When it rains, it pours. The monsoon showers have been tardy this year but criticism of India’s economic management from domestic and international investors (amplified by the financial press) has become a virtual torrent.
Bad news is followed by worse. No sooner does the government buckle under political pressure to postpone every item of business reform than markets tumble, the rupee sinks and international rating agencies rush to pull the plug. Standard & Poor’s, Fitch and Moody’s have all been harsh on Indian sovereign and corporate debt, especially that of its banks.
India’s public finances are in a mess. The government is over-borrowed, its debt to gross-domestic product ratio is the highest among developing countries and the looming drought can only make matters worse. The endless cycle of state elections this year will make populist politics and expanded public spending a given in the short term.
Persistent inflation at more than 7% has forced the central bank to keep a tight leash on credit. Borrowing has become expensive. “When the government is borrowing at 8%, companies have to deal with rates between 12% and 15%,” said Mukarram Bhagat, executive director of ASK Investment in Mumbai. “This is unsustainable. We’re in a slowdown phase.”
So what does the government do? For starters, it has brought India’s most progressive politician, P Chidambaram, back as finance minister. Business thinks he might roll back ill-conceived tax measures, such as the retrospective impost on capital gains, rationalise the indirect tax structure (the goods and services tax or GST) and force government to adhere to some degree of fiscal restraint. Chidambaram was the author of the Fiscal Responsibility and Budget Management Act in 2003 that sought to cap the fiscal deficit at 3% of GDP.
The problem, however, is business has lost patience. Indian companies are investing overseas rather than at home.
The Reserve Bank of India (RBI) says that Indian companies have invested close to $6 billion in acquisitions abroad in May and June this year. In fact they have being doing so for some time. Some of them were investing for strategic reasons (acquiring long-term resources like coal, oil & gas) but mostly for the opportunity unavailable at home.
Why would pharmaceutical, consumer goods or engineering companies invest in zero-growth Europe when, even by the most conservative estimates, India is growing at 6.5%?
Distressed assets, undervalued companies? It’s more likely they lack confidence in the government’s ability to manage a $2 trillion economy driven by 1.2 billion consumers.
As Gautam Trivedi, managing director and head of equities at Religare Capital Markets in New Delhi explained, “It is policy paralysis in the home market coupled with an economic slowdown that is driving Indian companies to invest abroad. Also as luck would have it, assets in the US and Europe are far more attractive today than two years ago.”
Indian companies have bought assets abroad when they had the means to do so. The Tatas bought steelmaker Corus for $7.6 billion and auto manufacturer Jaguar Land Rover for $2.3 billion, to become the UK’s biggest manufacturing employer. Bharti Airtel acquired Zain Telecom’s Africa business for $10.7 billion. Lakshmi Mittal bought Arcelor to become the world’s biggest steelmaker. But this time it’s different. Medium size companies, who would normally expand to service a domestic market, are investing overseas.
Shailesh Haribhakti, chairman of accounting firm BDO India, takes a different view. “India’s economy is fundamentally strong, by any global measure we have traction, we have growth.” The reason Indian companies aren’t investing is they have a lot of spare capacity. “In pharmaceuticals I would estimate we have 65% to 75% capacity utilisation, in cement about 70% to 80% and in steel, just 60% to70%.” Until demand picks up, companies will sit on cash. Energy is the serious long-term worry and energy-intensive industries are the ones at risk.
But how long can companies sit on cash and earn from treasury operations? Trivedi of Religare is candid: “Indian companies are loath to return cash to shareholders. It’s the mindset of the Indian promoters/management where they believe that they can do a better job with the cash rather than return it to investors. Historically there has been so much opportunity in India that the cash has usually ended up in assets or capex; some productive, some not so productive. What this also means is that when the cycle turns the cash will be deployed very fast.”
The business cycle is key to the story. India has been hurt by a combination of negative currents. Inflation has undermined business confidence and the RBI has persisted with a tight money policy till the government puts its finances in order. That is impossible in the short term. Just as India’s exports began to grow, recession in its principal markets put paid to those hopes.
But Bhagat forecasts interest rates have peaked and inflation will come down. More interesting, he says that the oft-blamed policy issues aren’t the bogeyman. Policy reform isn’t critical to re-energising the economy. “The same set of policies gave us 9% growth two years ago. What has changed is the sentiment, the corruption, the scams. That has hurt investor confidence.”
Business confidence can’t be taken for granted. A stable government and the rule of law will go a long way in restoring trust.
This article first appeared in the August issue of FinanceAsia magazine