Jayanth R. Varma
Reproduced with the permission of Vikalpa, the journal of the Indian Institute of Management, Ahmedabad, in which the paper was first published (January-March 1998, 23(1), 27-38).
Vikalpa (http://www.iimahd.ernet.in/vikalpa). All rights reserved Until the early nineties, corporate financial management in India was a relatively drab and placid activity. There were not many important financial decisions to be made for the simple reason that firms were given very little freedom in the choice of key financial policies. The government regulated the price at which firms could issue equity, the rate of interest which they could offer on their bonds, and the debt equity ratio that was permissible in different industries. Moreover, most of the debt and a significant part of the equity was provided by public sector institutions.
Working capital management was even more constrained with detailed regulations on how much inventory the firms could carry or how much credit they could give to their customers. Working capital was financed almost entirely by banks at interest rates laid down by the central bank. The idea that the interest rate should be related to the creditworthiness of the borrower was still heretical. Even the quantum of working capital finance was related more to the credit need of the borrower than to creditworthiness on the principle that bank credit should be used only for productive purposes. What is more, the mandatory consortium arrangements regulating bank credit ensured that it was not easy for large firms to change their banks or vice versa.
Firms did not even have to worry about the deployment of surplus cash. Bank credit was provided in the form of an overdraft (or cash credit as it was called) on which interest was calculated on daily balances. This meant that even an overnight cash surplus could be parked in the overdraft account where it could earn (or rather save) interest at the firm’s borrowing rate. Effectively, firms could push their cash management problems to their banks. Volatility was not something that most finance managers worried about or needed to. The exchange rate of the rupee changed predictably and almost imperceptibly. Administered interest rates were changed infrequently and the changes too were usually quite small. More worrisome were the regulatory changes that could alter the quantum of credit or the purposes for which credit could be given.
In that era, financial genius consisted largely of finding one’s way through the regulatory maze, exploiting loopholes wherever they existed and above all cultivating relationships with those officials in the banks and institutions who had some discretionary powers. The last six years of financial reforms have changed all this beyond recognition. Corporate finance managers today have to choose from an array of complex financial instruments; they can now price them more or less freely; and they have access (albeit limited) to global capital markets. On the other hand, they now have to deal with a whole new breed of aggressive financial intermediaries and institutional investors; they are exposed to the volatility of interest Vikalpa (http://www.iimahd.ernet.in/vikalpa). All rights reserved 2
rates and exchange rates; they have to agonize over capital structure decisions and worry about their credit ratings. If they make mistakes, they face retribution from an increasingly competitive financial marketplace, and the retribution is often swift and brutal. This paper begins with a quick summary of the financial sector reforms that have taken place since 1991. It then discusses the impact of these reforms on the corporate sector under five main heads: corporate governance, risk management, capital structure, group structure and working capital management. The paper concludes with a few pointers to the tasks that lie ahead particularly in the light of the East Asian...