India's private corporate sector has withdrawn into a shell. With the notable exception of Ambanis of Reliance, none of the big names project a vision of a spurt in gross fixed assets, sales and profits in the medium term. Mid-cap corporates from which a wave of new initiatives should have come, remain subdued.

Liberalisation was expected to unleash new products, processes and technologies. In the first episode of reform, this is precisely what appeared to be happening. But starting with the first half of 1996-97, enthusiasm waned. In 1997, the primary markets for both initial issues and rights issues moved into the doldrums.

There is widespread gloom. A variety of explanations have been offered for this. Lack of demand; fall in government's capital expenditure; and tight credit and high interest rates (the last are no longer valid). These are contributory factors to the investment decline after 1995-96. But they do not sufficiently explain flagging initiatives.

Two things are clear. One, entrepreneurs -- the established business houses and mid-cap companies -- are not pushing for investment. Two, the investing public, from individuals to merchant bankers to mutual funds, have become risk-averse. The combination of entrepreneurial caution and investor shyness has created what may be called a crisis of confidence.

The crisis has stemmed from over-expectation generated by reform. The original sin was the abolition of capital issues control without getting the market into position for fair pricing of capital issues. Sebi declined (unexpectedly, but rightly) to fix premiums of new and rights issues; this left a vacuum since merchant bankers and underwriters, even mutual funds, did not rate issue prices. Instead, they joined the game of exaggerated premiums. A case of cosy relationship between financial intermediaries and predatory capitalists. These market institutions fuelled over-expectation. Once it became clear that neither dividend nor capital appreciation prospects could justify the inflated premiums, came the crash. All this may be old hat. But the high premium expectations led many an entrepreneur up the garden path. Companies embarked on expansion in 1993-94 with borrowed funds in the expectation that once their projects neared completion they could raise cheap equity finance at a massive premium. Alas, the share markets collapsed. Several corporates resorted to high cost short-term borrowings in the hope that high premium issues would soon be the order of the day. They were not prepared for the CRB caps scam.

Companies like Core Parental and the Essar group are conspicuous cases which found the rug pulled from under their feet. The question may be asked why the development financial institutions did not come to the rescue of the companies which were badly hit even though they were executing worthwhile projects. Possibly, the problem was that many disadvantaged companies were defaulting on short term debt. So they were not considered sound borrowers.

But denial of funds by the development financial institutions (DFIs) only fulfilled their risk prophesy. A related question is why did not the concerned companies accept the reality of the market and issue shares at low or nil premium. The answer seems to be that they couldn't; their existing shareholders would have objected to dilution of equity at a low price. But waiting for share premiums to revive turned out to be a pipe dream. Several companies therefore pruned capital expenditure; while many put their proposals on hold. This is what triggered the investment recession in the private sector. But many finally had to make preferential issues: to the Indian controlling interest, to joint venture partners, and to foreign constituents. The preferential issues were made at a premium, but over the low prevailing share prices. If foreign investors increased their grip over the companies at a low price, the reason was the poor shape of the market, and not discriminatory government policy.

The crisis of confidence has another dimension. However unpleasant it may seem to say this, the big Indian corporates have simply not ventured into mega projects, though every one is agreed that a dozen or so investments of Rs 1000-5000 crore each should kick-start the economy. The DFIs and commercial banks alike are yearning to invest their surplus in large projects. But the big corporates are not eager to think big.

Indeed, India's capitalist big brass would rather that foreign investors come into infrastructure and "other industries" that require very large investment. These, according to Rahul Bajaj of Bombay Club, require very large investments, which Indian entrepreneurs may not be able to raise. So, all this talk of giving precedence to domestic liberalisation is hot air.

But what bugs the big Indian entrepreneur? The equity issue in support of big projects or ambitious expansion programmes must be large. The big entrepreneur does not have enough funds to control the majority stake. He will then have to share equity with the public and investment institutions. What is at stake thus is family control over enterprises. The unwillingness to dilute family control is thwarting the development of Indian capitalism.

The crisis of confidence has many dimensions. The big are unwilling to think big for fear of loss of family control. Mid-cap companies, caught by the crash in equity premiums and prices, have been thrown to the wolves by DFIs. The capital markets have simply not developed the institutions to assess equity risk (premium). Nor do the markets have any mechanism to filter such information as is doled out by corporates. Finally, abetting the crisis of confidence is the unwillingness of borrowers to service debt. Corporates default on deposits from the public with impunity. Banks and financial institutions are confronted with non-performing assets. According to the policy-maker, banks are solely responsible for reducing NPAs. There is nothing in the economic system that requires the borrower to fulfil his obligations to the lender. Legal proceedings for recovery take nine to ten years. The financial system suffers a severe haemorrhage.

Liberalisation assumes that markets will function; serve as a warning system; and impose discipline and punish. This is not happening. Liberalisation assumes capitalism has a vision. But capitalism dares not dream. The crisis of confidence is the result of flawed fundamentals.

Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.