Capital Formation for Entrepreneurial Development

Mazie Nakhro, PhD

Finance is regarded as the lifeblood of a business enterprise because it provides access to all the sources for production and marketing activities. So to start with, a serious entrepreneur should do his part by contributing a reasonable share of funds from his own sources. Normally, most financial institutions would expect him (and his business partners)to come up with 25 percent of the project cost. That level of ownership capital (business equity) would at least provide some cushion for payment of debts at short notice and for purchasing whatever it might need to keep the business running uninterruptedly.

To finance a project, the Reserve Bank of India also recommends that a small enterprise maintains a capital structure of 3:1 debt-equity ratio, that is, three-fourths borrowed and one-fourths owned. If a debt is over three-fourths of the capital structure, the bank may consider the financial investment in a business too risky and in such case it may not approve a loan application from an entrepreneur. 

How can we solve this problem of capital formation for entrepreneurs? Here are some thoughts perhaps our government could consider:

1. Ask Our National Banks to be More Local Sensitive: As financial intermediaries, banks play two very important roles in the economy. First, they facilitate purchases of goods and services by allowing people to write checks against their deposits. Second, they take in deposits from people who want to save and use these deposits to make loans to people who want to borrow. But some of the standard rules of the banks (SBI and other commercial ones) currently operating in Nagaland may not be very applicable for the Naga people, especially in the area of giving loans. In the Naga cultural context, the main assets are lands and their ownerships are not easily transferable because of the tight landholding system. Hence, these banks understandably hesitate to accept our real estate properties as securities against our applied loan amount. On the other hand, it is reported that they collect an estimated deposit of Rs. 7,532crore(including government deposits) and yet only a fraction of it is used for entrepreneurial development in Nagaland. For example, the credit inflow to self-help groups is said to be as low as 1.67 crore rupees. So what are they, especially the commercial banks, doing with the rest of our money? These deposits do not just remain as ‘idle liquidity’ in some safety deposit box. Obviously, the banks would be converting our deposits into investments as all banks do. In other words, banks make money by using our money---lending to borrowers and earning on compound interests. But my suspicion is that these deposits are hardly used for investment or entrepreneurial projects within our State. Could they be then giving loans mostly to non-Naga investors or some rich businessmen from somewhere else? To limit this likely diversion of loanable funds, our government should come up with some policies that would require the banks in Nagaland to invest primarily in Nagaland.

2. Set up Cooperative Banks: A well-respected educationist recently told me: “There are people in Kohima who are putting money in the bank to the tune of 5 crore. This is not investment. It stops money to circulate in our land.”  If this is true, we must find a way to correct the problem. Perhaps the best way would be to set up our State government owned cooperative banks or private community banks or even credit unions in every district of Nagaland. The objectives of these banks should be to encourage the circulation of money within our people for developmental purposes and to make loans more easily available to entrepreneurs. We should create ways for our entrepreneurs and business persons to obtain loan and they could do so by using their lands or other valuable assets as collateral securities. In case of default in payment of the full loan amount, our government or the local community could seize the borrowers’ properties. Now these become lien properties which a cooperative bank may hold on to or sell for a profit. For example, lien properties in the United States are auctioned off to the public on certain dates at County Court Halls and given away to the highest bidders with clear and free titles.

3. Keep Money From Flowing Out of State: Many non-locals make their money in Nagaland and then send a huge part of it to other parts of India. And we locals also spend so much of our own money outside of our state, especially for educational and medical reasons. This is how the money which we get from Delhi flows out of Nagaland. To fix these problems, we ourselves must begin running the businesses and have good educational institutions and well-equipped hospitals. Another way to keep our money within Nagaland is this: All our politicians and bureaucrats who benefit from public funds must be required to deposit a certain percentage of their income in our “cooperative banks” in Nagaland so that these funds may circulate within our local population or be made available for our entrepreneurs and business people to borrow.

4. Enforce Mandatory Savings: Many people hold excessive amounts of cash in hands. This is a waste of resources. Cash itself yields a zero return. This being the case, the government may mobilize savings by introducing a policy of compulsory deposit schemes and paying participants an attractive rate of interest to stimulate savings. It also could expand the Public Provident Fund Scheme, offer sale of IOU certificates (government bonds), or encourage people to buy life insurance plans. It is important that people are offered many options of savings so they can learn how to let their money earn a lot more money over the years. Another forced savings could be in the form of collecting taxes on purchase of luxury goods, cigarettes, and liquor. And most of the money collected from the people could be converted into making loans for entrepreneurs so they can create businesses and provide employment. This, then, could easily be a win-win investment strategy for everyone concerned. But having said all these, the government should take the lead. It must initiate forced savings by decreasing its expenses on administration and non-development programs, and enforcing a complete ban of all illegal taxations on the public. These measures would not only alleviate the burden of government revenue deficit but they could also get the government moving in the direction of budget surpluses, or public savings, which can be turned into loanable funds. Thus, a budget surplus would increase the supply of loanable funds for investment. And higher investment, in turn, means greater capital accumulation and more rapid economic growth.

5. Mobilize Foreign Resources: The government could mobilize capital in the forms of foreign aids and commercial borrowing on its own credit and pass it on to our private sector businesses to borrow for purposes of investment. Although it would depend a lot on the goodwill of others, grants might be obtained from friendly nations, aids might be requested from the World Bank or International Monetary Fund, and assistance might be sought from various foundations. Then we have multinational companies that are interested to invest in both public and private sector enterprises, and they bring with them the latest technology and a lot of employment opportunities. Furthermore, the government could attract Foreign Direct Invest mentor enter into some sort of foreign collaborations. Or portions of the external funds raised could be utilized in some public-private partnership enterprises or be given as loans to entrepreneurs and business firms. This is what a caring government would do: letting the public ride on its back and leveraging entrepreneurs to succeed.

6.  Put Proper Infrastructure in Place: Perhaps the most important thing the government could do is to build our economic infrastructure because of the following reasons: law and order attract investments; good roads and railways facilitate transportation of goods; good communication promotes marketing; adequate power ensures production and operation. Without these basic facilities in place, no business can survive or succeed. For example, inadequate power supply paralyzes production. On the supply side, low production results in low income, then low income results in low savings, and low sayings in turn result in low investment which is capital formation. Or on the demand side, if income is low, the purchasing power of the people comes down and therefore the demand for goods or services also comes down. Consequently, more production becomes meaningless. And when there is less production, there will be less opportunity for employment which implies poverty. This is a vicious cycle which we see especially in India, Pakistan, Bangladesh, among others. So as Ragner Nurkse, a prominent development economist, would argue, the way to break out from this vicious cycle of “economic underdevelopment trap” is to find a solution to the problem of capital formation. 
 



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