After coming under fire for focusing on financial gains, the government's development finance arm hopes its backing for an Indian venture fund will blaze a trail for the private sector
In June, Andrew Mitchell, the international development secretary, gave a good kicking to the Commonwealth Development Corporation (CDC), the government's development finance arm with a remit to invest in places where others fear to venture.
Wholly owned by the Department for International Development (DfID), the CDC was told to slash bonuses for its top executives, become a "development-maximising, not a profit-maximising, enterprise", and start investing directly in projects rather than indirectly through fund managers.
Set up in 1948 to promote economic development in Britain's colonies, the CDC is the government's main vehicle for supporting the private sector in developing countries. It has been criticised for focusing too much on financial gains, and last year it emerged that CDC executives had racked up huge expenses.
In March the Commons international development committee (IDC)recommended splitting the CDC in two, with one part left to continue private equity investments, which make "impressive financial returns", and the other taking more direct action on the corporation's poverty alleviation brief.
DfID did not go along with the committee's recommendation, but Mitchell's strictures about "development-maximising" appear to be getting through.
As part of DfID's focus on the poorest people in India, the CDC – which is sitting on top of £2.8bn of assets (technically, taxpayers' money) – will invest $50m in an Indian venture fund founded by a former investment banker. Narayanan Shadagopan, formerly of Credit Suisse and Royal Bank of Scotland, set up Pragati to look for investments in India's eight poorest states.
Bihar, Jharkhand, Madhya Pradesh, Chhattisgarh, Uttar Pradesh, Rajasthan, Orissa and West Bengal are home to some 421 million people who are defined as "multi-dimensionally poor" by the Oxford Poverty and Human Development Index, more than the 26 poorest African countries combined (410 million). This is the flipside of India's economic success story, complete with its first Formula One, and where the collective net worth of the country's 100 wealthiest individuals stands at $241bn (admittedly down from $300bn in 2010), according to India Today.
Typically, private equity is looking at investment returns of 20% so Pragati will be aiming for these kinds of returns although Anubha Shrivastava, the CDC's managing director, Asia, is more cautious.
"Not all stories will be success stories," she said at the CDC's office on Victoria Street, not far from DfID, reflecting the arm's length relationship between the two. "By anchoring this venture, we are not so much focusing on financial returns as kickstarting of a process of reform of the business ecosystem."
The CDC joined forces with Shadagopan as he too was interested in investing in India's poorest states. His name came up as CDC officials talked to chambers of commerce, lawyers and accountants who form a useful network for contacts.
Shrivastava said: "He was looking at some poor states and had the right ideas for the first poorest state fund in india. We helped him to hone his fund strategy, interviewed his team and suggested skills they would need. It's a sizeable investment for us and we're hopeful others will come in."
Pragati is venturing into difficult territory. Investors have shied away from India's poorest states, where the unskilled population, lack of finance and poor infrastructure have proved strong deterrents. A lack of a proper regulatory framework and corruption do not help either. Moreover, investments in such regions often fail because of poor access to markets and weak infrastructure. While fully aware of the pitfalls, Shrivastava still believes good returns can be made in such unpromising environments.
"We are saying to investors 'come on guys, there are commercial opportunities and it's not diffcult as you think it is,'" she said.
Shrivastava said the CDC had thought long and hard about putting $50m into Pragati, but believes there are enough projects to absorb the funds. After contributions from other investors, she estimates the fund will have between $80m to $100m for projects in infrastructure, health, manufacturing and education. Pragati will make investments in the range of $5m to $15m.
The investment is sorely needed. Historically, the eight poorest states have been neglected by Indian and foreign investors, in what the CDC describes as a market failure. The CDC will be keeping a close eye on Pragati, especially in its first few deals, as its success will be crucial to attract other investors.
Possible deals include one with a company in Madhya Pradesh that manufactures products for municipal waste management. The company is looking for an investment to expand, while a railway equipment company in Uttar Pradesh hopes to introduce a new design that could reduce fuel consumption by as much as 30% in diesel engines.
"It's very much a hands-on process to begin with," said Shrivastava, who visits Delhi every month. "The first few deals need to be structured properly so they resonate with other investors."
Mitchell, a former investment banker at Lazard's and a vocal supporter of the private sector in development, says Britain will transform its development relationship with India over the next few years.
"These kind of investments from CDC will bring our new vision to life," he said. "There is still desperate poverty in India – for instance, in Madhya Pradesh half of all young children are malnourished. Providing much-needed capital to promising small businesses in states like this can help people escape poverty, providing jobs and security and boosting economic growth."