The M&A rush

The newspapers are filled with tales of acquisitions. Firms, it seems, are spending more time buying businesses than building them. This is great for investment bankers, but is it right for India? In a more placid period, firms were generally controlled by families, and the family visualised running the firm forever. Even if a family was not particularly good at converting the capital and labour of a company into profits, its members tended to hang on. Many times, an acquisition comes about when someone talks sense into the family, that it is better to sell a business when the offered price is bigger than the net present value of the cash flows that might be obtained by keeping it in the family. Such acquisitions are good because they shift productive assets from less competent hands to more competent ones.

A feature of these transactions is the interplay with rupee convertibility. On display now is the full range of transactions""foreign companies buying Indian companies; Indian companies buying foreign companies; control of an Indian company changing hands outside India. These productivity gains through mergers and acquisitions (M&A) would not have been possible if India had not embarked on dismantling capital controls. More needs to be done in terms of removing policy and procedural bottlenecks caused by capital controls.

Also relevant in this context are the remnants of the licence-permit raj: government permission or support is still required for entry into too many areas. Global retailers can't come into India through the front door, which encourages less qualified teams in India to go into retailing, knowing that in a few years, when the policy environment changes, they will be able to sell to the global firms. Similarly, the RBI does not allow foreign banks enough leeway to do business in India, which generates incentives for them to buy weak Indian banks. The land market in India is so distorted that the best way to be a hotel company in India is to buy a few hotels or an existing hotel company.

Virtually every large global firm faces a choice in India between building and buying. When building is hard""given the entry barriers in India""there is a bias in favour of buying. Such transactions enhance efficiency""it is surely better for India to have a good bank (foreign or Indian) buy up a less well-managed Indian bank. The flow of control transactions steadily erases history: a productive asset may have a certain incompetent owner for historical reasons, but this gets handed over to a more efficient management team. These transactions are healthy for India: they generate GDP growth out of thin air, and ratchet up competitive pressure in one industry after another. As the licence-permit raj breaks down, and entry barriers are removed in sector after sector, such transactions will diminish. Internationally, entry barriers are those created by the market, not by governments, and the make-versus-buy decision tends to be less distorted. Logically, no one should be surprised if there is a bigger M&A/GDP ratio in India than is found in the UK or the US.