The Changing Nature Of Indian Capitalism

By focusing on crony capitalism, we run the risk of focusing on yesterday’s narrative, writes Saurabh Mukherjea.

<div class="paragraphs"><p>The BSE building rises above surrounding buildings in Mumbai, on March 16, 2007. (Photographer: Scott Eells/Bloomberg News)</p></div>
The BSE building rises above surrounding buildings in Mumbai, on March 16, 2007. (Photographer: Scott Eells/Bloomberg News)

When it comes to corporate life, the conventional negative narrative that is spun around India is that of crony capitalism.

The Conventional Narrative…

Since political parties routinely accuse each other of crony capitalism and the media loves carrying stories about billionaires who have gamed the system, this has become the default mental model used by many to understand India. Indeed, celebrated books are written on this subject including James Crabtree’s vividly written book from three years ago, ‘The Billionaire Raj’.

…Does Not Do Justice To India

However, as I explain below, the conventional narrative around scams and cronies doesn’t even begin to describe either the scale of the challenges or the opportunities India faces as it tries to make the transformation from what the World Bank calls a Lower Middle-Income country with around $2,000 per capita income to an Upper Middle-Income country – which are nations with a minimum per capita income of $4,000.

The Changing Nature Of Indian Capitalism

Let Me Begin With Challenges In India Before Going On To Opportunities

As my colleagues and I have described in our new book ‘Diamonds in the Dust: Consistent Compounding for Extraordinary Wealth Creation’, the major challenge India faces is thuggery by business owners who are not crony capitalists – they are just corrupt businessmen. Many of these businessmen fly under the radar – they are not household names and when they run away from India after looting billions from their shareholders and from their lenders, it is not front-page news.

In our book we have analysed this underbelly of Indian capitalism, companies who have meaningfully diminished your net worth although you might not be aware of the same. For example, we have described at length a company called Cox & Kings Ltd. The company has a long and interesting history but if you look at the firm’s accounts carefully, as the Enforcement Directorate recently did, you find that billions of dollars—raised in the stock market and from the banks—disappeared.

<div class="paragraphs"><p>(Image: BloombergQuint)</p></div>

(Image: BloombergQuint)

Whilst we have used forensic accounting techniques, to show how the monies disappeared, the interesting thing is that for nearly a decade my colleagues have been reading Cox & Kings’ accounts and were left perplexed that this company was consistently able to raise so much money. Why weren’t the investors heeding the published financial statements of Cox & Kings? Or of Amtek Auto or Dewan Housing Finance – companies whose accounts we have dissected in our new book.

Our research suggests that nearly half of all listed companies in India have significant accounting issues.

Most of these companies are in sectors where the role of the state is modest at best. Hence, by focusing on crony capitalism, we run the risk of focusing on yesterday’s narrative whilst seeking remedies for today’s problems.

Two More Facets Of Modern India That Pose Immense Challenges As Well As Opportunities

Over the past decade, India has been economically integrated as a nation. The national highway network has doubled. The number of people taking domestic flights has more than quadrupled. The number of people with broadband connections has grown 50-fold over the past ten years. 13 years ago, when I migrated to India, one in three families had a bank account. Now, nearly all families have a bank account. And of course, the Goods and Services Tax has meaningfully integrated the economy over the past four years ago.

The integration of India has handed over a decisive advantage to well-managed, efficient enterprises who are spreading their wings nationally and in so doing obliterating smaller local and regional franchises. For example, as the economy gets integrated, lending, which was once dominated by regional players is now seeing the emergence of a few national leviathans like HDFC Bank Ltd. and HDFC Ltd., with both lenders now safely ensconced in the list of top 20 profit generators in India. Similarly, if you look at the 70 or so unicorns which have been created in India, almost all of them are in some shape or form formalising and consolidating industries that are informal and dispersed eg. cab transport, food delivery, poultry consumption, groceries, and education.

The United States went through this phenomenon in the half a century prior to the Great Depression. Japan developed much the same way in the half-century after the Second World War. Ditto for South Korea after the Korean War.

<div class="paragraphs"><p>The Standard Oil Refinery No. 1 in Cleveland, Ohio, in 1889. (Photograph:&nbsp;Case Western Reserve University)</p></div>

The Standard Oil Refinery No. 1 in Cleveland, Ohio, in 1889. (Photograph: Case Western Reserve University)

100 Unicorns: India Inc.’s Billion-Dollar Club Is A Lot Bigger Than Thought

In parallel, India is experiencing the same tech and data related opportunities that the Western world faces i.e. smart lenders, insurers, retailers, and consumer goods companies are collecting data on your and my earning and spending patterns and tapping into our digital footprint to navigate their way around this vast and complex country which is ripe with opportunity.

In ‘Diamonds in the Dust’, we have provided case studies of extraordinarily able firms like Asian Paints, HDFC Bank, Kotak Bank, and Pidilite who have built extremely powerful franchises in India by harnessing technology in the context of the modern Indian economy far more adroitly than their competitors.

In so doing, these efficient Indian companies are validating what John Sutton of the London School of Economics wrote 30 years ago in a prescient book titled ‘Sunk Costs and Market Structure’. Sutton foresaw how the application of modern marketing techniques, R&D, and technology would lead to the polarisation of profits.

Case Study Which Illustrates, In The Indian context, John Sutton’s Theory

In 1970, Asian Paints invested Rs 8 crore in the first supercomputer to be purchased by a private-sector enterprise in India. Asian Paints then used this computer to collect detailed data on paint demand – across its vast dealer network, for every colour, for every truckload delivered to every dealer. As a result, Asian Paints’ management developed greater familiarity with understanding and managing data than any other paint company in India. Through the 1980s, 1990s, and through to current day, they fed this data into increasingly sophisticated software platforms which helped them predict demand, time their raw material purchases and manage their inventory and production cycles.

The company’s working capital cycle (i.e., receivables + inventory – trade payables – other current liabilities) in its decorative business shrank to a mere six days from a hundred days 25 years ago.
<div class="paragraphs"><p>Buckets of Asian Paints paint at a store in Mumbai, on Feb 6, 2021. (Photographer: Dhiraj Singh/Bloomberg)</p></div>

Buckets of Asian Paints paint at a store in Mumbai, on Feb 6, 2021. (Photographer: Dhiraj Singh/Bloomberg)

A super crunched working capital cycle gave Asian Paints free cashflows which were 8x better than its competitors. The company re-invested these cashflows in expanding capacity (which has grown 15-fold in the last 25 years) and in further technology investments, for example, around cost optimisation, and around 3D visualisation technology at its ‘Beautiful Homes’.

This dynamic creates a synergistic spiral which makes it difficult for Asian Paints’ competitors to compete with the firm (i.e., Asian Paints has better tech and more data and hence better cashflows which in turn leads to greater tech investments from Asian Paints which in turn leads more cash flow and so on). Having grown free cashflows over 70-fold in the last 20 years, Asian Paints is amongst India’s most consistent compounders.

You Might Ask ‘Why Is This Relevant For Me?’ Here’s Why…

The two facets of India that I have just laid out are transforming the corporate landscape. Today, no more than 15 companies account for 90% of all corporate profits generated in India. A decade ago the corresponding figure was just above 30%.

Given this immense concentration of profits in the hands of a few companies, it should come as no surprise to you that just 16 companies accounted for 80% of the wealth generated by the Nifty 50 over the past decade. By the way, very few of these companies are crony capitalists.

What Does It Portend For India As A Nation?

On the face of it the question ‘how can we stop corrupt companies from stealing investors’ money?’ sounds very different from the questions ‘who owns that data that you and I generate when we switch on our smartphones? Does the company own it? Does the customer own it? Or does society as a whole own it?’

However, all of these questions represent what economists call “a tragedy of the commons” i.e. a situation in which individuals users – who have open access to a resource – act independently according to their own self-interest and contrary to the common good of all users.

I don’t know how to solve these problems but I know of some people who have given considerable thought to such matters. In their book ‘Greed is Dead’, Sir John Kay and Sir Paul Collier highlight the work of “Elinor Ostrom, the political scientist who was awarded the Nobel Prize in economics for her studies on small communities which had built social conventions that overcome the” tragedy of the commons.

Ostrom’s remedies for such problems had three dimensions that I think are relevant for India.

  • Firstly, “Ostrom’s most fundamental requirement was boundedness: clarity as to who belonged to the community and who did not. People could join the community but common purpose could only develop if everyone knew to whom they owed obligations and from whom they could expect them…”

  • Secondly, “Ostrom also emphasised empowerment. Community members should be able to participate in modifying the rules as circumstances change…”

  • Thirdly, Ostrom emphasised ‘subsidiarity’ which means that “common purpose should be built and delivered through the lowest level at which co-operation is necessary.” So, for example, if in India investors like me are exercised about corporate fraud, it makes sense for people like me to write books like ‘Diamonds in the Dust’ laying out effective fraud detection techniques that other investors can use.

Beyond the world of investing, in India we have seen such civil society-driven intervention - as predicted by Ostrom’s research – work very effectively during the Covid-19 crisis. With the help of social media, a complex, interacting web of volunteers, medical professionals, donors, and civil servants came together to steer India through the second wave.

As James Crabtree explains in ‘The Billionaire Raj’, a century ago America addressed issues similar to those we face in India today. The fifty years of American economic integration prior to the Great Depression paved the way for the “Progressive Era” where middle-class Americans addressed the problems created by industrialisation, urbanisation, and political capture. A proactive middle class catalysed the creation of new institutions in the world’s richest democracy. A century on, a proactive Indian middle class can trigger a similar process in the world’s largest democracy.

Note: Asian Paints, HDFC Bank, Kotak Bank, and Pidilite form part of many of Marcellus Investment Managers’ portfolios.

Saurabh Mukherjea works for Marcellus Investment Managers. Marcellus’ new book, ‘Diamonds in the Dust: Consistent Compounding for Extraordinary Wealth Creation’ has been published by Penguin.

The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.