Over the past three decades — leading up to the recent global economic downturn — the trend was clear. The world’s capital markets were undergoing tremendous expansion, diversification and integration. Between 1980 and 2007, the volume of global capital flows increased dramatically. Meanwhile, according to various reports, the world’s financial assets — a combination of bank deposits, private and public debt, and equity — almost quadrupled in relation to global GDP.
This surge in global capital has been fuelled, in part, by worldwide financial market liberalisation coupled with the rapid-fire economic growth and burgeoning global influence of India and other emerging economies. Because the free flow of capital is the life-blood of sustainable economic growth and expanding prosperity, the world community at large — especially the G20 nations — needs to continue to facilitate and safeguard the flow of capital across borders. And India has a pivotal role to play in this regard.
Recent statistics from the World Federation of Exchanges reveal a dramatic shift in global markets. Between 2002 and 2007, the number of listed companies on the Nasdaq stock market and New York Stock Exchange (NYSE) dropped by 16% and 3% respectively, while the Asian markets increased significantly, with India growing 47%, South Korea 157% and Singapore 62%.
A similar eastward swing has occurred with regard to market capitalisation of the world’s stock exchanges. Between 2003 and 2008, the Nasdaq and NYSE decreased by 16% and 19% respectively, while the Asian markets enjoyed significant increases. India surged 132%, Shanghai 296%, and Hong Kong 86%.
Another noteworthy change has been taking place in the global economy. Many economists believe the recovery will be driven by a new phenomenon: growing consumer spending in emerging markets, with India in the forefront. This shift towards consumer-led growth in emerging countries will transform these areas into important import markets for the world’s manufacturers.
What’s behind this economic power shift towards India and other emerging economies? In a word: capital. A great deal of the eastward tilt stems from the escalating flow of capital across borders in recent years.
Since the introduction of the reform process in the early 1990s, India has witnessed a significant increase in capital inflows — in the form of foreign direct investment, foreign portfolio investment, external commercial borrowing and non-resident Indians’ inward remittances. The size of net capital inflows to India rose from $7.1 billion in 1990-91 to $108 billion in 2007-08. Today, India has one of the highest net capital inflows among the emerging market economies of Asia.
Important reform milestones that have contributed materially to India’s economic growth and its ability to attract capital include the following:
Abolishing the import licensing policy in the early 1990s, which opened the doors to a free trade regime.
Gradual and systemic rationalisation of the country’s tariff and Customs duty structure with the highest rate coming down from 400% to less than 25% on an average.
Convertibility of the country’s current account, allowing greater availability of foreign exchange into and out of the country to meet business requirements.
Gradual deregulation of several sectors, allowing foreign investment capital to flow into India combined with continuous financial sector reforms leading to both financial deepening and widening.
Slow and steady progress in privatising public sector enterprises.
And the general improvement in strengthening intellectual property rights by joining General Agreement on Tariffs and Trade.
Reforms like these encouraged the flow of investment capital into India and helped stimulate the recent era of dramatic economic growth. Indeed, the United Nations Conference on Trade and Development rates India as the most attractive emerging market economy for long-term investors. While there was an overall decline in foreign direct investment (FDI) in India in the depths of the recession last year, Indian FDI flows both in and out of the country have remained buoyant, defying global trends. Inbound FDI increased by over 40% to $3.26 billion in August 2009 alone.
Meanwhile, because capital, like traffic, flows in two directions, Indian firms have pushed forward on the path to more international investments. India’s international merger and acquisition activities have increased markedly over the past 20 years, and the trend is likely to accelerate. Indian firms are making billion-dollar-plus deals in industries as diverse as automotive, steel and tea. Indian outbound deals — valued at $0.7 billion in 2000 — jumped to $4.3 billion in 2005 and then swelled to $35 billion in 2007. Investments have been made in a wide variety of industries, including metals, pharmaceuticals, industrial goods, automotive components, beverages, energy, mobile communications, software and financial services. Indian IT companies have been buying smaller IT outfits in Europe, Latin America and Asia to gain global customers.
Surprisingly enough, the value of outbound deals from India actually recorded a modest increase in 2008, despite the challenging economic realities of the world today. Another sign that India is emerging from the global downturn with greater resilience than many other countries is its GDP growth. For 2008, it was an impressive 6.7%, and the economy is expected to grow by another 6.5% in 2009.
According to the World Bank Governance Indicators, macroeconomic corporate governance has a significant effect on inward FDI flows, suggesting host country governments and authorities should shape policy in this area to maximise such flows. The impact of transparency in corporate governance on FDI and firm performance is well documented.
How do corporate governance and risk management in India stack up against other emerging markets? The New York consulting firm Governance Metrics International (GMI) placed India 19th out of 38 countries on its list. Importantly, India ranks well above average among emerging markets. But more can be done to enhance corporate governance, not only in India but also in many other markets.
The enactment of Clause 49 — which increased the responsibilities of corporate boards, required the appointment of independent directors, consolidated the role of the audit committee and generally made management more accountable — seems to have had a reassuring effect on investors. Also reassuring to investors were the easing of overseas borrowing rules and the establishment of dedicated stock exchanges for small enterprises to enable them to access funds.
Still, more work needs to be done. What we hear from our clients suggests the following:
Continue the process of liberalising the investment norms into sectors that are still closed to foreign direct investment, such as retail and insurance.
Encourage even greater trade openness, which is important to improve absorption of capital inflows in the short run and to develop foreign exchange earning capacity that will enable an appropriate return on invested capital.
Move toward convertibility of the country’s capital account to facilitate smoother flow of foreign capital into and out of the country.
Push ahead with financial sector reforms already under way to enhance India’s role as a major hub for global finance.
Establish land reform policies to enable industrial development.
Reform education to provide access for skill development to broaden the participation in India’s growth.
Seize the strategic advantage — through technological and other innovations — to become a global leader in environmental sustainability.
Build on changes in tax policy, industrial policy and general economic policy by further reducing red tape and bureaucratic hurdles that remain an important concern that discourages foreign investment.
Embrace innovative technologies and strengthen intellectual property protection in India through convergence with international standards.
Building on liberalisation policies dating back to the early 1990s, the country has differentiated itself as a dynamic recipient and source of global capital. India’s prospects are brighter now than ever to be a leading magnet for cross-border capital investments in the years ahead. The power shift is on. Global capital is on the move. India’s time is now.
(The author is CEO of Deloitte Touche Tohmatsu)
http://economictimes.indiatimes.com/Opinion/Comments-Analysis/Cross-border-capital-flows-and-the-ascendancy-of-India/articleshow/5233876.cms
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