Corporate tax cuts aside, the way forward for the Indian economy will be paved with significant private investments which require effective corporate governance standards
The need for private investment by the corporate sector to provide impetus to the economy is of great interest and debate in India, given the clamour for significantly more private investment on the back of the corporate tax cuts by the government in the last calendar year. However, unfettering the corporates and allowing each agent to play its role in capital allocation decisions is essential in the grand scheme of things. The robust health of the corporate sector and the consequent advantages of a healthy investment environment are dependent on three major factors: the ability for and of firms to make optimal capital allocation decisions, an environment of efficient corporate governance standards and a regulatory framework that facilitates business.
While the counsel for routing excess capital from the corporate tax cuts to new investments commends itself, it is vital to ensure that at the firm level, new investments in the firm are indeed required. A corporate with excess capital has several choices, including that of reducing debt, investing in new capacity, share buybacks and accumulating the capital. Investing in new capacity is not necessarily always the best option from this range. The need to boost investments in India cannot be overemphasised but the focus must not shift from increasing productive investments. Mainly, while one hopes that the corporate tax cuts delivered last year lead to new private investments, the investments must not be at the cost of efficient capital allocation. Therefore, at the level of each business, the management concerned must decide to ensure the most productive capital allocation.
Essentially, this means that for those companies which have generated additional capital following the tax cuts, they have to make choices about what to do with the excess capital, subject to the nature of the industry, the debt-level of the company and the demand of the product. For certain companies, new private investment may make sense, while for others, reducing debt to shore up the balance sheet may be the most prudent decision. Regardless of what strategy the company adopts, the only criteria that should matter for the long-run health of the Indian economy is that companies choose the approach best suited for their circumstances.
There is little point in a company expanding capacity in the face of excess capacity. Capacity expansion, when not required, will lead to more of the same issues that the Indian economy faced, especially, over the second half of the last decade. Primarily, exuberant capacity expansion when not required, led to assets that failed to deliver returns commensurate with the risk undertaken. For the overall wellbeing and growth of the economy, capacity expansion must ideally occur when most required due to relatively higher capacity utilisation rates. A glance at the capacity utilisation numbers released by the Reserve Bank of India (RBI) shows a utilisation level of 73.6 per cent in the second quarter of 2019. This number was up at 83.20 per cent back in the first quarter of 2011.
One would assume that the excess capital with the private sector will head for expanding capacity as the utilisation rates inch higher. In the larger picture, allowing corporates, both large and small, to operate in an environment where they make the optimal capital decisions at a firm level is crucial for the robust health of the economy. Corporates must focus significantly more on creating sturdy balance sheets that can withstand the ebb and flow of the economic cycle.
Another pillar of economic growth is high corporate governance standards across the board. The efficient flow of capital in the economy and across corporate balance sheets is as dependent on optimal capital allocation decisions as it is upon maintaining the highest corporate governance standards. While India over the years has improved the corporate governance standards, issues around poor accounting standards and credit rating misses did mar the picture at the end of the last decade. It is essential that moving forward, both companies and regulators strive to improve the standards to facilitate more efficient capital flow.
Additionally, the stability of the regulatory regime must be guaranteed. While this is agreed upon by everybody, the ability to ensure that regulatory changes make economic sense is essential. Mainly, effective regulation must not
only be efficient in improving the regulatory standards but must also be practical in enforcement and usage. Ensuring a 'practical' regulatory environment is as important as maintaining the highest regulatory standards.
As India moves ahead and the Indian economy continues to formalise, corporates, both large and small, will have a significant role to play in the economy as investors, employers and capital generators. Allowing them a long-term horizon to make capital allocation decisions with the highest corporate governance standards in a stable regulatory environment will be a significant driver of further economic growth.
Taponeel Mukherjee heads Development Tracks, an advisory firm. Views expressed are strictly personal
- 17 May 2020 6:47 PM GMT
- 6 May 2020 6:06 PM GMT
- 8 May 2020 8:02 PM GMT
- 22 Aug 2019 6:17 PM GMT
- 25 Oct 2017 3:32 PM GMT
- 6 Jun 2020 8:27 AM GMT
- 6 Jun 2020 7:07 AM GMT
- 6 Jun 2020 7:02 AM GMT
- 6 Jun 2020 7:02 AM GMT
- 6 Jun 2020 7:01 AM GMT