12/23/2008

Politics Takes Backdoor to Progress

Politics Takes Backdoor to Progress

By Sean Hayes (Korea Times 12/03/08)

South Korea and India are scheduled to sign a Comprehensive Economic Partnership Agreement (CEPA). The accord will offer more opportunities for trade. However, many reforms are needed in both nations before the full benefits of the pact and free trade are realized.

For my Korean and international clients looking to invest in India, one of the most alarming discoveries is the dreadful state of the Indian banking sector.Many investors are hopeful for the continuation of 9 percent growth in India, but fear that if foreign direct investment (FDI) decreases, because of our present financial situation, it is likely that India's growth rate will drastically fall, which will naturally lead to fewer opportunities and benefits from investing in India.An interesting seminar, which I had the pleasure to present a paper at, hosted by the Asia-Europe Perspective Forum and the India-Korea Business and Policy Forum, was held Thursday.

The seminar discussed some of the necessary reforms that both nations need to quickly adopt. My presentation, at the seminar, emphasized business opportunities for Korean and Indian companies, while noting reforms that are needed in both countries.

In India, necessary reforms must be immediately implemented, according to many observers, in the banking sector. However, many fear that political interest groups in Korea and India, for their own self-interest and possibly self-preservation, will never allow them and that the status quo is likely to remain unchanged in the foreseeable future.

For example, India is vigorously seeking FDI mainly because of the lack of funding opportunities for local companies and the difficulty Indian companies face in obtaining external commercial borrowing (ECB).One reason for the funding difficulties, amongst others, is that India's financial sector is controlled by state-owned commercial banks, which are required to lend to ``priority" sectors.The Statutory Liquidity Rules (SLR) require that 25 percent of bank deposits in government securities, the nation has a low savings rate, the local stock markets only account for around 140 percent of GDP, and the bond market is dominated by the debt-ridden government (90 percent of the bond market in government debt).

These facts led to an economy that lacks the ability to adequately fund needed industries and corporations. Thus, FDI and ECB are vigorously sought.The answer to this problem, at first blush, is obvious. However, India is often, for political motivations, not willing to pursue the obvious.

India, first, needs to privatize banks. Nearly 80 percent of the assets and deposits in the banking sector are controlled by state-owned commercial banks. These banks are notorious for allocating capital in an inefficient manner.Secondly, India must lower the amount mandated to be loaned to priority sectors. Regulations mandate that state-owned banks must provide 40 percent and private banks 25 percent of their funds to priority sectors.

These sectors include politically sensitive entities such as agriculture enterprises and small businesses. These sectors' loans have a high likelihood of being non-performing and often are in industries that are returning very low returns on investment, thus leading to an inefficient use of capital.Additionally, India's high amount of government debt, SLR, and low stock market capitalization effectively creates a situation where companies have few internal sources of funding.

The answer lies in these and other liberalizations and the development and fostering of a vibrant and liquid market for corporate bonds.Koreans played an instrumental role in launching the Vietnamese stock market and will launch a Cambodian stock market. There experience in developing markets could be beneficial to an India striving to maintain consistent growth.

Hopefully, for the sake of India, politics will take a back door to development.

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SeanHayes@ipglegal.com