In a rapidly transforming global economic landscape in the face of inflation and fears of a global recession, India has emerged as a global juggernaut of growth. That India is at the beginning of an epoch that will drive economic growth and prosperity that will define the 21st Century is not debatable; however, we must endeavour to improve the existing ecosystem further.
India received some of the largest FDI inflows in the last decade. However, a majority of the FDI has been directed towards large corporations by large investment funds. To unleash the next phase of growth, India needs to direct FDI towards its millions of MSMEs to unleash their growth and true potential towards driving Global GDP growth and massive job creation in India. Equally important, India needs to facilitate the flow of capital from alternate investors sitting in Capital rich nations, such as search fund investors, smaller Private Equity funds and family offices.
At the outset, it must be clear that the pools of capital held by a wide variety of investors are sizable. By some estimates, family offices globally are managing USD 5.9 Trillion in assets.
The key question here is how do we facilitate the flow of capital from a wider variety of investors into a larger pool of companies than in the past? The answer lies in allowing for structures that will enable capital to flow seamlessly from a larger pool of investors into a larger pool of businesses. This is where the International Financial Services Centre (IFSC) has the potential to unleash the next phase of India's growth.
Development of the IFSC as an asset financing hub is essential, but so is the development of "Investment Structures" that will allow a wide variety of investors to tap into the Indian growth story. In the triad of public markets, large private players and MSMEs, India has seen significant foreign participation in the first two. The key driver for participation in the third space, essentially in the private markets with MSMEs, is a structure that facilitates capital flow, transparency and risk management for all involved.
The "Search Fund" structure used in the US is particularly suitable for driving significant FDI into Indian MSMEs. Such a structure allows a syndicate of investors to pool in capital into vehicles that, in turn, can invest that capital into a smaller company and have a professional manager run the business. This model has seen tremendous success in the US. Search funds have delivered exceptional returns, making them a very attractive investment vehicle - the pre-tax return on invested capital was found to be 5.5x, with a pre-tax internal rate of return of 32.6%. We see this model as particularly useful in an Indian context where the ability to scale MSMEs on a platform to take advantage of economies of scale, better technology and lower cost of capital is essential to generating value for the business and the investors.
At the outset, the "Search Fund" model is similar to a direct syndication model. However, the search fund facilitates the flow of capital from a pool of investors who individually are sizable (the average Family Office in the US has approximately USD 1 Billion in AUM) but not as large as the multi-billion dollar Private Equity or Pension Fund investors.
The IFSC has the potential to be a hub for such Search Fund models, thereby being the fulcrum in the flow of capital, technology and knowledge into India's MSME sector.
Indian policymakers and businesses must view the IFSC as a "centralised ecosystem" instead of a single point of financing availability. The ability of the IFSC to facilitate the flow of capital by allowing structures that help diversify risk will allow capital in all shapes and sizes to flow through the Indian economy.
IFSC must not only look to capture the financing component of the market but eventually become a hub for the financial plumbing of the entire BIMSTEC region by allowing for asset management, clearing and legal industries to develop. Mainly, as BIMSTEC region consumers spend more, the aim must be for the IFSC to provide an avenue for a centralised financial infrastructure hub that can truly cater to the needs of a growing region.
The interlinkages also create the ecosystem in terms of services, human capital and ancillary industries that are so essential for the long-run success of a financial centre such as the IFSC. As mentioned above, the need to cater to a multitude of needs will create the demand for high-quality human capital and boost the services industry relating to finance, information technology, legal and accounting needs. Further, creating a large service industry base will help fund the IFSC hub better and create a network effect allowing top-quality human capital to cater to the diverse industries bound by a common financial centre.
However, consistency in policy will be vital. A financial centre and surrounding businesses are, by their very nature, long-term decision-based and must be looked at through a long-term policy lens. That said, India's push for a global financial hub is a necessity in its ambition to further its position as a global economic superpower.
Poornima Vardhan & Taponeel Mukherjee, head AltG, a financial services firm that Identifies and Executes High Growth Capital Allocation Opportunities.
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