Policy puzzles leave PE investors in a maze

Private equity investors will continue to be interested in India, but the recent regulatory issues have raised doubts in their minds, says S.M. Sundaram, Partner and Chief Financial Officer, Baring Private Equity Partners India, a leading PE firm.

As long as people are willing to invest in emerging markets and as long as India continues to be in the top three or four in this category, capital flows will happen. The challenge now is where India ranks among the emerging markets. “More importantly, what is the kind of risk premium we should attach to India has started becoming top of the mind question for investors,” he says.

Capital rationing

Sundaram attributes this to certain regulatory issues of the past few months. Investors were aware of the challenges of doing business in India. For instance, they knew that getting a project off the ground in India took far longer than it did in, say, South Africa, Russia or Latin America.

They also knew that that the risk premium that they should attach as far as government approvals and regulatory clearances were concerned was three times that in other countries.

However, what has happened, says Sundaram, is that the ad hoc regulatory changes have forced PE investors to factor in a risk premium into their investment plans. Projects, which hitherto passed the test of investment worthiness, may no longer do so because of moves such as those aimed at revising tax laws with retrospective effect.

Investors will have to reckon with a reduced rate of return. Consequent capital rationing will happen. “The amount of capital which will get allocated for a 10-12 per cent return will naturally be less than what will get allocated for a 15 per cent return,” says Sundaram.

He is surprised by statements from bureaucrats and politicians that the proposed tax amendments will not affect capital flows into the country.

“You may still see capital coming into the country, but what may never get captured is how much more could have flowed in. No one will make a noise about what investments they are not going to make,” says Sundaram.

Intent gap

He feels that the global economic turmoil will not drastically affect the way PE investors behave. After all, private equity is long-term or patient capital. The investors are used to surviving multiple economic cycles. They are only interested in the fundamental strength of a business and whether the entrepreneur is one who can be trusted.

India, according to him, thanks to being a domestic-consumption-driven economy, can do much better in attracting funds if only it has policies that spur this consumption. Where it fails is that there is a huge gap between actual intent and stated intent.

For instance, if the government says it is going to lay 20 km of roads a day, is that the real intent? That may be the stated intent and the achievement will fall far short of what has been stated.

What is coming under question is stated intent versus actual intent versus execution. “The question we get asked as money managers is how are you going to handle these constraints and still make money,” he says.

On Baring’s strategy in India, Sundaram says it has about $1 billion across three funds, of which about $250 million is yet to be invested. Baring looks at about 10 sectors, including IT/ITeS, pharmaceuticals, biotechnology, real estate, energy, infrastructure, financial services, consumer goods and education.

Baring plays an active role in the companies it invests in, even if it has only a minority stake. It is particular that strict corporate governance standards are adhered to.

For instance, it will ask for chairmanship of the audit committee and at least a membership if not the chairmanship of the remuneration committee. Any inter-company transaction between the one in which it has invested in and another belonging to the promoter should have board approval and Baring’s nod.

“What we also do is try and populate the company with independent directors who will really be able to guide the promoters and the management,” says Sundaram.

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