Indian state capitalism looks to be in trouble

India’s stockmarket swooned upon the news that Narendra Modi, the country’s business-friendly prime minister, would return to power diminished and in a coalition after a recent general election. One benchmark, though, fell especially sharply and has yet to recover: the Bombay Stock Exchange’s index for Public Sector Undertakings (BSE PSU). It comprises 56 companies that have some private ownership but remain mostly owned, and entirely controlled, by the state.

This curious corporate structure dates back to India’s independence from Britain in 1947 and the country’s subsequent embrace of state planning, which was extended to encompass, in the Marxist-infused language of the time, “the commanding heights of the economy”. This came to include companies in everything from aviation and insurance to artificial limbs and banking. Only when India’s economy opened to the world in the 1990s did the approach change. Since then, politicians have tried, with varying degrees of enthusiasm, to put firms under private control.

Killing off the leviathan has proved difficult, however. When Mr Modi entered office in 2014, he vowed to accelerate divestment. His signature achievement has been the sale in 2021 of Air India to Tata, a vast conglomerate from which the airline had been expropriated in the 1950s. More often, deals have stalled owing to suspicion the buyer will be ripped off by the state or because of objections from vested interests, including powerful unions, employees who receive benefits such as housing from the firm in question and politicians who like being able to influence hiring at state-controlled companies.

The consolation, at least until the election, has been the excellent performance of many state-owned firms (see chart). Profits at the dozen state-run banks that are included in the broader PSU index have risen from $123m in the fiscal year that concluded just before the covid-19 pandemic to $18bn in the most recent one. Half have a return on equity in excess of 15%, a rate better than many big global banks, reflecting government-prompted consolidation and reforms to bankruptcy procedures. Other state-owned companies have also been run more efficiently.

Why are the stocks now suffering? In part it is because investors fear India’s new government will be less likely to impose reforms and to insulate the companies from regional political pressures on matters such as hiring, lending, factory openings and closings, and even the pricing of sensitive commodities like electricity, gas and petrol. More voices in government may also slow down further privatisation.

State-controlled firms in industries such as defence, infrastructure and technology saw their valuations rise as Mr Modi’s previous government focused on boosting economic growth. Now they may receive less support as state spending and attention shifts to social programmes. This reflects a particularly damaging aspect of state capitalism: even if businesses are for a time well run, they remain vulnerable to changes in the political weather. ■

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