Perils of Abstraction

In MARCH 2005 private equity firm Warburg Pincus, sold $560 million worth of Bharti Televentures’ stock in 28 minutes on the BSE. This attracted world-wide attention, both for the money Warburg made and the maturity and depth of India’s capital markets. Indeed, in a series of further transactions Warburg made around six times its original investment in Bharti. Paradoxically, the fact that Warburg was able to exit so smoothly, with loads of cash, made India more attractive for private equity and other sorts of foreign investors to come in. What’s the connection between this, and the Left’s demand that capital gains tax should be reintroduced and the DTAA with Mauritius scrapped in order to regulate flows of what it considers to be hot money? Simply this; the distinction between what the Left calls speculative inflows of capital and FDI, is partly artificial. Conceptually, the distinction between FII and FDI is crystal clear. The former goes into secondary markets and flies out at the slightest hint of trouble. The latter goes into factories and buildings, and is thus considered stickier.
In practice, things are far less clear. The activities of FIIs and hedge funds have made Indian markets enormously liquid. This liquidity makes FDI easier. FDI does not only mean building new factories. Many foreign investors prefer buying into existing companies — Holcim taking over Gujarat Ambuja, or Oracle buying into i-flex. Wellfunctioning secondary markets also make it easier for foreign investors to exit with their profits thus, paradoxically, encouraging others to enter. The phenomenon of pre-IPO placements by institutional investors also blurs the distinction. In the case of Reliance Petroleum’s recent IPO, the company attracted Rs 2,700 crore of investment through such a quasi-FDI placement. Similarly, FIIs heavily dominate the 50% of public issues reserved for institutional investors. This doesn’t count as FDI as ownership keeps changing with shares being traded every minute. But the original money going into public issues is for project finance. A deep primary market is dependent on a vibrant secondary market, a phenomenon for which FIIs are largely responsible.

-- The Economic Times Editorial dated 31st March 2006