A three-point agenda to boost investor confidence
To achieve sustained economic growth, the Modi Government 2.0 will need to boost investor confidence. For this, the efficacy and quality of capital are paramount. Better corporate and regulatory behaviour, and a stronger redressal mechanism, will deter errant corporate behaviour and help create a responsible and empowered investor community.
The central agenda for the next five years of Modi Government 2.0 will be economic growth and job creation. For this, industry will need capital to grow – in the form of both, foreign direct investments (FDI) and foreign portfolio inflows (FPI). Several reforms during the Modi Government 1.0 have helped build investor confidence, which caused an improvement in India’s rank on the World Bank’s Doing Business Report 2019. Some of the critical financial market reforms were the Insolvency and Bankruptcy Code (IBC), RBI’s asset quality review, the planned consolidation of public sector banks and their further capitalization (although a bit delayed), and the reforms on the protection of rights of minority investors. The past five years have witnessed regulations that have empowered investors: from bringing in better corporate governance norms, requiring a majority of minority shareholder votes on related party transactions, allowing class-action suits, and compelling stewardship of asset managers. And let’s not set aside the impact that e-voting has had (over the earlier show-of-hands method).
The rally in the markets following NDA’s decisive majority is evidence of investors’ support for a stable, and perhaps bolder, new government that has the mandate to act deftly. Independent of the change of guard at the Ministry of Finance, the reform agenda for financial markets can only move onward and forward. Among other things, in the next five years, the government must focus on three key issues.
 National Democratic Alliance; comprises the Bhartiya Janata Party (BJP) and its alliance partners
1. The corporate governance agenda is equally important to the ‘ease of doing business’
Every measure to improve corporate governance standards cannot be construed as an impediment to ‘ease of doing business’. The Modi Government 2.0 needs to align both SEBI and the corporate lobby on the criticality of good corporate governance in attracting capital – both FDI and FPI. While the tug-of-war between SEBI and the Ministry of Corporate Affairs (or the corporate lobby) is necessary for balanced regulation, the Modi Government 2.0 must have a single-minded focus on corporate governance as an integral part of attracting capital.
Given the number of licenses, and the paperwork it takes to start (and close down) a business in India, the ease of doing business is a legitimate concern. The World Bank’s Doing Business 2019 report (DB 2019) pegs India 77th (out of 190 countries) on the ease of doing business. While India’s rank improved during Modi Government 1.0 (it ranked 100th in World Bank’s Doing Business Report 2018), it is not a rank to be proud of – India ranks lower than several smaller economies such as Kyrgyz Republic (70th rank), Slovenia (40th rank), and Azerbaijan (25th rank).
But the argument of ‘ease of doing business’ is being used almost as an excuse to remove all curbs. SEBI has been thwarted in its focus towards strengthening the corporate governance standards time again, and has had to roll-back regulations or delay their implementation until it managed all the forces in play. In DB 2019, India ranked 7th on Protecting Minority Investors, which has been the result of the reforms on the governance agenda and the empowerment of investors through new regulation. Paradoxically, delays in implementation of stronger corporate governance reforms, or deviations from the stated agenda is likely to reduce India’s score and be counter-productive to India’s overall rank in World Bank’s Doing Business index.
2. Less regulation and more enforcement
The increasing amount of regulation is an attempt to plug the gaps caused by poor enforcement in India. This has resulted in an increased compliance burden for corporate India, and an equally onerous task of writing out new codes for the regulators. In the haste to bring about more regulation, the codes – in several places – are not clearly drafted, allowing companies to use interpretational loopholes (that may all be perfectly legal). Rather than bring in more regulation to plug ‘loopholes’, there is a case to reduce the regulation: while regulations are necessary for the important issues (those that protect corporations’, investors’, and other stakeholders’ rights), the remaining regulations can perhaps have a ‘comply and explain’ approach. Corporate India will likely react positively with a ‘comply or explain approach’ – as it has with CSR spend requirements.
India ranks 163rd on World Bank’s Doing Business 2019 Report on Enforcement of Contracts. The Indian legal system has pending cases that are not likely to be resolved in one lifetime. Jails are overcrowded. There have been long-standing vacancies for judge posts in several high courts. To ensure fast-track resolution for corporate matters, the National Company Law Tribunal was created, but its capacity is being almost completely usurped by the back-and-forth of companies under the IBC. The appeals process takes its own time, and at the final leg, the Supreme Court hasn’t painted itself in glory in recent times.
Expansion of the judiciary and other law enforcement agencies is a dire need for the country. Better enforcement will likely act as a deterrent to errant behaviour and make it speedier to hold people accountable.
3. Improve corporate governance levels at public-sector undertakings, including the banks
Public sector undertakings (PSU) are expected to set an example for private (not state-owned) companies, but their own governance levels are being questioned. PSUs are the larger listed companies and the more profitable ones, too. Their board composition is regulated – and while the intent is to ensure that different stakeholders’ views are brought to the board table, the overall quality of their governance has remained a concern for investors. A little under 40% of the directors on PSU boards are executive directors, and most have a common Chairperson and Managing Director. Almost 60% of the non-executive directors are current or past government employees. Less than 10% of all board members across PSUs have spent over 5 years on the board. And, these boards are unable to disassociate the compulsions of the government with that of the PSU.
The governance of public sector banks (PSB) is an even greater concern. These banks account for over 60% of the total banking assets. Most of these have large Gross NPA levels (over 10%) and several have capital adequacy levels lower than the RBI stipulated thresholds. Merging the banks – Bank of Baroda, Vijaya Bank, Dena Bank, and the proposed Punjab National Bank, Andhra Bank, Oriental Bank of Commerce, Allahabad Bank - will help to support the balance sheets of the weaker banks. But, in the end, there needs to be greater decision-making and accountability in these banks. With multiple audits, and vigilance mechanisms, there are greater incentives to not take decisions, rather than take bold ones. This, by itself, is detrimental to the overall credit market, which continues to rely on the banking channel for a dominant part of its funding requirement.
To follow through on the BJP’s 2019 election manifesto promise of a USD 5 trillion economy, there are several measures that the NDA government will need to take. But the biggest focus must be on the efficacy and quality of capital. For India to remain a sustained attraction for global funds, investors need to see better corporate and regulatory behaviour, and a stronger redressal mechanism. These are key pillars to sustainable economic growth.
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