, had neglected to fix. Clarity on tax and foreign ownership rules have reinvigorated the equity markets, allowing banks and their borrowers to improve their balance sheets.
The key, however, is lifting India’s profile on the global stage. Although regulators have tried to insulate India from foreign forces, the slump in the rupee in the second half of 2013 revealed the fatal flaw in that strategy. Like it or not, India’s future depends on international capital now more than ever, and the country needs to work hard to win investors’ confidence – and maintain it.
Modi knows this, and has done a good job of courting overseas Indians on recent missions abroad. There is, however, more convincing needed.
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