Roger Donnelly outlines the key risks facing foreign investors, contractors and suppliers doing business in India
Much of the credit for the macro-stability that India currently enjoys must go to Prime Minister Manmohan Singh, who, as finance minister in 1991, responded to a balance of payments crisis by restoring fiscal discipline and liberalising industry, trade and foreign investment policy.
This lifted the economy’s growth potential and allowed it to break out of the lacklustre annual 3.5 per cent ‘Hindu rate of growth’ it had endured in the post-war period to growth of more than eight per cent per annum – a rate that doubles the economy’s size every nine years. Better still, growth in that period has dipped below five per cent in only three years.
The Lehman Brothers collapse last September brought home the reality of the global economic crisis to corporate India. Companies have found themselves cut off from foreign funding and hammered by stock market falls. Post-Lehman capital outflow and rising risk aversion have triggered a sharply depreciating rupee and rising domestic interest rates.
Meanwhile, in the ‘real’ economy, there have been setbacks from the world economic downturn, Mumbai terrorist attacks and scandals in the outsourcing sector. The result is likely to be a sharp slowdown in consumption, investment and export growth, including in the important categories of outsourcing exports and remittances from migrant workers.
The government is weighing in with significant stimulus to cushion the slowdown: so far, 350 basis points of official interest rate cuts; an AU$6.07 billion public spending boost; and interest rate subsidies and VAT reductions for exporters. Despite this, growth in 2009 could still slide below five per cent.
Also, according to the World Bank, India ranks 180 out of 181 economies for contract enforceability. A plaintiff in a payment dispute has to go through 46 procedures, which take an average 1420 days to complete and cost an average 40 per cent of the value of the claim.
Developments to watch
A closely fought general election is due by May, and business and the markets will look askance at any ‘third front’ (made up of communist and populist regional parties) victory, even though many of those parties aren’t totally opposed to liberal capitalism.
The reputation of the business process outsourcing (BPO) sector has been dented lately: several large US firms, such as Dell, have cancelled contracts with Indian call centres because of concerns about service quality; Telstra and Nestlé are reviewing contracts with India’s fourth-largest software firm, Satyam Computer Services, after the revelation of an AU$1.5 billion fraud; and the World Bank has blacklisted software companies Megasoft and Wipro. Then again, the international downturn could actually bolster demand for outsourcing as Western firms seek cost savings to stay alive. BPO accounts for nearly one-third of Indian export revenues.
So far Delhi is responding in a measured way to the Mumbai terror attacks, but the business climate could suffer if tensions rise.
Anti-industrial protests supported by both the political right and left are thwarting numerous large-scale industrial development and mining plans, particularly in the northern and eastern states. A plan by Tata Motors to build its AU$3050 Nano car in West Bengal has been one recent casualty. Naxalites – armed Maoist rebels – frequently join in the protests and turn them violent. Mining operations are particularly threatened by Naxalites in Bihar, Orissa and Jharkhand. The richer southern and western states are more welcoming to investment, although not completely immune from the problem.
A court decision allowing tax authorities to pursue British telecom company Vodafone for AU$3.05 billion is unsettling foreign investors. Vodafone has been assessed for capital gains tax on a deal in which it bought a controlling interest in an Indian mobile phone company. Vodafone argues that the transaction took place offshore between overseas-registered companies and that such deals have never before been taxed in India, and it disputes the retrospective character of a law under which it is being pursued. The authorities, for their part, have become impatient with companies registering in Mauritius to take advantage of a double tax treaty that allows them to avoid capital gains tax on their Indian business dealings. The government needs to clarify its laws on taxation of foreign investors if it wants to sustain foreign direct investment inflows.
Roger Donnelly is Chief Economist, Export Finance and Insurance Corporation (www.efic.gov.au).
THE TIGER’S TALE
Rohit Singh looks at the advantages of corporate investment in India
In these financially difficult times, senior management of multinational corporations are trying to protect their own turf rather than thinking about investing in new regions. But growth economies like India are as relevant for multinationals in recessionary times as they were in the expansionary phase. India’s $1.7 trillion economy, which is fuelled primarily by strong domestic demand, is still estimated to have grown at 6.5 per cent for the financial year ending March 2009. This remains an enviable achievement.
In January 2008, most Indian CEOs were upbeat about their growth plans. The BSE Sensex had reached an all-time high of 21,206 and companies were raising capital from private equity firms at stratospheric valuations to fund domestic investment and their overseas acquisition ambitions. Time-tested valuation multiples had lost their relevance in the deal-making euphoria. Most Indian companies were acquirers in the global mergers and acquisitions (M&A) context rather than targets.
Now, though, the mood of Indian promoters seems to have changed. They are more realistic about their growth plans and are busy stress-testing their assumptions based on the new ground realities. Some of them are even willing to entertain discussions that could lead to a majority stake sale in their companies, which would have been close to unthinkable 12 months ago.
The private sector in India is still dominated by family owned businesses, which have adapted themselves remarkably well from the erstwhile ‘licence quota raj’ to the current free-trade environment.
Indian companies, even small- to medium-sized ones, have competed strongly against well-capitalised multinationals. Most are underleveraged compared to their global peers and have the wherewithal to cope with a downturn. When approached by a foreign company, they are typically in no hurry to sell and demand a full and fair price – the memory of the good times fades slowly. Even recently, we have seen several M&A deals fall through due to a mismatch of valuation expectations between buyer and seller.
Structures to bridge this gap have become common, such as earn-out agreements, whereby a foreign company acquires an upfront majority stake in an Indian target and then buys out the remaining stake over a period of time at pre-agreed performance-based valuation multiples. This mechanism also ensures that the target management team transitions its responsibilities or integrates into the new management over a longer time frame.
Since the Mumbai terrorist attacks, many companies are asking themselves if this is the right time to invest in India. They are sceptical about the unforeseen risks of investing in a developing economy.
I was in New York when 9/11 occurred and also present in the Oberoi hotel a few hours before the Mumbai attacks, and my view is that all large cities share similar risks of being soft targets for terrorist activities. The people of Mumbai showed great resilience during the recent crisis and the city got back on its feet within 24 hours of the attack. People went back to work with a determination that they would not allow the free sprit of the city to be curbed by a few terrorists.
It is this unflinching attitude and determination to succeed that will fuel India’s growth over the next decade, and foreign companies are well-advised to participate in that growth story.
Rohit Singh is Mumbai Managing Director of Business Development Asia LLC (www.bdallc.com).