My article which appeared in 31st Jan 2019 issue of Free Press Journal

Capital markets set to be growth catalyst for India

written by R Kannan January 31, 2019 9:19 am

By 2025, India will have one of the most sophisticated financial markets in the world, with the best practices and adoption of cutting edge technologies. Companies have to identify the right business model and funding model to capitalise on emerging opportunities, says R.Kannan

India has a very robust capital market and if the economic growth continues its momentum, by 2025 India could be among the top three capital markets in the world. India is growing at a rate of more than 7 per cent per annum now and going forward, for the next few years, Indian economy is likely to grow at a CAGR of 7 per cent. Many strategies and action plans are being discussed by various stakeholders on how to reach a Gross Domestic Product (GDP) of $5 trillion, as fast as possible. The robust growth in India is facilitated by various sources of funding. India is gradually moving from bank-based funding model to market-based funding model. In fact, in the last two years, markets have played a major role in meeting the funding requirements of corporates and the government. In the financial year 2018 (FY18), the funds raised from the capital market through equity and debt amounted to Rs 8.8 lakh crore, more than $100 billion.

India has one of the highest gross savings in the world. The savings of 30 per cent is mainly invested in physical assets in India and only a small portion of the savings is invested in capital markets. The level of financial intermediation in India is insignificant compared to other major markets in the world. The savings in the economy is about $750 billion a year and for infrastructure, India requires only $200 billion a year and including the capex in other sectors, the requirement of funds is lower than the overall savings. If a higher level of financial intermediation is achieved, this will result in meeting the funding requirements of Indian corporates and government through internal, domestic sources. Today, there was a reliance on foreign direct investment (FDI) and other investments by FIIs/FPIS from abroad to meet the funding requirements. A well-developed capital market will facilitate the channelising of funds smoothly to the required sectors.

Economies in the world can be classified into three categories in terms of how the funding needs in the economy are met. In the first category, many of the developed countries figure and the main sources of funding in the economy are capital markets. Even the charitable institutions and municipal bodies go to capital markets to meet their funding requirements. The second category of countries rely on both bank funding and capital markets to meet their fund requirements. In the third category, most of the funds required come from the banking system. India falls under the second category and the capital markets are in a take off stage and in future it is likely that the funds raised from capital markets will exceed the funds raised from banks. This trend is already visible in the Indian market. India is moving towards a higher level of financialisation.

The recent trends in digitalisation, demonetisation, financial inclusion, investor awareness, new financial products, introduction of GST and fintech revolution would accelerate the process of financial intermediation. The faster adoption of emerging technologies by customers including mobile transactions and digital transactions will help in introduction of many new financial products. The other trends which will accelerate the growth of capital market include: Opening of bond markets to retail segment, introduction of Real estate investment trusts (REITs) and infrastructure investment trusts (InvITs), securitisation, rising incomes, adoption of financial products in rural areas, cross sale of financial products, increasing popularity of wealth management and development of commodities trading market.

In any economy, where the per capita GDP is above $1500, the financial services sector grows at double the rate of the GDP growth. Assuming that, our economy will grow at a CAGR of 7 per cent in the coming years and reach a level of $4 trillion by 2025. The savings in a year will rise to $1.2 trillion. The capital markets will see a growth of 14 per cent CAGR. The resources raised from capital markets in a year will rise from $120 billion in 2018 to $300 billion in 2025. Mutual funds have become very popular in India and in the last few years and the industry size was at $331 billion at the end of March 18. At a growth of 15 per cent CAGR, the size of assets managed by mutual funds will rise to $880 billion by March 2025. The concept of systematic investment plans (SIPs) and the government outsourcing the management of corpus of the pension and other organisations also will a give a fillip to the mutual fund industry.

IPOs & secondary markets

India has the largest number of listed companies in the world and the average amount raised in Initial public offerings (IPOs) by a company has multiplied several times. Further, the stock exchanges also had opened windows for companies from SME sector to get listed and separate platform for trading of the stocks. There is a continuous introduction of new products and processes in the market, which will make the financial intermediation take off in a big way.

Life insurance

The penetration of insurance in India is very low and at the end of March 2017, the sector had a premium of $64.64 billion. The CAGR in the past was around 13 per cent. Assuming the same trend will continue, the size of this sector will rise to $170 billion annual premium. The share of private sector and new products in the overall pie will increase.

Non-life insurance

The size of the industry at the end of March was at $19.71 billion (premium). The industry is likely to grow at a CAGR of 14 per cent per annum. The premium by March 2025 is likely to rise to $56 billion a year. The insurance industry is likely to have assets under management of more than $1 trillion by 2025. Only insurance and pension industries have long term funds, which can be deployed in Iong-gestation infrastructure projects without any asset liability mismatch.

Pension funds

The funds under the management at the end of October 2018 was at Rs 2.63 lakh crore. This industry is likely to grow at more than 20 per cent per annum. The industry can provide long term funds for the Infrastructure sector. By 2025, the industry size is likely to be at Rs 10,00,000 crore.

Private equity & venture funds

In India, the concept of alternate assets has taken off. Various types of funds focussing on different aspects of the economy have emerged. Various new initiatives by the new government has given a big fillip to start up movement in India and at the end of 2017, the PE investments in India were valued at $26.45 billion and they grew at a CAGR of 28 per cent in the last five years and assuming that, they will grow at 20 per cent CAGR in the coming years, the industry will grow to $110 billion.

NBFCs

In the last few years, Non-banking financial companies (NBFCs) were growing at 18 per cent+ per annum and they had gained market share from bank funding. Especially, in realty funding, NBFCs increased their share substantially. But most of their funding was coming from banks and mutual funds. NBFCs mobilised short term funds and deployed in long term assets. This has resulted in a mismatch of asset liability. Their under writing losses also increased. Due to recent fiasco in the NBFC sector, these companies are in the process of realigning the business model and funding model. Despite the setback, this sector is likely to grow at a CAGR of 15 per cent in the coming years. Their share in total outstanding credit in India stands at 18 per cent and this is likely to rise to 25 per cent by 2025. The recent developments in the banking, financial services and insurance (BFSI) sector including the issues relating to NBFC sector and emerging vigilant regulation will force the marginal players to exit the business. There will be a consolidation from mergers and acquisitions. The companies with good underwriting skills, robust asset and liability management (ALM) and diligent risk management system will take over the weaker ones leading to consolidation of the industry.

To become the third-largest capital markets in the world, some of the action plans which could be taken by the authorities and stakeholders could include: Create enabling legislation for the faster growth of the markets. Stable policies. Assuring a certainty of implementation of policy/rule for at least five years. Improve the ease of doing business in these sectors. Allowing the introduction of new financial products available in other parts of the world. Introduce many new products where, the main target segment will be retail customers.Create an integrated and unified approach to regulation of all the business segments in capital market. Create incentives for investment in long dated instruments. Move towards a single KYC concept in the financial services sector. Create a centralised data base, where the data from all the regulators are aggregated, stored and used for formulating future policies. Develop a robust system for security of data and use of data for authorised purposes.

Use the electronic media to create an awareness among most of the population on the financial products. By 2025, India will have one of the most sophisticated financial markets in the world, with the best practices and adoption of the cutting edge technologies. Customers will have wider choice of financial products to choose from. The technology will bring challenges including cyber security and by 2025, the adoption cyber security solutions will have attained a maturity. India will become one of the most attractive markets for investment and our market capitalisation is likely to be in the top three in the world. Banks and financial services companies constitute a significant portion of the market indices in India today and in the total market capitalisation of the country. Considering the high growth of the capital markets, the preference for BFSI stocks will rise further and their share in overall market capitalisation will rise. The capital markets will play a major role in the years to come. In future, there will be a thrust on innovation in products, processes and distribution channels which will increase the share of capital markets in financial transactions in the economy. In conclusion, the future of capital markets in India is good and will grow at a healthy growth. The capital market offers opportunities for stakeholders including companies, banks, NPFCs, insurance companies, wealth managers, pension funds, private equity and venture capital and brokers. The higher level of financial intermediation and faster adoption of fintech technology will ensure a higher growth of capital markets. Companies have to identify the right business model and funding model to capitalise the emerging opportunities and participate in the growth of capital markets.

The author is Head Corporate Performance Monitoring and Research, Hinduja Group

https://www.freepressjournal.in/business/capital-markets-set-to-be-growth-catalyst-for-india/1448605

Brexit Concerns - The way forward

The Article appeared in Free Press Jouranl

Brexit concerns: The way forward

written by R Kannan January 3, 2019 8:33 am

When the Brexit referendum was put to vote in UK, the general expectation was that it would remain in the EU. In the June 23, 2016 referendum, 17.4 million voters, 52 per cent, backed Brexit ,while 16.1 million, 48 per cent, backed staying in the union. The difference was only 4% of voters, 1.3 million. Since the time available for Brexit was 21 months from the date of referendum, the UK government was hopeful that before the period gets over, they would be able to strike a deal for post Brexit scenario with EU and other members countries and the Brexit process would be smooth, less painful and could be achieved in a least effort with least cost. After the result of referendum was out, it created ripples in UK. Looking at the thin margin, many felt that , Brexit would be bad for the UK Economy. There were also talks that second referendum should be conducted, since the margin was thin and for a event which would have significant impact for all the stakeholders, it was better to reconfirm the mood of people again before going ahead with such a big economic reform. By end of December 2018, the post Brexit deal is yet to be reached. This has created a lot of uncertainty in the minds of all the stakeholders and will have significant short term impact on the UK economy. Closer to the implementation date, it emerges that there are many issues relating to immigration, trade barriers, cost of doing business, logistics, hospitality, business competitiveness and the need to add many new departments and functions in various government departments with huge financial outlays. Further, it has created a turbulence in terms of future of businesses, employees and the economic growth. Brexit decision is a unilateral decision.

The ECJ, in its recent statement, opined that since UK decided to exit EU on its own, till the post Brexit agreements are in place and the date of Brexit arrives, UK still has the discretion to withdraw from Brexit. Of course, UK has to go through the governance procedures, indicating that it could go through the process of parliamentary vote or any other procedure including a new referendum which would allow UK to withdraw from its proposal to exit EU. As the dead line nears, the expert predictions also indicate that the Probability of UK remaining in the EU has increased. There is an increased concern and wish that UK withdraws from the process of Brexit. Considering the fact that UKs trade with Europe amounts to 49% of its total trade, Brexit is likely to increase the cost of trade in terms of additional procedures, transport delays, additional levies and reducing the ease of doing business. Today many countries are focussing on liberalising the trade and set a goal to move towards higher rank in ease of doing business.

In 2009, the ease of doing business rank of UK was at 5 and it slided to 9 by the year 2018. If Brexit is brought in effect, UKs rank is likely to slide down further. Brexit will increase the trade barriers. To reduce the impact of the barriers, the efforts should be to remove tariffs and eliminate non-tariff barriers to trade. The assumption behind Brexit is that this would happen, which will not be true when it comes to the implementation. When various expert studies predicted the loss of economic output, one of the main reasons highlighted in those studies was the presence of new trade barriers.

Brexit will reduce FDI. Of the total FDI in UK, in Jan 2018, 42.6% of the investments were from EU and from the companies which have strong ties with the UK. After the Brexit, the cross border trade will reduce, thereby reducing the attractiveness of investments by EU companies in UK. Brexit will have impact on availability of skilled employees. As of now, there are one million Britons living in EU and 3.5 million citizens living in UK. EU has made a provision for UK nationals to remain in EU and have introduced a scheme for them to stay in EU. But it is unclear what will happen to 3.5 million from EU who are living in UK. Even UK nationals have started registering for citizenship in other countries to avoid the uncertainty. After the Brexit, it is not clear how the dynamics will work out. If EU citizens leave the country, it will create a big gap in skills required. This will also impact the productivity of the economy. The relationship of UK with other EU countries will undergo a big change.

At the same time, UK will have opportunities to consider other partners to expand its trade, especially from Asia, the countries like; India, China, Malaysia, Vietnam, and Thailand. The predictions by various experts on the post Brexit Scenario, project that there could be an economic output gain of 7% to Economic output loss of 18%. Reduce the ease of doing business and reinstating the barriers to trade is bound to reduce the economic output for both UK and EU. According to various experts, to assess , whether the Brexit is good or bad, there is a need to make the assumptions made for going for the Brexit vote transparent to every one.

While putting to vote, the action plans identified for how the migration would be handled has to be discussed in detail. The post Brexit predictions by UK government includes, the incremental growth , which will accrue to the UK economy through non – Brexit policy related actions. While looking at the post Brexit scenario, the effect of non Brexit policy related actions on economic growth should be separated, so as to understand the real effect of Brexit on the future of UK economic growth. In this world of VUCA, Brexit can have a negative effect on the UK and European economies. Whereas the scope for achieving a very high economic growth through Brexit is very limited. Further, most of the European economies are growing at the rate of 1 to 2 % and introducing a new uncertainty will debilitate Europe when there are other factors like trade wars and withdrawal of Stimulus by US and Europe.

In the light of this, the following options could be looked at in resolving this issue. The government can take measures including , putting the proposal to vote in the parliament, conducting a second referendum or adopt any other procedure as per the UK legislation, which allows the withdrawal of the proposal to made to EU. This will help to maintain the status quo, removing all the uncertainties for both UK and the EU. Till now, no deal has been arrived at and there is an immediate need to decide on the way forward from March 2019. To reduce the impact of no deal, which is likely to be very costly for the UK economy, in the event of deciding to proceed with Brexit,the following options could be looked at. Send a proposal to EU to extend the time period of Brexit by another six months to one year, go with the Brexit and allow the present arrangements to continue for six months to one year, enter into agreements with each individual member country of EU, where the agreement is similar to, mirror image of the one signed by UK to be part of the EU. By considering the above options, UK should be able to come out of the short term uncertainty and will have time to look at all the options which will ensure the continued competitiveness of UK economy and its long-term stable future.

https://www.freepressjournal.in/analysis/brexit-concerns-the-way-forward/1428351

R Kanan is the Head of Corporate Performance Monitoring and Research, Hinduja Group. (Views are personal).