Making India : Will the Elephant dance

India at one time accounted for 30% of GDP of the world, according to Angus Madison, alongwith China which also had similar massive share, before both the asian giants went into deep slumber. India continues to have huge share in terms of population today with 1 in 6 persons being Indians, but not GDP. China, on the other hand has managed to modernise itself and is better than first world with relentless efforts over last 3 decades. India only started the march in 1990s when it was pushed back to the wall. The first generation reforms have clearly provided a launchpad over last 25 years and the pace has been accelerating off late, with India poised to become fifth largest economy, though still quite small in per capita GDP. The next 25 years will determine whether India can match China's spectacular rise and become second or third largest, claiming back its share or match the population share. The optimism stems from the fact that population is no longer a weakness, but as China has shown, a big strength. Of course, China's model was driven by being industrial engine for the world, whereas India's will be services engine of the world. In the world where data is the new oil, India's diverse and young population is a huge asset, especially for training AI, which some say as the new electricity. What India needs to achieve the aspiration for growth is two things: easy capital and easy laws. These two are like the shackles over the possible explosive growth potential India has. Lets look at them one by one. Both are critical for start up India to succeed, while the second is also necessary for getting foreign capital into India. One can think of finance being a prerequisite for upside growth, whereas legal efficiency a mitigant to downside.

Finance : Scoring the upside

Most of India's population resides in semi urban or rural areas though urbanisation is increasing rapidly. For the vast swathe of population, starting new enterprise as an SME is fraught with complexities. The biggest reason for this is access to finance. Capital is the lifeblood of any enterprise. India is a unique country where cost of capital for SMEs is reasonably low, and the distribution of the bank branches is one of the largest in the world. However, most of these branches act only as liability generators, or to implement specific asset side programs such as agriculture related or priority sector loans. The reason for this is general credit has still been a function of looking into the eye of a potential borrower and deciding the integrity the old fashioned way. As J Pierpont Morgan, the father of modern banking said,

“The first thing (in credit) is character… before money or anything else. Money cannot buy it.”

India took his advice rather seriously. It did not help that data for any rational decision making was never available, and where it was, it could never be relied upon fully. This problem was not only for the SMEs, but even for big names, as the recent NPA mess shows. Most of those big ticket loans which went bad were made on the basis of extensive data, except that the data was either speculative (future projections) or false (fraud). For SMEs which relied on hand written bills or in many cases no bills for revenues or costs, it was never possible to actually figure out the financial condition from facts. Thus came emphasis on secured credit, where if the loan went bad, lender made the loss from the underlying property, whether it was a bank or private money lender or loan shark. However, this made process of capital raising tedious, connection driven and unnecessarily time consuming. Today the system stands on the cusp of a major breakthrough, as for a key part of funding requirement for any enterprise, which is for business as usual. This was earlier met by concept of maximum permissible bank finance, a last century assessment technique. Today, with all invoices becoming digital, thanks to GST, demonetisation and now eway bill, the entire working capital can move purely to invoice based granular financing. This implies creating limits based on broad activity levels, but utilising it only for payment for a certain good or service, against an identified counter party with a GST bill. Most of the large corporate defaults leveraged the lacunae of working capital system. Given the gargantuan amount of total bank credit in India, any reduction in defaults will increase access to credit for SMEs. If the cost of capital for SMEs comes down from its current 20% to say 12-14%, and the need for fixed asset collateral is diluted with specific cashflow underlying, the SMEs will certainly fly. Banks of course need to change their credit procedures, such as outdated norms of assessment, branch based restrictions and instead invest in automated credit decisions, analytics and fraud security. With the cloud based software as a service (SaaS) products, the cost of IT infrastructure and linkages has literally crashed making it possible to run lending business digitally, at a fraction of cost before, with larger coverage and lower risk.

Laws : Dealing with the downside

The second limiting factor today is laws. While finance may hopefully become easy soon with the slew of measures to improve generation of reliable data, the legal process is not so data driven. If finance is the lifeblood for continuous expansion of business, a seamless legal system is the safety valve for dispute resolution or weeding out bad apples. It is extremely important for the legal system to deliver quick and effective solutions to problems between economic agents for efficient functioning of financial system.

According to William Penn, the founder of state of Pennsylvania in United States,

To delay justice is injustice.

However, one routinely come across cases in India where a commercial dispute (or for that matter, any dispute) lingers on for years. The number of laws are too many whereas the actual implementation is patchy and backlog of past cases in decades. Due to lack of efficient administration of laws, the pendulum of administration keeps swinging between too heavy handed or too lax. Again like banking where the process of whether to give a loan has become too subjective, legal processes have also become quite arcane for most people. The complex structure of the various courts, lack of their predictive data especially in terms of actual judicial decision making and lack of deadlines makes the process long winded and sometimes leveraged by the more powerful and unscrupulous people with resources. In this fast paced digital age , the judicial holidays and long judgments evoke bygone era, with the concept of turnaround time being non existent. Specifically with reference to corporate or SME activity, whether for finding quick solutions for disputes or for closing business, higher time taken increases the risk multi fold. In fact, that is another reason for access to capital being difficult as detailed above and generally banks becoming more and more risk averse. Unless the underlying laws and accompanying rules are made simpler, with strong implementation and time bound legal resolution, India will be always at a disadvantage, whether for Indians or for foreigners. This could be one reason why India has not yet produced a company worth few hundred billions of dollars, despite it being now the fifth largest economy and one of the largest markets globally for all sorts of things.

To summarise, for Indian elephant to dance, each of its molecules need to jiggle, which would be the millions of its SMEs. And to dance, they need capital for growth with fresh thinking from banks and a safety net in form of supportive legal system that helps by delivering speedy justice.