As India's government forecasts 6.5% growth in gross domestic product for the fiscal year ending in March 2018, Vik Mehrotra of Venus Capital, the founder of the first India-focused hedge fund in the 1990s, explains why family office investors should meet the Indian demand for capital.
India is one of most compelling economic growth stories globally, but growth is being hindered by the lack of lending by banks to small businesses. For providers of private capital like family offices, that presents a huge investment opportunity and a chance to support Indian development.
According to the World Bank, small and medium-sized enterprises (SMEs) account for over 80% of total industrial enterprises and employ around 117 million people in India. More than half of these firms are based in rural areas and so they are playing a vital role in raising incomes and lifting millions of workers out of poverty. Others provide the consumer goods, real estate services, restaurants and IT products that the growing middle class is eager to consume.
But SMEs in India are starved of the growth capital that they need to invest in their future. Banks are mainly bureaucratic, state-run institutions. They weren't recapitalised after the 2008 financial crisis and, on average, have estimated non-performing assets of close to 20%. Their risk-averse management are failing to lend to the country's army of small businesses. High interest rates only compound the problem; the overall gap finance gap in the SME sector is estimated at $418 billion.
That's where private capital comes in. It's no surprise that a thriving alternative lending sector has established itself to become an integral part of India's financial system. With such massive unmet demand for growth capital from businesses, non-banking finance companies (NBFCs) have stepped in to fill the gap and supply direct lending quickly and efficiently to SMEs that want to take India into the future.
The Indian government has expressed support for NBFCs through various reforms. The Insolvency and Bankruptcy Code and the older SARFAESI Act have strengthened the rights of lenders to ensure they can recoup bad loans much more easily. For example, NBFCs with more than $85 million in assets can, like banks, now seize collateral without the need to go through lengthy and exhausting court procedures.
NFBCs have grown steadily in number and market share in recent years, which underscores the success of their business models and the strength of their target markets. Key sectors include real estate, services, consumer goods, restaurants, food and drink, and IT. Return on assets for NBFCs, which have exhibited a good amount of stability in recent years, are typically higher than those for banks. And they still constitute only 11% of the banking segment in terms of assets, suggesting there is tremendous scope for further growth.
For those seeking stable returns from that growth, another attractive element of direct lending to SMEs is the very low loan default rate in country's private sector. That means that investors in the Indian NBFC sector can enjoy returns equivalent or greater to Indian equities but without the volatility. It is a means of accessing the Indian growth story without many of the risks associated with equities.
And that growth story look sets to continue. Half of the country's 1.3 billion citizens are under the age of 25, and the population will continue to get younger until 2026. A million people enter the workforce every month. And, of course, all those young, upwardly-mobile Indians with money in their pockets desire the trappings of a more affluent society: cars, homes and consumer goods. This vast emerging middle class means the demand side of the equation is going to be strong for a long time.
A few years ago I said that the 21st century belongs to India. And given the demographic fundamentals, I'm convinced that remains true. The process of reform which began 25 years ago will continue to push the country towards prosperity, and NFBCs are playing a vital role. The smart investors are already reaping the rewards.