An Entrepreneur's Sorry Story

Anirudha Dutta
Updated: Nov 8, 2012 10:26:34 PM UTC

A few days ago, I spent some time with a group of people deliberating on what the agenda for India’s next government should be. People assembled in the room were a motley group with varied backgrounds from different sections of life, barring yours truly whose experience is limited to financial services only.

Since the Chatham House Rule (a core principle that governs the confidentiality of the source of information received at a meeting) applied to the deliberations, I am not at liberty to disclose the names or identities of the participants. Needless to say, there were different shades of opinion. In a country as diverse as India, that is not surprising and the plurality of views is very welcome.

Just before I left for the discussion, I had asked some of my colleagues and a few friends for brief answers to the following two questions:

  1. Other than corruption, what do you think is India’s biggest problem?
  2. How is India best equipped to solve it?

Predictably the answers were varied. Here are some samples:

  1.  Lack of political will
  2. Country’s resource base is insufficient
  3. Government – the mother of all problems
  4. Bureaucracy… presence of several middlemen
  5. The way it (India) builds its cities, and its labour laws that hinder job creation
  6. High inflation and poor infrastructure
  7. Sustained high inflation and fiscal deficit
  8. Disparity in income levels

The group that met was subsequently divided into smaller units to debate on specific subjects viz land, labour, capital and redistribution schemes. I was a part of the group that talked about labour; and as any discussion on labour is wont to, we were soon debating on why Indian entrepreneurs cannot scale up their businesses. Is it due to regulatory reasons (labour laws and the like) or infrastructure issues (power, affordable real estate, schools and so on)?

As the reader would have guessed, there were different view points and each view cogently argued.

One major impediment for entrepreneurs is the application of laws. It leaves a lot of room for discretion (and therefore, rent-seeking many a times) and delays implementation and execution to an extent where many entrepreneurs are happy to not expand; sometimes, they even give up their entrepreneurial dreams.

Here's one such story of Kaushik, a budding entrepreneur, who came back from the US to pursue his dreams in India. He gave up after four years of trial and his story (in his own words) is reproduced below:

The parliament passed the Credit Information Companies (Regulations) Act in 2005. The Gazette notification of the same came out on June 23, 2005. There were 13 bid submissions for licenses from various applicants.  At the time of submission of application, the RBI suggested a 6-7 month turnaround time in approving the license applications provided all the documents were in order; an additional 90 days for provisional grants and another 90 days thereafter for the final grant. 

During subsequent interactions with the RBI, it became clear that it was waiting for the Government to clarify on the quantum of FDI to be allowed within CICs (Credit Information Companies). No work on the application would be done without having the FDI quantum fixed.  Around the same time there were media reports on the FDI cap (ranging between 10 percent and 74 percent) being deliberated by the government and regulatory authorities.

Towards the end of January 2008, a media person called me to suggest that the Cabinet had decided on the FDI limit at 49 percent. When I rushed to the RBI with the information and subsequent media reports on the same, the federal bank cautioned me about my exuberance; it stated that there was official notification yet of the changes in the FDI policy, and no action could be based on rumours or media reports.

In mid-March that year, the official notification came from the Government pegging the FDI cap at 49 percent. The RBI promised a 90-day turnaround from then.

However in mid-June, we received another notification from the RBI suggesting that the share of Indian participants be capped at 10 percent. Thus, for the 51 percent Indian holding there had to be at least six participants. Companies were given seven days to respond with a revised shareholding. (The official reason for this additional cap on Indian shareholders was to diversify the holding, but ostensibly to limit the number of applicants.)

Given that was over we expected a quick turnaround; however the day the cash-for-votes scam broke in the Parliament, I received a call from a friend in a rival company who asked me to check the RBI website.  The site carried an additional notification suggesting that the maximum holding of any foreign company would also be limited to 10 percent even though 49 percent FDI was allowed.

We approached the RBI for clarifications on this, and were told that the decision was taken at the highest level keeping in mind that the investment limit for foreigners is only 10 percent in financial institutions in India.  Since CICs would ultimately fall into this category it was better to have the same rules across the board. 

No amount of reasoning (about the fact that most foreign participants in CICs were not financial investors but those who invested in technology, processes and IP and would need higher levels of investment and control within newly-formed companies to maintain their commitment levels) helped. Even suggestions that subsidiaries of foreign banks were wholly owned by them did not cut much ice as the decision of the 10 percent cap was taken by the authority.

Reaching out to a wider audience within the government and the RBI, we were told to wait till November 2008, when the then RBI incumbent’s tenure would end. We were also told that if a new person came in there would be a possibility of change; however if the incumbent continued then we should be resigned to a 10 percent cap. 

As we waited for the decision in November to come through, we worked out various permutations and combinations with our lawyers for a kind of structuring that would allow us to still manage with a 10 percent cap, given the company’s commitment to be part of the Indian economy.

Finally at the end of the year, there was a change at the helm of RBI and we received a notification shortly thereafter about the qualifications of those foreign companies who could invest up to 49 percent. With a huge sigh of relief we got back to work expecting a quick turnaround of fortunes.

But there was another twist in the tale. Soon thereafter, given that the quantum of foreign holding in certain prominent banks like ICICI Bank and HDFC Bank were higher than 51 percent, their origins as Indian banks were questioned.  Since some of these banks were part of Indian shareholders, we were quite concerned and reached out to the RBI once again. We were advised to wait for actual notifications to come around on this. Soon after, we received our provisional license around early March next year.

However, our joy was short-lived as we were informed that shareholdings of certain Indian banks in our case would be considered as foreign shareholding and would eat into our FDI limit unless we changed them.

The classification of these banks were a classic case of an Indian compromise which massaged both bureaucratic and regulatory egos, while allowing businesses to function without causing major upheavals. The prominent Indian banks were allowed to remain Indian; their shareholdings in any venture until then was considered Indian, but their shareholding in any new venture henceforth would be considered foreign.

We were put to test: On the eleventh hour, we were supposed to change our shareholding pattern and find new partners. The saga ended in 2009 with the grant of a final application which had a completely new set of partners as most of our earlier set was disqualified due to the new classification of banks.

Few Issues to be Highlighted:

1. Setting up a competitive credit bureau landscape in the country that would allow lending to a wide cross-section of consumers and keeping and monitoring the risk levels of banks while managing the lending process was the original goal of the CIC Act. The current incumbent that was originally formed in early 2000s but was not part of the CIC Act was allowed to function throug the entire process, thus completely changing the competitive nature of the landscape.

2. Allowing for the right set of competitors with the requisite knowledge, technology and processes were the criteria decided upon by bureaucratic and regulatory bodies. A bit of research and tightening of the regulations that were framed nearly 18 months after the original Act by the Parliament would have helped the due process significantly. World-over there are only 3-4 global players in this fairly niche area and the right set of regulations would have clearly kept out a whole host of other players who applied for licenses in the hope of making money.

3. Credit bureaus are important financial infrastructure that not only help financial institutions manage their credit risk process better, but also increase the breadth and scale of financial lending in the country.  Today when I hear about the RBI complaining that banks are not doing enough to increase lending or to decrease the ratio of cash in the economy, I smirk; it is the same RBI that took more than four-and-a-half years after the Act was passed to issue licenses to legitimate applicants, a process they could have easily completed in less than two years. 

4. Today when I see Government managers running pillar to post trying to manage political contradictions in pushing forward with further regulations that they believe would boost the economy, my only suggestion is that it is best if they work on timely and effective execution of existing policies and programmes; that would provide at least 1.5-2 percent fillip to GDP growth.

I wish Kaushik's tale had a happier ending. He deserted his entrepreneurial ambitions and has joined an American corporation in Mumbai. In the next blog, I will narrate the 'adventures' of two professionals who have set up a not-for-profit organisation with which I am associated.

As a part of our deliberations on labour, I discovered a couple of things: EPFO has an expense charge of 4.5 percent (I am yet to verify this but it came from a participant who should know his numbers) and nearly 40 percent of a worker’s salary in the organised sector gets deducted for various things like PF, ESI etc. 4.5 percent seems to be very high to run a mutual fund which essentially invests in government securities and the like.

I rapidly glanced through the EPFO Annual Report for 2010-11, and the annual administrative charges that employers of non-exempt organisations pay is 1.1 percent of the wages (see pg 22).

As an entrepreneur mentioned, none of his employees go to ESI hospitals because the facilities are poor. Therefore, their contribution is a waste; they would rather pay premium for health insurance. This is one of the major reasons for the rise in contract workforce in recent years. And therein lies another story for another day.

Rent-seeking and regulatory arbitrage benefit a few, something that we all know of, but is only spoken of in private conversations or stray media articles. It often needs outsiders like Arvind Kejriwal to come and stir the proverbial hornet's nest. Sandipan Deb has written some good columns on this in Mint.

The thoughts and opinions shared here are of the author.

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