RIL-RPL merger: A fair deal for all?
RELIANCE Industries Ltd, known to have pioneered the shareholder culture in India, was guided by a simple philosophy while merging Reliance Petroleum Ltd (RPL) with itself. The deal had to be positive for RPL shareholders and at least neutral for those of RIL.
The merger between RIL and its subsidiary RPL that took the market by surprise was almost waiting to happen given the strategic fit and the changed global scenario where selling fuel is becoming increasingly difficult. While stock markets and analysts are still trying to figure out if shareholders in RIL and RPL have got a fair deal under the swap ratio (one of RIL for 16 of RPL), industry experts have given a thumbs up to the deal and the timing of the move.
The tax savings that will accrue to the merged entity were the obvious attraction. The intra-company sales between the two refineries (RIL’s and RPL’s) or even gas sold by RIL to the refineries which would have attracted taxes will now go through without that extra cost. Besides, crude sourcing that has often posed peculiar problems for RIL, given the complexity of its refinery, will now turn to its advantage.
Crude oil suppliers often insist on selling a shipload of expensive sweet crude along with large contracts of the cheaper heavy sour crude that RIL contracts from far and wide to maintain its refining margins well ahead of its competitors. Meanwhile, blending products from the two refineries will help RIL to produce fuel matching Euro 4 and Euro 5 grades, a requirement of the western markets. This apart, the company will capitalise on shipping freight flexibilities to beat hurdles posed by the Indian customs authorities that do not allow two companies to load products in a single vessel.
RPL’s new refinery would have been a burden on RIL’s books for some time in the changed market conditions, but that now stands reduced given that the profits of the depreciated older refinery would help negate some of the high cost implications.
The merger between RIL and its subsidiary RPL was a deja-vu — for many — the older avatar of RPL, which oversaw the construction of RIL’s first refinery at Jamnagar, was merged with RIL. It is another instance of the corporate philosophy of the RIL group that has absorbed subsidiaries into the parent company once the risks involved with the execution of a new venture are taken care of.
But this time around, the factors leading to the merger could be much beyond the guiding corporate philosophy. The 29-million tonne RPL-executed new refinery was commissioned around late December and the first cargoes of naphtha, diesel oil are already on their way to the western markets. It is estimated that the refinery would be scaled up gradually and it would be running full throttle by mid-2009. In normal circumstances full-capacity production would be the time to look forward to as it allows companies to monetise their investments quickly. RIL, which has sunk huge investments, however, is faced with the daunting task of selling fuel at a time when there is a huge demand contraction. The global meltdown has forced most refineries servicing markets such as the US, Europe or Japan to either hold back or slow down till demand recovers. Even RIL’ partner Chevron chose to divest its 5% stake in the RPL refinery instead of scaling it up to the agreed level of 28%.
It is ironical that the very advantage that RIL projected around three years ago when it began constructing the new refinery at Jamnagar has now become its biggest disadvantage, at least for the time being. In 2006 most energy analysts projected demand for oil to grow to 91 million barrels per day (mmbd) from 81 mmbd in just four years, led by a sustained growth in the Asia-Pacific economies. Also, petrol, diesel and jet fuel were expected to account for almost 75% of the increased demand. The International Energy Association had also estimated capacity addition in the refining industry to lag behind at 4.6 mmbd as against a requirement 6.2 mmbd.
RIL hoped to capitalise on the early bird advantage as its new refinery at Jamnagar is one of the most advanced complex refineries, equipped to produce grades of fuel (both de-sulphurised diesel and low benzene petrol) that are acceptable in the western markets. Put simply, the RPL refinery was almost tailor made for the holiday-goers in California who would push up gas demands every time summer set in.
But with almost all developed economies now in deep recession, the matrix has turned upside down. The magnitude of drop is large. For example, in September last year, the decline in US oil demand was of the same size as the absolute oil consumption in India — about 2.7 million barrel per day.
RIL needed to move fast to address the changed market conditions. Merging RPL with RIL is expected to help the company optimise costs on several fronts apart from using the strengths of both to aggressively push products both in the export market and domestically. Will this consolidation be equally rewarding for shareholders?
• RIL is faced with the daunting task of selling fuel at a time when there is a huge demand contraction
• The advantage RIL projected when it began constructing the new Jamnagar refinery has now become its disadvantage
• Merging RPL with RIL is set to help the company optimise costs on several fronts
Monday, March 30, 2009
Metaphor for new Indian middle class
The Shatabdi is definitely the perfect metaphor for the middle class in India, which is morphing and sneakily changing, but in its own way, using its own logic
MANY of us have trouble picturing exactly who the members of the great Indian urban middle class are. Though we talk about them all the time, it still is like pornography: “I’ll know it when I see it but can’t exactly describe it’’. When visiting western businessmen talk, with a gleam in their eye, of investing in India because of the growing middle class, one is a bit worried about what images they carry in their heads about this group. The trouble is that our consumer base is so variegated, that even field research, away from meeting rooms, provides every kind of anecdotal evidence, to confirm any kind of mental picture that anyone might have, on any count.
A recent trip from Delhi to Rishikesh on the Shatabdi was a ‘eureka moment’. The Shatabdi is definitely the perfect metaphor for the middle class. Santosh Desai of Future Brands wrote once that the autorickshaw is a metaphor for India. It can weave its way in and out of utter confusion, is ugly, noisy and inconvenient, but it serves the purpose quite well, at an incredible low price. Unlike an amusing bumper sticker on a Volkswagen that said: “when I grow up, I will become a Mercedes”. The autorickshaw will not grow up to become a car. It will — and is — becoming a much better autorickshaw. But after seeing the Shatabdi, the thought occurs that the autorickshaw may be a metaphor for the lower SEC (socio-economic class) C and D Urban India (roughly the second and third income quartiles of urban India); but the Shatabdi is definitely a metaphor for upper middle India: SEC B, the lower end of SEC A2 and the top end of SEC C (the 5th to 25th or 30th percentile by income of urban India). Roughly that is about a 75 to 100 million people, and is the middle class that we think about.
The Shatabdi is a higher being than the regular train, even if it uses the same old railway station. Even the non-executive, coach class, is quite steeply priced, demand is greater than supply. It comes with an e-ticket, and a certain “culture class” of customers that fits marketer’s definitions of “The Middle Class”. The chair car is definitely like an upper middle class drawing room, and though the air conditioning works well, there is a cocktail of many strong smells in the air. Some of them you soon get used to, even welcome, partly because the strong smell of the cleaner assures you that cleaning has actually been done.
Having not been on a Shatabdi for many years, one was struck by how “upwardly mobile” it had gradually become. And yet, how it has stayed the same on many counts too. Looking at the overhead baggage racks (open racks still), it is clear that a luggage revolution has happened. Smart suitcases (when compared to what we used to see earlier), lots of soft luggage, nylon backpacks — but the same old coolie system, even their uniforms unchanged! The luggage rack definitely made a statement about what progress Consumer India has made and the attitude it now sported, based on what luggage they were ‘wearing’. No uniformity here, no herd mentality, lots of individualism. No boring single brand here, this was the full blown variety of the gray market, importing from around the world! (The same, by the way, can be said for the winter wear of the passengers. No more aunt knitted hand-made sweaters. Wind cheaters of all hues, and machinemade sweaters and caps. And also of the closed footwear. No cumbersome heavy leather shoes in sight anymore.)
THEN came the newspaper boy, in uniform, with an entire range of newspapers. As one clumsily reached into the wallet, after having picked four newspapers, the paper boy says with a cheeky “don’t you know” grin that it is free — on the house, just like in airplanes! The seats actually recline smoothly and the age-old train feature of a ring to place the water bottle in still exists, but now has bottled water, on the house, not carried from your house.
Breakfast comes — same old sad looking contents — in fact much worse quality because it is pre-packed. But the packaging has improved in leaps and bounds. The chana was in a sealed foil container and the baturawas actually more a kind of bread-batura than a conventional batura, folded in the shape of a cone and in a wrapper that made me think it would definitely grow up to be a croissant beater. But the “separate tea’ is here, tea bag, low grade plastic hot water flask, dairy creamer, packed sugar on the side.
The toilets were filthy. Some things never change. But on the other hand they had a roll of toilet paper — a definite evolution in sophistication from the past. However, the toilet paper was dangling from an improvised holder comprising a plastic string. The metric this writer uses to see the state of evolution of a society is the cleanliness of its public toilet and the number of people who light a cigarette under a no smoking sign. By these metrics, both Russia and China are not so great. Our airport toilets are cleaner now but train toilet are not yet so. When will Hindustan Unilever, the messiah of mass consumption, collect some consumer insight on how we use dirty toilets, and give us individual use products that can help us on this count? But that is the subject of yet another article.
The highlight was the customer satisfaction survey that was handed out. It not only was a very well designed questionnaire by a leading market research agency, it had to be self filled, and small disposable plastic ball point sticks, no doubt made in China, were handed out with each. The dimensions of evaluation also reflected the more evolved, higher order needs the new middle India has — cleanliness of compartment floor, windows, and uniforms worn by the staff, as compared to a general cleanliness question that we would have asked earlier; aesthetic appeal of the compartment (definitely a higher order need!), temperature of the meal and body language of the serving staff.
Of course, everyone was on their mobile phone either working or socially networking throughout the journey and a few young salesmen were also on email. When I got off at Haridwar, and was looking for the car that was supposed to pick me up, my coolie said to me impatiently, why don’t you phone the driver, how can he not have a phone!
This is middle class India, morphing and sneakily changing, but in its own way, using its own logic. Just like the Shatabdi.
The Shatabdi is definitely the perfect metaphor for the middle class in India, which is morphing and sneakily changing, but in its own way, using its own logic
MANY of us have trouble picturing exactly who the members of the great Indian urban middle class are. Though we talk about them all the time, it still is like pornography: “I’ll know it when I see it but can’t exactly describe it’’. When visiting western businessmen talk, with a gleam in their eye, of investing in India because of the growing middle class, one is a bit worried about what images they carry in their heads about this group. The trouble is that our consumer base is so variegated, that even field research, away from meeting rooms, provides every kind of anecdotal evidence, to confirm any kind of mental picture that anyone might have, on any count.
A recent trip from Delhi to Rishikesh on the Shatabdi was a ‘eureka moment’. The Shatabdi is definitely the perfect metaphor for the middle class. Santosh Desai of Future Brands wrote once that the autorickshaw is a metaphor for India. It can weave its way in and out of utter confusion, is ugly, noisy and inconvenient, but it serves the purpose quite well, at an incredible low price. Unlike an amusing bumper sticker on a Volkswagen that said: “when I grow up, I will become a Mercedes”. The autorickshaw will not grow up to become a car. It will — and is — becoming a much better autorickshaw. But after seeing the Shatabdi, the thought occurs that the autorickshaw may be a metaphor for the lower SEC (socio-economic class) C and D Urban India (roughly the second and third income quartiles of urban India); but the Shatabdi is definitely a metaphor for upper middle India: SEC B, the lower end of SEC A2 and the top end of SEC C (the 5th to 25th or 30th percentile by income of urban India). Roughly that is about a 75 to 100 million people, and is the middle class that we think about.
The Shatabdi is a higher being than the regular train, even if it uses the same old railway station. Even the non-executive, coach class, is quite steeply priced, demand is greater than supply. It comes with an e-ticket, and a certain “culture class” of customers that fits marketer’s definitions of “The Middle Class”. The chair car is definitely like an upper middle class drawing room, and though the air conditioning works well, there is a cocktail of many strong smells in the air. Some of them you soon get used to, even welcome, partly because the strong smell of the cleaner assures you that cleaning has actually been done.
Having not been on a Shatabdi for many years, one was struck by how “upwardly mobile” it had gradually become. And yet, how it has stayed the same on many counts too. Looking at the overhead baggage racks (open racks still), it is clear that a luggage revolution has happened. Smart suitcases (when compared to what we used to see earlier), lots of soft luggage, nylon backpacks — but the same old coolie system, even their uniforms unchanged! The luggage rack definitely made a statement about what progress Consumer India has made and the attitude it now sported, based on what luggage they were ‘wearing’. No uniformity here, no herd mentality, lots of individualism. No boring single brand here, this was the full blown variety of the gray market, importing from around the world! (The same, by the way, can be said for the winter wear of the passengers. No more aunt knitted hand-made sweaters. Wind cheaters of all hues, and machinemade sweaters and caps. And also of the closed footwear. No cumbersome heavy leather shoes in sight anymore.)
THEN came the newspaper boy, in uniform, with an entire range of newspapers. As one clumsily reached into the wallet, after having picked four newspapers, the paper boy says with a cheeky “don’t you know” grin that it is free — on the house, just like in airplanes! The seats actually recline smoothly and the age-old train feature of a ring to place the water bottle in still exists, but now has bottled water, on the house, not carried from your house.
Breakfast comes — same old sad looking contents — in fact much worse quality because it is pre-packed. But the packaging has improved in leaps and bounds. The chana was in a sealed foil container and the baturawas actually more a kind of bread-batura than a conventional batura, folded in the shape of a cone and in a wrapper that made me think it would definitely grow up to be a croissant beater. But the “separate tea’ is here, tea bag, low grade plastic hot water flask, dairy creamer, packed sugar on the side.
The toilets were filthy. Some things never change. But on the other hand they had a roll of toilet paper — a definite evolution in sophistication from the past. However, the toilet paper was dangling from an improvised holder comprising a plastic string. The metric this writer uses to see the state of evolution of a society is the cleanliness of its public toilet and the number of people who light a cigarette under a no smoking sign. By these metrics, both Russia and China are not so great. Our airport toilets are cleaner now but train toilet are not yet so. When will Hindustan Unilever, the messiah of mass consumption, collect some consumer insight on how we use dirty toilets, and give us individual use products that can help us on this count? But that is the subject of yet another article.
The highlight was the customer satisfaction survey that was handed out. It not only was a very well designed questionnaire by a leading market research agency, it had to be self filled, and small disposable plastic ball point sticks, no doubt made in China, were handed out with each. The dimensions of evaluation also reflected the more evolved, higher order needs the new middle India has — cleanliness of compartment floor, windows, and uniforms worn by the staff, as compared to a general cleanliness question that we would have asked earlier; aesthetic appeal of the compartment (definitely a higher order need!), temperature of the meal and body language of the serving staff.
Of course, everyone was on their mobile phone either working or socially networking throughout the journey and a few young salesmen were also on email. When I got off at Haridwar, and was looking for the car that was supposed to pick me up, my coolie said to me impatiently, why don’t you phone the driver, how can he not have a phone!
This is middle class India, morphing and sneakily changing, but in its own way, using its own logic. Just like the Shatabdi.
Wednesday, July 30, 2008
After This Week's Victory, Will the Congress Government Press Ahead with Reforms?
Published: July 24, 2008 in India Knowledge@Wharton
On Tuesday, the United Progressive Alliance (UPA) led by Prime Minister Manmohan Singh won a trust vote in Parliament by a surprisingly large margin, beating out the combined opposition by 19 votes. The UPA received 275 votes while the combined opposition of the extreme Right and the extreme Left mustered 256. It wasn't as close as in 1999, when the Rightist Atal Bihari Vajpayee government lost by just one vote. But the debate -- centering in part on the government's insistence on going ahead with a nuclear deal with the U.S. --was far more acrimonious.
The crisis has been long in the making, and time was running out for both Singh and U.S. President George Bush. The latter has just a few months left in office; Singh has to call for elections to be held before May 2009.
When the Indian government took the step of approaching the International Atomic Energy Agency (IAEA) with the draft India-IAEA safeguards agreement for approval by its board of governors, the Left parties cried foul. They have been supporting the UPA from the outside. Without their backing, the government was reduced to a minority. The Left has been opposed to the nuclear deal on ideological grounds. Prakash Karat, general secretary of the Communist Party of India (Marxist) has often criticized it for being too pro-U.S. and undermining Indian sovereignty. As for the Right -- principally the Bharatiya Janata Party (BJP) led by Vajpayee and shadow PM L.K. Advani -- the nuclear deal was conceived when the BJP was in power. Consequently, its arguments against it now sound opportunistic.
Opportunism is actually the order of the day. Filling in for the Left (which has 59 members of Parliament -- MPs) is the Samajwadi Party (SP), which has 39. Other parties -- several of which have just one MP in the House -- moved into horse-trading mode. "The price of an MP is Rs25 crore ($5.8 million). No one has principles anymore," Communist Party of India (CPI) general secretary A.B. Bardhan said at a meeting to launch the Left campaign against the government. A few days later, rebel Congress MP Kuldeep Bishnoi told a rally that he had been offered $23 million for his vote.
The House descended into chaos when three BJP members took out bundles of currency notes (a total of Rs1 crore -- $234,000) and alleged they had been paid that amount as an advance to abstain from the trust vote. The total promised payoff, they claimed, was $2 million. The Speaker has ordered an investigation.
These big numbers, the mudslinging and the drama have overshadowed the more important issues. A political dimension is in play, including the forging of new equations and the emergence of a third front -- which opposes both the UPA and the BJP-led National Democratic Alliance (NDA. Led by Mayawati Kumari of the regional Bahujan Samaj Party (BSP), it promises to complicate affairs in the coming general elections.
New Highs and Lows
The man on the street may find such circus games entertaining, but he has far more serious things to worry about. Inflation, around 12%, is at a 13-year high; industrial growth at 3.8% in May is at a six-year low. On July 16, the Bombay Stock Exchange Sensitive Index (Sensex) fell to a 15-month low of 12,514, a drop of 40% over the 20,873 recorded in January 2008. The rupee has dropped to 43 to a dollar after being in the 38-39 range.
The central government's fiscal deficit is seen by many as out of control. According to rating agency Fitch, the budgeted deficit could increase from the projected 2.8% of gross domestic product (GDP) to 4.5% of GDP because of farm loan waivers, a pay hike for government servants, increased interest payments and subsidies. Add to this items that are not captured in the budget (principally bonds to finance oil subsidies), and the total deficit could cross 6.5%. Fitch has lowered its estimate of GDP growth in 2008-09 from 9% to 7.7%. It has also revised India's local currency outlook from stable to negative. Other rating agencies such as Standard & Poor's (S&P) and Moody's have been making warning noises. In fact, S&P has estimated the combined deficit of the center and the state governments at 9% to 11%.
With elections around the corner, the principal worry is inflation. Indeed, the trust vote debate didn't talk much about the nuclear deal. The key issues seem to be horse trading and inflation, with the former winning by several lengths. But the nuclear deal does matter. Strategic issues and security concerns aside, the agreement would end India's technology pariah status. The country was consigned to the doghouse after it undertook its first underground nuclear test in May 1974 at Pokhran, in northwestern India.
The nuclear deal will have a positive fallout on business, says a survey of 400 CEOs by the Associated Chambers of Commerce and Industry (ASSOCHAM). India could attract $40 billion worth of foreign direct investment (FDI) in 15 years in nuclear energy. An earlier ASSOCHAM survey in June had indicated that CEOs expected FDI for 2008-09 would fall $7 billion short of the $35 billion target, thanks to the economic and political uncertainty. For 2007-08, the commerce ministry had set its sights on $30 billion in FDI and managed to garner only $25 billion.
The nuclear deal is expected to open the floodgates of business between the two countries. Tentative alliances have already been struck between big Indian business houses and their U.S. counterparts -- and not in the nuclear arena alone. In defense, procurement by India is expected to top $70 billion in the next five years. There are other spin-offs in areas such as space.
"The nuclear deal is good for Indian business and industry for two reasons," says Rajesh Chakrabarti, professor of finance at the Hyderabad-based Indian School of Business (ISB). "First, in the long run, it will help ensure adequacy of power supply. Ultimately, our other sources of generating power are going to dry up and the nuclear way will be the only way to go for India. Secondly, because of the nuclear deal, there will be further trust and interaction between India and the U.S. This will have a positive impact on Indian businesses."
"The nuclear deal will be good for the future of the country," industrialist Adi Godrej told business channel CNBC-TV18. "And I think some of the reforms agenda could be executed before the [general] election. I think that will build confidence. I also feel that one of the major negatives -- high inflation -- will probably be contained by March."
"Inflation will be controlled," Prime Minister Singh told newsmen even as the debate was on. "It is something we are very concerned with." And within the House, finance minister P. Chidambaram, speaking in defense of the trust motion, rattled off statistics to show how great a job the government had done.
It has, if one goes by the number of social and economic programs announced. Major questions have arisen, however, on whether they have been implemented properly. It is also true that this government -- with reformers Singh and Chidambaram in its ranks -- has not made much progress on the liberalization front. Some political observers lay the blame for this on the Left, a conglomeration of several parties. A government beholden to it for support -- threats of withdrawing have been commonplace -- has had to fall in line.
Speeding up Unfinished Reform
Is this a golden opportunity? Will the next few months see a big-burst reforms agenda? Industry seems to hope so. The recent ASSOCHAM survey said 72% of 400 CEOs polled expected the government to speed up unfinished reforms in the pension, insurance and civil aviation sectors. There was some optimism on labor reforms, too.
Delhi-based economic daily Business Standard quotes government sources as saying that Singh will "expedite action on implementing the long-awaited reforms in the banking, insurance and pension sectors." Writing in the same paper, Jamal Mecklai, CEO of Mecklai Financial, a leading foreign exchange risk management consultancy, says: "Having tasted the champagne bubbles of victory, we can be sure that [Singh] will forge ahead with the large slate of reforms that were held up."
Not everybody is uncorking the bubbly, however. "If you look at the different constituents of the UPA and even within the Congress, there is very little consensus on reforms," says Paranjoy Guha Thakurta, an independent political commentator, who until recently was founder-director of the New Delhi-based School of Convergence. "Like apple pie and motherhood, reform sounds very nice, but people are more concerned with inflation and food prices."
Adds New Delhi-based political commentator and former journalist Sumit Mitra: "The chances of a government rushing with reforms in the final year in office are generally bleak. They are particularly so in India at the moment, with a procession of state-level elections ahead. Besides, the Leftists, usually regarded as the biggest obstacle to reform, are not the only ones skilled at putting the clock backward. The Samajwadi Party, which now promises to fill the vacuum created by the Left, has quoted its price already."
"I doubt if we will see any quick-fire reforms," says Chakrabarti of ISB. "There is too little time until the next elections and they will be reluctant to take a gamble and start any controversies. Major reforms usually happen with a government which has a long enough mandate and not one in the last year of office."
What are the reforms that may get through without too much trouble? The sectors are:
* Insurance: This is one area where the MNCs are eagerly anticipating change. Nearly a decade has gone by since Parliament passed the Insurance Regulatory and Development Authority Act in 1999. Private sector players in the industry have finally begun making money. There is currently a cap of 26% on FDI in this sector. Chidambaram had earlier proposed that this be increased to 49% but had to back off because of opposition from the Left. He may now able to get this done.
* Banking: The government currently has 50% plus stakes in the public sector banks. The proposal is to allow dilution. Also, shareholders in these banks are allowed 10% voting rights regardless of their actual equity holding. This could change, allowing more mergers & acquisitions (M&A). FDI in banking is capped at 10%; this could be raised to 26%.
* Pensions: The Pension Fund Regulatory Authority Bill will be passed and a pension regulator appointed. This is the first step in the creation of new pension funds, which will compete with the monopoly Employees Provident Fund Organization (EPFO). However, the government is likely to keep the EPFO out of the ambit of the proposed changes. In time, however, it will have to compete in the marketplace as the Life Insurance Corporation is doing with the joint venture insurance companies.
* Privatization: Singh and Chidambaram advocate a 10% divestment in several public sector units (PSUs). The two leading candidates for public issues are Oil India Ltd. (OIL) and NHPC. Others on the list include Rashtriya Ispat Nigam, Manganese Ore (India), Nuclear Power Corporation, Railtel and Telecommunications Consultants India. The sale of 10% in OIL and NHPC could take place as early as September or October of this year.
* Telecom: The FDI cap may be raised from the current 74% to 100%. This was one of the issues that got in the way of the Bharti deal with MTN of South Africa.
* Atomic energy: Foreign entry may be allowed. Today, even the Indian private sector is barred from this strategic sector.
If all these changes take place, a flood of foreign money could flow into India. The country could actually meet the FDI target of $35 billion set by the commerce ministry. The key question, as Mitra points out, is whether the Samajwadi Party will play ball. One school of thought is that with the margin of victory at 19 votes rather than the one or two votes expected initially, the party may not carry so much clout. The reality will be apparent soon. One has only to look at how the UPA government placates the party.
The entry of the Samajwadi Party in a supporting role has introduced a new dimension into Indian politics -- the lobbying by, and influence of, the corporate world. Amar Singh, general secretary of the party, is close to Anil Ambani, the younger Ambani scion and chief of the Anil Dhirubhai Ambani Group. As is well known, he is feuding with his elder brother Mukesh, who controls the Reliance Industries group.
Amar Singh has been making various proposals to the government but insists that there is no quid pro quo for his party's support. Yet people have taken the list of demands -- made in letters and in personal meetings with Congress leaders -- very seriously. Mukesh Ambani, in fact, met the PM to present his side of the picture. This immediately attracted the ire of the Left. "The Prime Minister's office (PMO) should not become the conciliation office for warring corporates, however desperate the ruling party may be to retain power," the Communist Party of India Marxist (CPM) politburo said in a statement. "Corporate houses are openly in the fray to lobby their interests in the run-up to the confidence vote," the CPM added. The PMO issued a statement denying that the PM was involved in any mediation effort.
What has Amar Singh asked for that has ruffled so many feathers? First, he wants a windfall tax on oil company profits. This will affect Reliance and, to a lesser extent, the Essar group. Second, he wants the export-oriented unit status given to Reliance's Jamnagar refinery scrapped. This will force the company to sell petrol in the domestic market. The result: a huge loss as the public sector refineries get a subsidy which the private sector is not entitled to. (Reliance and Essar have practically closed down their petrol retail chains because there is no way they can make money.) Third, he made various suggestions about spectrum allocation. (Anil Ambani's Reliance Communications is one of the largest players in telecom space.)
"For all practical purposes, these letters could have been written by Anil Ambani himself. And Amar Singh is also very open about his friendship with Ambani," says Guha Thakurta. "There has always been corporate involvement in politics. Everybody knew it, but they didn't talk about it. It was in a wink-wink, nod-nod fashion. Today, thanks to Amar Singh, it is all out in the open. But I like it."
"I consider the increasing openness about the business-politics relationship to be a positive development," adds Chakrabarti of ISB. "Business has always played a strong role in Indian politics. But because of the very strong bias towards Nehruvian socialism, [businessmen] were never very publicly involved. Now, because of liberalization, there is a change in mindset. Business is no longer a dirty word. It is more acceptable and is present more publicly and transparently in politics.
"Even before independence, several businessmen like Jamnalal Bajaj and G.D. Birla were financial backers of Mahatma Gandhi," he says. "While no one questions their patriotism, they must have benefited by way of boycotts of foreign products etc. With Nehruvian socialism, big business had to take a backseat because it was not considered to be politically correct. Even in the Indira Gandhi era, business was viewed as some kind of semi-illegitimate activity and there was no political acceptance of the business class.
"But, like in every democracy, political parties in India, too, always took money from business houses. But it has always been in black money. The influence of business on policymaking has been huge in the past."
Chakrabarti cites a concern in some quarters that "because of the massive and disproportionate wealth that has accumulated in the hands of a few people, India may go the Russia way, where you have a few oligarchs who practically own the entire system. I personally don't see this as a threat. I feel that India is too large a market and it is difficult for a group of people to hijack the political process."
Business is one more element that has been added to the mix. And the number of such elements may be getting too much to handle. As the trust vote with all its allegations of buying MPs shows, you need to woo too many people simply to survive.
"In the future, India has to choose between political incohesiveness and economic growth," says Sumit Mitra. "If it continues to make too many concessions to too many regional and caste groups, or parties wedded to ideologies that are long past their sell-by dates, there is little chance of the country joining the super league of global economies in the foreseeable future. Its politics needs to be reformed before its economy."
Friday, June 13, 2008
Investing in India: Where Is the Smart Money Going Now?
It seems as though everyone is investing in India. During the past few years, every type of investment in the country -- including private equity and venture capital -- has exploded. Last year, net foreign institutional investment inflows topped $17 billion. In contrast, just four years ago, in 2004-05, total FDI (foreign direct investment) in India stood at $3.75 billion.
At first, investment tended to focus on the technology sector; today's investments are in everything from real estate to infrastructure. In a keynote speech at this year's Wharton India Economic Forum, Vinod Dham, managing director of the NEA-IndoUS Ventures and former vice president/general manager of the Microprocessor Products group at Intel, noted that online services, business process outsourcing and mobile value-added services were the top three investment areas in 2007. While the bulk of the investments are still in the IT and IT-enabled services sector, health care is beginning to pick up, Dham noted, and opportunities are often regional: Bengaluru (formerly Bangalore) for IT, Hyderabad for life sciences, Mumbai for mobile/media, Chennai for manufacturing, and Delhi for business process and knowledge process outsourcing.
So how are companies getting into these opportunities, and how are the deals changing over time? A panel discussion at the conference, moderated by Bain & Company private equity practice head Sri Rajan, explored the current environment and gave the audience a taste of what is to come.
The Investment Landscape
Haramb Hajarnavis, senior member, principal investments area at Goldman Sachs, laid out the landscape. "Historically, deals were smaller in size and more growth-oriented," he noted. "On the exit side, most entrepreneurs opted for an initial public offering. Now that's all changing -- the deal size has gone up to an average of $45 million, and every flavor of investment can be found. You see multinationals, private equity players, hedge funds and sovereign wealth funds. Cross-border M&A is also emerging as a source of opportunity. The sectoral focus has widened. Buyouts have started to happen, and some exits now involve selling to others. ICICI Ventures sold a stake in Infomedia India to TV 18, as an example. We see a lot of trends in India that were in China before."
Ranjit Pandit, managing director of General Atlantic Partners LLC, noted that the majority of his firm's overall holdings were between 10% and 35%, so they were already familiar with the kinds of investments they were looking at in the Indian market. "We are minority investors; we identify high-growth sectors so we can generate returns and do it without leverage," he said. "We're also getting more comfortable with sectors we're not familiar with -- it just takes more time."
Zubin Dubash, India Region head for Merrill Lynch Global Private Equity, said that his firm had begun its private equity endeavor on a global level during the 1990s. "The bulk of our investments had been in the U.S. and Europe -- control situations, leveraged buyouts, etc. During the last few years, we have been looking to expand our footprint -- into Brazil, Australia, Japan, China and, four months ago, India. While we are used to doing control transactions in the rest of the world, we're seeing very little of that in China or India. We wanted to tailor our own flexible strategy to do minority investments." Dubash said that the important factor wasn't whether it was a minority or control type of investment: "The important thing is, are you really a partner with the promoter? Many promoters choose private equity deals based on value. But private equity players can bring lots of different things to the table -- access to customers, access to acquisitions or even operational efficiencies."
Small Stake, Small Voice?
Ensuring some level of influence in a company without a controlling interest isn't always easy. "Sometimes you get it wrong, sometimes you get it right," said Pandit. "The key is, before you do the investment, to get comfortable with the promoter. You have to align the objectives on both sides, which is hard when you have a powerful promoter or when many branches of a family -- with different viewpoints -- are involved with the business. Getting behind some of these facets is very important." The most successful experiences have been situations where people have come from nothing and are interested in building enterprises, said Pandit. "Looking back in time, think of Infosys as an example -- there were a few professional managers who left another enterprise and who had the technology and the right governance model in place."
Hajarnavis agreed that it was a challenge. "We do try for larger transactions; we're not in a rush to deploy hundreds of millions of dollars of capital over a certain number of months. We don't have a specific timeline -- it's a long-term business. We lived through this in China as well, where we started small and over time we evolved to write larger checks. We view this as a once-in-a-lifetime opportunity for the company, so we have to be patient."
Hajarnavis admitted that there was some pressure from limited partners, who wanted India exposure. "If we didn't have a presence there, the question would be asked -- why are we not there? As with any other sector, we have to localize our product -- private equity -- for the Indian market. There may not be a lot of leveraged buyout opportunities, but there are lots of other growth capital opportunities over the next few years. We want long-term relationships with these companies. Goldman Sachs also has had the strategy of following its clients -- we see where they have gone. Every large client of Goldman has an interest and a presence in India. That creates a reason for us to be there also."
Governance structures are important, but hard to influence, the panelists noted. "We have very little influence, so you have to do the homework before getting in," said Pandit. "You see either a structure of command-and-control or where people genuinely are bettering themselves and building institutions. It's hard to change it once you're in there." Issues around hiring, where to take the business, how much risk to take -- all of these are important, he noted. "Ultimately the bet you make is on the top management team. You can't spend lots of time on all these issues if you have a lot of deals."
What Value Does a Firm Add?
Dubash, who was previously CFO at leading BPO firm WNS Global Services, gave the panel the perspective of the other side, recounting what Warburg Pincus (WNS' majority shareholder) had brought to the table. "The biggest value addition they brought was a team of people to facilitate a capture, and then they built a world-class team around that. Also, whenever we did an acquisition, we had access to their entire team's expertise in a particular area. When we wanted to open an office in Romania, we put our neck on the line and took a cut in variable pay, and the firm supported us."
Pandit added that firms typically could add value in three areas. "One is the management team, of course. Second, alliances can add value -- bringing new technology, customers, sourcing and revenue. Third would be the complementarities -- other companies in the portfolio that we are aware of. We see things on the horizon that a company may not. And we can provide funding to make things happen."
"We all strive to be a sounding board for CEOs; we want them to think of us as their business partner," noted Hajarnavis. "I'd like them to reach out to us. That's what we're there for, and when we can add value. If I know what problem the company management is trying to solve, I can put the resources of our company at their disposal."
Do the Sweet Deals Still Exist?
Even a few years ago, proprietary deals were sometimes possible, noted Rajan. When asked about the current environment, the panelists said it would be tough to find any advantage these days. "In a hot capital market, competition is inevitable," said Pandit. "The advantage that any private equity firm has is its relationships. We have a track record of supporting companies, so it sometimes allows us to get a leg up, to have the opportunity to look at a deal."
Hajarnavis noted that Indian entrepreneurs were sophisticated when it comes to understanding the value of their business. "Given the culture of negotiation, they always want to find the best deal," he said. "It's our responsibility to explain to them our tangible value-added. We may get privileged access for a short period of time or maybe one extra meeting that helps us come up with the right judgment, but really, there's no friends-and-family discount out there."
"We're new to the market in the PE practice," added Dubash, "but the relationships I've developed for 20 years are good, so deal flow has not been an issue. You do get some privileges, but you at least have to be in the range in terms of pricing."
At first, investment tended to focus on the technology sector; today's investments are in everything from real estate to infrastructure. In a keynote speech at this year's Wharton India Economic Forum, Vinod Dham, managing director of the NEA-IndoUS Ventures and former vice president/general manager of the Microprocessor Products group at Intel, noted that online services, business process outsourcing and mobile value-added services were the top three investment areas in 2007. While the bulk of the investments are still in the IT and IT-enabled services sector, health care is beginning to pick up, Dham noted, and opportunities are often regional: Bengaluru (formerly Bangalore) for IT, Hyderabad for life sciences, Mumbai for mobile/media, Chennai for manufacturing, and Delhi for business process and knowledge process outsourcing.
So how are companies getting into these opportunities, and how are the deals changing over time? A panel discussion at the conference, moderated by Bain & Company private equity practice head Sri Rajan, explored the current environment and gave the audience a taste of what is to come.
The Investment Landscape
Haramb Hajarnavis, senior member, principal investments area at Goldman Sachs, laid out the landscape. "Historically, deals were smaller in size and more growth-oriented," he noted. "On the exit side, most entrepreneurs opted for an initial public offering. Now that's all changing -- the deal size has gone up to an average of $45 million, and every flavor of investment can be found. You see multinationals, private equity players, hedge funds and sovereign wealth funds. Cross-border M&A is also emerging as a source of opportunity. The sectoral focus has widened. Buyouts have started to happen, and some exits now involve selling to others. ICICI Ventures sold a stake in Infomedia India to TV 18, as an example. We see a lot of trends in India that were in China before."
Ranjit Pandit, managing director of General Atlantic Partners LLC, noted that the majority of his firm's overall holdings were between 10% and 35%, so they were already familiar with the kinds of investments they were looking at in the Indian market. "We are minority investors; we identify high-growth sectors so we can generate returns and do it without leverage," he said. "We're also getting more comfortable with sectors we're not familiar with -- it just takes more time."
Zubin Dubash, India Region head for Merrill Lynch Global Private Equity, said that his firm had begun its private equity endeavor on a global level during the 1990s. "The bulk of our investments had been in the U.S. and Europe -- control situations, leveraged buyouts, etc. During the last few years, we have been looking to expand our footprint -- into Brazil, Australia, Japan, China and, four months ago, India. While we are used to doing control transactions in the rest of the world, we're seeing very little of that in China or India. We wanted to tailor our own flexible strategy to do minority investments." Dubash said that the important factor wasn't whether it was a minority or control type of investment: "The important thing is, are you really a partner with the promoter? Many promoters choose private equity deals based on value. But private equity players can bring lots of different things to the table -- access to customers, access to acquisitions or even operational efficiencies."
Small Stake, Small Voice?
Ensuring some level of influence in a company without a controlling interest isn't always easy. "Sometimes you get it wrong, sometimes you get it right," said Pandit. "The key is, before you do the investment, to get comfortable with the promoter. You have to align the objectives on both sides, which is hard when you have a powerful promoter or when many branches of a family -- with different viewpoints -- are involved with the business. Getting behind some of these facets is very important." The most successful experiences have been situations where people have come from nothing and are interested in building enterprises, said Pandit. "Looking back in time, think of Infosys as an example -- there were a few professional managers who left another enterprise and who had the technology and the right governance model in place."
Hajarnavis agreed that it was a challenge. "We do try for larger transactions; we're not in a rush to deploy hundreds of millions of dollars of capital over a certain number of months. We don't have a specific timeline -- it's a long-term business. We lived through this in China as well, where we started small and over time we evolved to write larger checks. We view this as a once-in-a-lifetime opportunity for the company, so we have to be patient."
Hajarnavis admitted that there was some pressure from limited partners, who wanted India exposure. "If we didn't have a presence there, the question would be asked -- why are we not there? As with any other sector, we have to localize our product -- private equity -- for the Indian market. There may not be a lot of leveraged buyout opportunities, but there are lots of other growth capital opportunities over the next few years. We want long-term relationships with these companies. Goldman Sachs also has had the strategy of following its clients -- we see where they have gone. Every large client of Goldman has an interest and a presence in India. That creates a reason for us to be there also."
Governance structures are important, but hard to influence, the panelists noted. "We have very little influence, so you have to do the homework before getting in," said Pandit. "You see either a structure of command-and-control or where people genuinely are bettering themselves and building institutions. It's hard to change it once you're in there." Issues around hiring, where to take the business, how much risk to take -- all of these are important, he noted. "Ultimately the bet you make is on the top management team. You can't spend lots of time on all these issues if you have a lot of deals."
What Value Does a Firm Add?
Dubash, who was previously CFO at leading BPO firm WNS Global Services, gave the panel the perspective of the other side, recounting what Warburg Pincus (WNS' majority shareholder) had brought to the table. "The biggest value addition they brought was a team of people to facilitate a capture, and then they built a world-class team around that. Also, whenever we did an acquisition, we had access to their entire team's expertise in a particular area. When we wanted to open an office in Romania, we put our neck on the line and took a cut in variable pay, and the firm supported us."
Pandit added that firms typically could add value in three areas. "One is the management team, of course. Second, alliances can add value -- bringing new technology, customers, sourcing and revenue. Third would be the complementarities -- other companies in the portfolio that we are aware of. We see things on the horizon that a company may not. And we can provide funding to make things happen."
"We all strive to be a sounding board for CEOs; we want them to think of us as their business partner," noted Hajarnavis. "I'd like them to reach out to us. That's what we're there for, and when we can add value. If I know what problem the company management is trying to solve, I can put the resources of our company at their disposal."
Do the Sweet Deals Still Exist?
Even a few years ago, proprietary deals were sometimes possible, noted Rajan. When asked about the current environment, the panelists said it would be tough to find any advantage these days. "In a hot capital market, competition is inevitable," said Pandit. "The advantage that any private equity firm has is its relationships. We have a track record of supporting companies, so it sometimes allows us to get a leg up, to have the opportunity to look at a deal."
Hajarnavis noted that Indian entrepreneurs were sophisticated when it comes to understanding the value of their business. "Given the culture of negotiation, they always want to find the best deal," he said. "It's our responsibility to explain to them our tangible value-added. We may get privileged access for a short period of time or maybe one extra meeting that helps us come up with the right judgment, but really, there's no friends-and-family discount out there."
"We're new to the market in the PE practice," added Dubash, "but the relationships I've developed for 20 years are good, so deal flow has not been an issue. You do get some privileges, but you at least have to be in the range in terms of pricing."
Can Dalal Street Tame the Inflation Monster?
Reliance Industries, India's biggest company by market capitalization, on April 21 announced its fourth quarter and annual results. The company reported a net profit (excluding exceptional items) of Rs.15,261 crore ($3.8 billion) on annual revenues of Rs. 139,269 crore ($34.4 billion). "Reliance beats Street estimates," said Thomson Financial News. "Reliance misses estimates," said Bloomberg.
Estimates can, of course, vary. But, at a time when nobody seems to know how to read the future of India's economy, such mismatched interpretations of corporate performance just add to the confusion. "The market has decoupled from reality," says Nandan Chakraborty, head of research at financial services provider Enam.
It seemed so simple a few months ago when the BSE sensitive index (Sensex) touched an all-time high of 21,207 on 10 January. Finance minister P. Chidambaram spoke optimistically about a 9% rate of GDP growth. Reserve Bank of India (RBI) governor Y.V. Reddy was reported to be considering an interest rate cut to boost investment. And stock analysts were gung-ho about the so-called decoupling theory: How the stock markets in rapidly-growing economies like India and China would be unaffected by the impending recession in the U.S.
Today the Indian markets have crashed. The first quarter of calendar 2008 was the worst since 1992. Market indices have fallen 28% in dollar terms. Some stocks are down more than 50%.
Now opinions vary widely on GDP growth in 2008-09. The Delhi-based Oxus Research & Investments is perhaps the most optimistic; it toes the Chidambaram line of "9% is still possible." Deutsche Bank estimates it at 8.4% and UBS 8.2%. Occupying the middle ground are the Asian Development Bank (8.0%), the International Monetary Fund (7.9%, for calendar 2008) and Lehman Brothers (7.6%). Bringing up the rear are HSBC, JP Morgan Chase and Morgan Stanley (all 7%). Meanwhile, rating agency Crisil (a Standard & Poor's company) has reduced its estimate to 8.1% from its earlier forecast of 8.5%.
Raising Interest Rates
Chidambaram, too, has tempered his GDP growth estimates. "The choice is clear," he told the Indian Merchants' Chamber at the end of March. "If we want to check inflation, we must be prepared for a slightly lower rate of growth... If the RBI decides to raise the CRR (cash reserve ratio) and interest rates to counter inflationary trends, it would certainly affect the rate of GDP growth."
The RBI has already raised the CRR, the percentage of their deposits banks must park with the central bank, from 7.5% to 8%. This will be done in two phases by May 10. In its credit policy statement of 29 April, the RBI left interest rates unchanged. However, it raised CRR by another 0.25%. Banks will have to maintain a CRR of 8.25% from May 24.
The acknowledged villain of the piece is, of course, inflation. The RBI, which says that its prime mandate is to contain rising prices, had earlier indicated that its comfort zone was 4.5% to 5%. Over the past few weeks, the numbers have risen way past that limit. In January 2008, the wholesale price index inflation was 3.8%. By March 29, it had risen to 7.41%. It then dropped to 7.1% for the week ending April 5 but rose again to 7.33% the following week. No one expects prices to go down any time soon. According to a recent survey by global management consultants McKinsey & Co, 64% of the Indian executives polled believed that inflation would go up in the next six months.
"The most immediate concern at present is inflation," says Rajesh Chakrabarti, a professor of finance at the Hyderabad-based Indian School of Business (ISB). "There is no denying that inflation has gone up much more than what the government would have wanted. In recent years, the government has been very specific in saying that it wants to contain inflation to less than 5%, and now it has gone to 7%.
"The trouble with inflation management seems to be that the government will resist raising interest rates because the interest rate differential with the U.S. is already quite large and they wouldn't want to widen it further," Chakrabarti explains. "One of the things that the government is trying to do is put in price ceilings and quantitative controls, which have historically not worked, not just in India, but elsewhere also. These are difficult to administer. This is a 1970s-80s kind of solution. But one can understand the government's need to do this as they don't want to touch the monetary policy at this point in time because of foreign investments, etc. The government is constrained by what is called the impossible trinity of international finance (the perceived irreconcilability of the three objectives -- capital freedom, exchange rate maintenance and independence of monetary policy)."
The solutions that Chakrabarti is talking about are manifesting themselves everywhere. The government has been squabbling with cement and steel manufacturers, arm-twisting them to hold down prices. "It is my view that cement manufacturers and, to some extent, steel producers are behaving like a cartel," Chidambaram told Parliament in late April. "We are looking at the legal and administrative provisions that are available." Steel companies, on their part, point to rising input costs. An uneasy truce has been reached with manufacturers agreeing to hold prices for a couple of months. But this could break down if companies see themselves slipping into the red.
The government has taken several other steps, including various export bans and import duty cuts. Even the annual export-import policy was revised. For example, this year, what made headlines was a total ban on cement exports and the withdrawal of all incentives on the export of primary steel. The export target for 2008-09 has been increased to $200 billion -- an increase of 23% over the $155 billion achieved in 2007-08. This was short of the $160 billion target for the year.
Increase in steel and cement prices leads to pressure on user industries. Two-wheeler manufacturer Hero Honda has announced a price hike. Car manufacturers are being forced to the wall. And the Tata group's Rs. 100,000 ($2,500) Nano, the inexpensive car due to roll off the assembly lines soon, may be impossible to manufacture at such a low price.
Soaring Food Prices
But this is not where the crisis is most acute. The price increases that hurt, especially in an election year, are those of food grains. "Another big concern is that in India and also globally there seems to be somewhat unbalanced growth (in the composition of the growth itself)," says Chakrabarti of ISB. "This seems to put pressure on food prices internationally. Food exports are also being limited, and Vietnam and other countries are not exporting as much rice as they did in the past. Given India's income distribution and poverty levels, rising food prices are of particular concern here. Food prices going up will mean a significant reduction in the standard of living for a very large part of the population. Normally, the stopgap arrangement has been through imports. But this time it will not be so easy because the rising food prices seem to be global."
For public consumption, the government has to be seen to be taking steps. But most experts are doubtful whether they will do any good. "I feel that the [inflation] numbers are going to be around 6% -- above the 5% magic benchmark," says Ajit Ranade, chief economist of the Aditya Birla group. "The inflation numbers for seasonal goods like fruits and vegetables may come down. There might be some moderation in food grains. But I don't see overall inflation numbers coming down very quickly. This is a global problem." The United Nations World Food Program (WFP) has compared the crisis to a silent tsunami and said that 100 million people are at risk. Wheat and rice prices have risen to record levels. "A wave of food-price inflation is moving through the world, leaving riots and shaken governments in its wake," as The Economist recently wrote in a cover story on the subject. "Agriculture is now in limbo. The world of cheap food has gone."
Oil prices in India have crossed $110 a barrel, though these are not reflected in the inflation numbers as the government subsidizes fuel prices. Still, oil refineries are feeling the pinch. Indian Oil Corporation says it is losing Rs. 238 crore ($59 million) a day on retail fuel sales.
There are other worries. The Index of Industrial Production (IIP) plunged to 5.8% in January. It recovered to 8.6% in February, but that was much below the 11.2% recorded in February 2007. For the first 11 months of fiscal 2007-2008, the IIP has come down to 8.7%, compared to 11.2% for the same period last year. Growth has taken a backseat. "There is a crisis of confidence too," says Chakraborty of Enam.
Subprime Losses
Ripples of the subprime crisis in the U.S. have spread to India -- but they are ripples, not waves. Perhaps the only major sufferer among the banks and financial institutions is ICICI Bank, which had a mark-to-market loss of $264 million as of January 31. The bank explained that it had provided $90 million already and would provide another $70 million. But the losses hit the headlines only after the answer to a Parliament question brought out the details. This gave rise to the feeling that there could be other losses hidden in the banking system.
According to one estimate, the total losses could add up to Rs. 20,000 crore ($5 billion). The RBI, however, says there is no systemic risk. Given the cautious nature of India's central bank, observers believe that the losses could be lower. The State Bank of India, the country's largest bank, says that its clients' derivative losses could be around Rs. 700 crore ($173 million). Unfortunately, not all banks are being open about their exposure. This has added to market fears that more shoes could drop in the future.
The corporate results so far have been a mixed bag. Even within sectors, there are no clear signals. Infosys created much enthusiasm within the information technology (IT) industry when it announced upbeat performance and strong prospects for the future. A few days later, India's largest IT company -- Tata Consultancy Services (TCS) -- poured cold water over the euphoria. "The TCS performance is below par," says Manik Taneja, an analyst with Emkay Share and Stock Brokers. Even so, some optimism lingers. Raamdeo Agarwal, joint managing director of Motilal Oswal Securities, says that if companies report the expected 18% to 20% growth in profits, the markets will recover.
According to Enam's Chakraborty, "In January 2008, the Indian market was banking on global and domestic liquidity, despite its over-leverage, combined with pockets of over-valuation and over-ownership. Since then, India has been one of the worst performing markets, even as most global markets have bounced back, banking on being rescued by the U.S. Federal Reserve, while commodity inflation has aided Brazil and Russia."
Chakrabarti of ISB says that what happens in the U.S. matters enormously to India. "On the export front, if the global slowdown continues -- and worldwide there is an expectation that the U.S. economy will be slow for at least the next few quarters -- then exports are likely to drop. How deep the drop will be depends largely upon the U.S. market because, historically, when America slows down, most other economies also follow. It now remains to be seen if the slowdown will be as global as it has been in earlier times.
"In the medium term, things don't look too good for India. But given the structural changes that India has made, I believe that it will be only a temporary blip. In the long run things will be back on track. The question is when? I believe that in 12 to 18 months we will be back to where we were. I don't expect a long term slowing down."
Subir Gokarn, chief economist of Standard & Poor's Asia Pacific, agrees. In his April review of the economy -- CRISIL EcoView -- he writes: "The recent downturn in investment activity has clearly contributed to the overall deceleration in manufacturing. This, and other indicators, such as credit growth, point to the onset of a cyclical downturn in the economy. This is obviously a matter of concern, but, at this point, our expectation is that the downturn will be both shallow and short. Remember that barely five years ago, GDP growth was less than 6% a year. Compared to that, we are now worrying about it falling to 8%. That is perhaps the best reflection of how dramatically the economy and its investment climate have changed in such a short span of time."
Estimates can, of course, vary. But, at a time when nobody seems to know how to read the future of India's economy, such mismatched interpretations of corporate performance just add to the confusion. "The market has decoupled from reality," says Nandan Chakraborty, head of research at financial services provider Enam.
It seemed so simple a few months ago when the BSE sensitive index (Sensex) touched an all-time high of 21,207 on 10 January. Finance minister P. Chidambaram spoke optimistically about a 9% rate of GDP growth. Reserve Bank of India (RBI) governor Y.V. Reddy was reported to be considering an interest rate cut to boost investment. And stock analysts were gung-ho about the so-called decoupling theory: How the stock markets in rapidly-growing economies like India and China would be unaffected by the impending recession in the U.S.
Today the Indian markets have crashed. The first quarter of calendar 2008 was the worst since 1992. Market indices have fallen 28% in dollar terms. Some stocks are down more than 50%.
Now opinions vary widely on GDP growth in 2008-09. The Delhi-based Oxus Research & Investments is perhaps the most optimistic; it toes the Chidambaram line of "9% is still possible." Deutsche Bank estimates it at 8.4% and UBS 8.2%. Occupying the middle ground are the Asian Development Bank (8.0%), the International Monetary Fund (7.9%, for calendar 2008) and Lehman Brothers (7.6%). Bringing up the rear are HSBC, JP Morgan Chase and Morgan Stanley (all 7%). Meanwhile, rating agency Crisil (a Standard & Poor's company) has reduced its estimate to 8.1% from its earlier forecast of 8.5%.
Raising Interest Rates
Chidambaram, too, has tempered his GDP growth estimates. "The choice is clear," he told the Indian Merchants' Chamber at the end of March. "If we want to check inflation, we must be prepared for a slightly lower rate of growth... If the RBI decides to raise the CRR (cash reserve ratio) and interest rates to counter inflationary trends, it would certainly affect the rate of GDP growth."
The RBI has already raised the CRR, the percentage of their deposits banks must park with the central bank, from 7.5% to 8%. This will be done in two phases by May 10. In its credit policy statement of 29 April, the RBI left interest rates unchanged. However, it raised CRR by another 0.25%. Banks will have to maintain a CRR of 8.25% from May 24.
The acknowledged villain of the piece is, of course, inflation. The RBI, which says that its prime mandate is to contain rising prices, had earlier indicated that its comfort zone was 4.5% to 5%. Over the past few weeks, the numbers have risen way past that limit. In January 2008, the wholesale price index inflation was 3.8%. By March 29, it had risen to 7.41%. It then dropped to 7.1% for the week ending April 5 but rose again to 7.33% the following week. No one expects prices to go down any time soon. According to a recent survey by global management consultants McKinsey & Co, 64% of the Indian executives polled believed that inflation would go up in the next six months.
"The most immediate concern at present is inflation," says Rajesh Chakrabarti, a professor of finance at the Hyderabad-based Indian School of Business (ISB). "There is no denying that inflation has gone up much more than what the government would have wanted. In recent years, the government has been very specific in saying that it wants to contain inflation to less than 5%, and now it has gone to 7%.
"The trouble with inflation management seems to be that the government will resist raising interest rates because the interest rate differential with the U.S. is already quite large and they wouldn't want to widen it further," Chakrabarti explains. "One of the things that the government is trying to do is put in price ceilings and quantitative controls, which have historically not worked, not just in India, but elsewhere also. These are difficult to administer. This is a 1970s-80s kind of solution. But one can understand the government's need to do this as they don't want to touch the monetary policy at this point in time because of foreign investments, etc. The government is constrained by what is called the impossible trinity of international finance (the perceived irreconcilability of the three objectives -- capital freedom, exchange rate maintenance and independence of monetary policy)."
The solutions that Chakrabarti is talking about are manifesting themselves everywhere. The government has been squabbling with cement and steel manufacturers, arm-twisting them to hold down prices. "It is my view that cement manufacturers and, to some extent, steel producers are behaving like a cartel," Chidambaram told Parliament in late April. "We are looking at the legal and administrative provisions that are available." Steel companies, on their part, point to rising input costs. An uneasy truce has been reached with manufacturers agreeing to hold prices for a couple of months. But this could break down if companies see themselves slipping into the red.
The government has taken several other steps, including various export bans and import duty cuts. Even the annual export-import policy was revised. For example, this year, what made headlines was a total ban on cement exports and the withdrawal of all incentives on the export of primary steel. The export target for 2008-09 has been increased to $200 billion -- an increase of 23% over the $155 billion achieved in 2007-08. This was short of the $160 billion target for the year.
Increase in steel and cement prices leads to pressure on user industries. Two-wheeler manufacturer Hero Honda has announced a price hike. Car manufacturers are being forced to the wall. And the Tata group's Rs. 100,000 ($2,500) Nano, the inexpensive car due to roll off the assembly lines soon, may be impossible to manufacture at such a low price.
Soaring Food Prices
But this is not where the crisis is most acute. The price increases that hurt, especially in an election year, are those of food grains. "Another big concern is that in India and also globally there seems to be somewhat unbalanced growth (in the composition of the growth itself)," says Chakrabarti of ISB. "This seems to put pressure on food prices internationally. Food exports are also being limited, and Vietnam and other countries are not exporting as much rice as they did in the past. Given India's income distribution and poverty levels, rising food prices are of particular concern here. Food prices going up will mean a significant reduction in the standard of living for a very large part of the population. Normally, the stopgap arrangement has been through imports. But this time it will not be so easy because the rising food prices seem to be global."
For public consumption, the government has to be seen to be taking steps. But most experts are doubtful whether they will do any good. "I feel that the [inflation] numbers are going to be around 6% -- above the 5% magic benchmark," says Ajit Ranade, chief economist of the Aditya Birla group. "The inflation numbers for seasonal goods like fruits and vegetables may come down. There might be some moderation in food grains. But I don't see overall inflation numbers coming down very quickly. This is a global problem." The United Nations World Food Program (WFP) has compared the crisis to a silent tsunami and said that 100 million people are at risk. Wheat and rice prices have risen to record levels. "A wave of food-price inflation is moving through the world, leaving riots and shaken governments in its wake," as The Economist recently wrote in a cover story on the subject. "Agriculture is now in limbo. The world of cheap food has gone."
Oil prices in India have crossed $110 a barrel, though these are not reflected in the inflation numbers as the government subsidizes fuel prices. Still, oil refineries are feeling the pinch. Indian Oil Corporation says it is losing Rs. 238 crore ($59 million) a day on retail fuel sales.
There are other worries. The Index of Industrial Production (IIP) plunged to 5.8% in January. It recovered to 8.6% in February, but that was much below the 11.2% recorded in February 2007. For the first 11 months of fiscal 2007-2008, the IIP has come down to 8.7%, compared to 11.2% for the same period last year. Growth has taken a backseat. "There is a crisis of confidence too," says Chakraborty of Enam.
Subprime Losses
Ripples of the subprime crisis in the U.S. have spread to India -- but they are ripples, not waves. Perhaps the only major sufferer among the banks and financial institutions is ICICI Bank, which had a mark-to-market loss of $264 million as of January 31. The bank explained that it had provided $90 million already and would provide another $70 million. But the losses hit the headlines only after the answer to a Parliament question brought out the details. This gave rise to the feeling that there could be other losses hidden in the banking system.
According to one estimate, the total losses could add up to Rs. 20,000 crore ($5 billion). The RBI, however, says there is no systemic risk. Given the cautious nature of India's central bank, observers believe that the losses could be lower. The State Bank of India, the country's largest bank, says that its clients' derivative losses could be around Rs. 700 crore ($173 million). Unfortunately, not all banks are being open about their exposure. This has added to market fears that more shoes could drop in the future.
The corporate results so far have been a mixed bag. Even within sectors, there are no clear signals. Infosys created much enthusiasm within the information technology (IT) industry when it announced upbeat performance and strong prospects for the future. A few days later, India's largest IT company -- Tata Consultancy Services (TCS) -- poured cold water over the euphoria. "The TCS performance is below par," says Manik Taneja, an analyst with Emkay Share and Stock Brokers. Even so, some optimism lingers. Raamdeo Agarwal, joint managing director of Motilal Oswal Securities, says that if companies report the expected 18% to 20% growth in profits, the markets will recover.
According to Enam's Chakraborty, "In January 2008, the Indian market was banking on global and domestic liquidity, despite its over-leverage, combined with pockets of over-valuation and over-ownership. Since then, India has been one of the worst performing markets, even as most global markets have bounced back, banking on being rescued by the U.S. Federal Reserve, while commodity inflation has aided Brazil and Russia."
Chakrabarti of ISB says that what happens in the U.S. matters enormously to India. "On the export front, if the global slowdown continues -- and worldwide there is an expectation that the U.S. economy will be slow for at least the next few quarters -- then exports are likely to drop. How deep the drop will be depends largely upon the U.S. market because, historically, when America slows down, most other economies also follow. It now remains to be seen if the slowdown will be as global as it has been in earlier times.
"In the medium term, things don't look too good for India. But given the structural changes that India has made, I believe that it will be only a temporary blip. In the long run things will be back on track. The question is when? I believe that in 12 to 18 months we will be back to where we were. I don't expect a long term slowing down."
Subir Gokarn, chief economist of Standard & Poor's Asia Pacific, agrees. In his April review of the economy -- CRISIL EcoView -- he writes: "The recent downturn in investment activity has clearly contributed to the overall deceleration in manufacturing. This, and other indicators, such as credit growth, point to the onset of a cyclical downturn in the economy. This is obviously a matter of concern, but, at this point, our expectation is that the downturn will be both shallow and short. Remember that barely five years ago, GDP growth was less than 6% a year. Compared to that, we are now worrying about it falling to 8%. That is perhaps the best reflection of how dramatically the economy and its investment climate have changed in such a short span of time."
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