The year-long rise in foreign currency reserves shows no sign of abating. This reflects the low capacity of the economy to absorb available foreign currency.

India should have rushed to expand investment with imports of plant and machinery. Industry ought to have aggressively boosted capacity utilisation with imports of raw materials, intermediates and components. (Expanding investment buoys up aggregate demand and thus creates room for increased capacity utilisation). But neither expectation has materialised.

Burgeoning foreign currency reserves are bloating the domestic money supply. This is slated to be neutralised with enlarged public debt. The Reserve Bank proposes to sell government securities already on its books. This means ownership transfer of public debt to the commercial banks. There is thus little chance of government borrowings in excess of the budgeted amount being earmarked for new investment (in the public sector or the joint sector). The no-acceleration growth scenario will remain unchanged.

It would have been a different matter if foreign direct investment (FDI) in new assets (not in equity for takeover of existing assets) had assumed a mega dimension. In that event, the equity investment brought in (generally 100 per cent) would have covered the cost of imports of plant and machinery.

In the second round, with new manufacturing capacity in place, FDI demand for imports of intermediates, components etc. would have become visible.India needs FDI in a big way. FDI inflow reportedly exceeded foreign portfolio investment in 1996-97. Even so, cumulative FDI has not been enough. There is little evidence of new demand for imports. The policy focus must therefore be on getting FDI into new assets. It may be unfashionable to say so, but FDI must be allowed to freely choose the sectors of the real economy in which it wants to grow: be it consumer goods, intermediates, or infrastructure. For, as of now, the problem is one of deficient aggregate investment.

Besides the import slack, the other indicator of deficient investment is inactivity in the primary issues market. There are two reasons for the lull. Savers have become shy, perhaps even wary; and there are not enough good issues coming on offer.

The impact of investor phobia on corporate investment tends to be neglected because, so runs the argument, savings flow into the financial system any way; what does not go into the primary market, moves into bonds of the development financial institutions (DFIs) — like IDBI, IFCI and ICICI — or into deposits with the commercial banks. The reasoning is correct. Here precisely lies the rub.

Consider the financing pattern of corporate investment. This is broadly 1 of equity, 1 of long-term debt and 1 of short-term debt (commercial bank borrowings). But there is no reason why financial savings should flow in the 1:1:1 proportion to the segmented players in the financial markets. Since resources minus for primary markets means resources plus for DFIs and the commercial banks, savings of 100 will tend to be distributed as follows: primary market 20, DFIs 30 and commercial banks 50.

But, given the 1:1:1 financing pattern, the low allocation of the savings to the primary market (20), results is an unlendable surplus with DFIs (10) and commercial banks (30). Aggregate savings (100) then exceed domestic investment (60).

The problem of excess savings gets exacerbated when top Indian corporates access GDRs (resulting in a dearth of worthwhile rights issues for the domestic market) and external commercial borrowings (ECBs) to bypass (or minimise) borrowings from DFIs and the commercial banks. Investment may then be more than inferred from the estimate of savings surplus (40), but the larger investment bypasses domestic savings. The rise in investment does not lead to a corresponding increase in absorption of domestic savings.

The situation is mitigated somewhat, but only somewhat, by FDI. Thus, assume that FDI of 10 comes into the country. Since this comes wholly in equity (there have been few capital issues from foreign direct investors), the impact on the primary market will be nil. But FDI demand for funds from DFIs could be 10 and from the commercial banks 10, assuming no external commercial borrowings. In this case, the absorption of domestic savings (100) would rise from 60 to 80.

Though ECBs cannot be ruled out altogether, there is no denying that the savings `surplus' would decline, even if modestly, with a rise in FDI investment. The issue is how aggressively domestic lenders will accommodate FDI to thus absorb excess domestic savings. But there is no knowing how soon FDI will accelerate. There is thus a case for enlarged public investment (with borrowings exceeding the budget target) to ginger up aggregate investment.

If the cuckoo does not sing, do you coax the bird, beat it or wait? There is no guarantee that FDI will burgeon; public investment with enlarged public debt is heresy; and waiting is not feasible since the investment deficiency in relation to available savings will only reinforce the no-acceleration of growth syndrome.

It is time to ask if India has enough entrepreneurs to boost private investment. Entrepreneurs are usually taken to mean select corporates, say, the Crisil 500 companies. But the top corporates have raised enough from the primary markets during the last three years, and as much as they could from the DFIs and commercial banks; many have tapped GDRs and ECBs as well. It will be a couple years before they look for opportunities to expand their empires.

But take a close look at the non-corporates. Their numbers are very large. They get some working capital from the banks, and term loans to a limited extent from DFIs. But they have no access to the primary market or to large long-term capital: they are fundamentally dependent on NBFCs and informal lenders. The arm's-length approach of the organised financial sector (that is, the DFIs and the commercial banks) has confined many non-corporates to their size class, that is, prevented them from growing big.

If the banks and DFIs continue to focus on the cream of CRISIL 500 companies, they will be in no position to optimise investment of available domestic and foreign savings. They must look beyond their nose, and nurture fledgling non-corporates. The commercial banks and the DFIs have the expertise to ferret out the potential growers. They also have enough knowledge about the market (what is in demand, what products can be competitively manufactured, what technology to adopt and how it can be accessed) to goad non-corporates to become mid-sized corporates, and the mid-sized ones to jump into the giant league.

The financial system has segmented its business. The big institutions look at only the established corporates. Non-corporates are left to fend for themselves. The financial system is also in a straitjacket: the lender of working capital does not foray into term lending and vice versa; and the commercial banks stay away from primary issues.

The configuration of resources disbursed by different players in the financial system does not match the requirements of the real economy. The mismatch is at bottom responsible for a savings surplus in a savings short economy. In Japan, Korea and of late in Malaysia and Thailand, banks have close links with industrial borrowers, big and small. Indeed, banks call the shots by virtue of the ownership of equity of industrial borrowers. The short point is, from being mere money-lenders, DFIs and banks must become participative entrepreneurs.

Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.