Prospects for India's development
PROSPECTS FOR INDIA'S DEVELOPMENT
24 April 2000
Business 487
Professor Marvin Zonis
Leonardo Cherman
Meredith Persily
Debra Strober
Tomoko Tanaka
Gary Wong
ACKNOWLEDGEMENTS
The India group would like to thank CNA Financial, Deutsche Bank, Diamond Technology Partners, and Pfizer for making our trips possible. Through their support, we were able to perform primary research in New Delhi, Bangalore, Goa, Jaipur, and Bombay. The additional regional perspective provided tremendous value to us when developing our hypothesis about the Indian market.
In addition, we would like to thank the many interview contacts who welcomed us to their country and candidly provided information and perspective to us.
Table of Contents
ACKNOWLEDGEMENTS 2
Table of Contents 3
I. The Bottom Line 4
II. Model and Variables 4
In order to develop a model for India we analyzed the following variables: 4
III. Data and Analyses 4
A. The Political Environment 4
Current Status 4
Barriers to Progress 5
B. Labor Policy 7
Snapshot 7
Status and Barriers 7
C. Privatization and Liberalization of Key Industries 9
Snapshot 9
Initiatives 9
Barriers 10
D. Financial Reforms and Foreign Direct Investments (FDI) 11
Snapshot 11
Status 11
Initiatives and Barriers 12
E. Information Technology Sector 13
Snapshot 13
Status 14
Impact on Investment Potential 15
Barriers 15
IV. Variable Mix 16
V. Conclusion 17
VI. Appendix I: Exhibits 19
Exhibit III.A.1: The Lok Sabha Elections -- General Summary 1952-1998 19
Exhibit III.A.2: National Voter Turnout in Federal Elections: 1960-1996 20
Exhibit III.A.3 21
Exhibit III.B.1: Purchase Power Parity 22
Exhibit III.C.1: India Telecoms Regulatory Structure 22
Exhibit III.C.2: Infrastructure and Other Investments, as% of GDP (Private Sector Investment) 23
Infrastructure 23
Other 23
Exhibit III.D.1 24
Exhibit III.D.2 25
Exhibit III.E.1 IT Sector Revenues for 1994-1999 (source: NASSCOM) 25
Exhibit IV.1: Variable Interactions 26
Exhibit V Alternative Scenarios 27
End Notes 29
I. The Bottom Line
On the surface, India presents itself as a tremendous growth opportunity given its enormous population, well-established democratic institutions, notable successes in the software industry, and its recent introduction of competition in certain key industries. At the same time, the government's failure to implement necessary privatizations, reduce subsidies substantially, streamline its government agencies, and meet the educational needs of its population put into question the government's commitment to wide-scale reform. The government's need to attain consensus has presented a significant barrier to rapid reform. Meanwhile, the federal government has put much of the decision-making power into the hands of the state governments, and, certain southern states have pioneered privatizations in energy and telecom and have also excelled in private industry. As a result, we see tremendous growth potential in these states.
India still maintains some of the legacy of the Soviet Union that failed to push the country towards market reform. China's recent development has made the country begin to question its development path. Southern states, that are more industrially aligned with the West, have begun to see the fruits of private industry and will continue to develop and present excellent investment opportunities. The lagging states in the north will only develop once they begin comparing themselves to the south and recognize that they are missing out on much of what reform has to offer.
II. Model and Variables
In order to develop a model for India we analyzed the following variables:
1) Politics: Stability, the Party System, Coalitions and Consensus
2) Labor Policy and Education
3) Privatization and Liberalization of Key Industries
4) Financial sector reforms and impact on Foreign Direct Investment
5) The Software Industry and the Role of Overseas Indians
Indeed, an infinite number of variables are relevant to the India model. However, we sought a mixture of macro and micro variable in order to grasp the challenges at the local and national levels. Indeed, this approach was appropriate given that the country offers some micro opportunities, both in terms of geography and selected industries. Where the country falls short, however, is in the ability to enact necessary structural changes in the society.
III. Data and Analyses
A. The Political Environment
Current Status
At the most basic of levels, India's overriding political environment can be broken into two realms: international and domestic. India's foreign policy consists of a necessary preoccupation with Pakistan (with whom it seems to skirmish every Spring), with China (it's largest threatening neighbor) and those general issues involved with building and maintaining a nuclear arsenal. While its relationships with regional neighbors are tenuous at best, all factors indicate that India's standing in the international community is such that beyond diverting precious funds and attention away from domestic issues, India's international realm should pose no major hurdles for the near future. On the other hand, the domestic realm very strongly characterizes the near-term future of foreign investment in India. The nature of coalition politics and the problems it causes for consensus-building is hindering the necessary political and economic reforms that will allow India to effectively create and implement domestic policies. A strong government that can lead India through initially painful economic reforms is necessary if India is to emerge as a new Asian tiger. Only a strong leadership will allow India to surmount the major hurdle that is Nehru's 45-year legacy of protectionist economic ideology and the remnants of its Cold War era alignment with the Soviet Union in order to create the necessary conditions to entice foreign investment.
Barriers to Progress
International Climate
Pakistan
Though the Indian self-perception as a major international power makes China its primary regional threat (and primary nuclear threat), for the foreseeable future Pakistan is India's main source of instability. As evidenced by the recent 28% increase in the defense budget, large amounts of funding are diverted to the military for fighting skirmishes over the Line of Control (LOC) in Jammu and Kashmir. The October 21, 1999 military coup in Pakistan has further destabilized the region while the hijacking of an Indian Airlines plane in December of 1999 remains a source of embarrassment for India. Peace between the two countries is not yet on the horizon. Pakistan cannot initiate peace because its new military regime requires the immediate Indian threat to legitimate its existence. Nor can India broker peace because its historic policy of non-compromise on the "internal" issue of Kashmir dictates that a compromise on the question would seal the doom of the new coalition (see following section on domestic politics for more information). Yet full-scale war between the two countries also remains unlikely. Pakistani General Pervez Musharraf cannot initiate an official war with India because his economy relies too heavily on the generosity of the international community (namely the US and the IMF) to risk their dismay. Meanwhile, India must maintain its historical position of taking the moral high ground where Pakistan is concerned in order to maintain its international standing. So, for the near future, with both countries devoid of stable leadership, capital and time-intensive skirmishing will continue to be a drain on resources, but should not prove fatal.
The Nuclear Issue
In terms of nuclear weapons, as long as China maintains its nuclear arsenal, and as long as the non-proliferation regime supported by the West remains incapable of extending the security of a nuclear umbrella to non-nuclear states, India will retain its nuclear arsenal and refuse to sign the Non-Proliferation Treaty (NPT).i Though historically this has been a point of contention in particular with the United States, it looks like the NPT will become less of a sticking point for Indo-US relations in the future. For example, in October 1999 the US ratified the Glenn Amendment (to the Arms Export Control Act) which allows the President to waive certain types of sanctions imposed on India in the aftermath of its controversial May 1998 nuclear test. In addition, the US Congress, having failed itself to ratify the CTBT, has severely hampered US ability to leverage Indian non-compliance with the NPT. Both of these events suggest a slackening of tension over non-proliferation issues, hence, the lowering of a barrier to foreign investment in India.
Domestic Climate
The Coalition Government and Rapid Turnover
India's domestic political system has lacked stable leadership for close to six years - in just one year alone, three different governments controlled the country. There have been three elections since 1996, the most recent of which took place in October of 1999 and brought yet another monstrous coalition government to power - an increase in the number of parties from 18 to 24. (The problem is getting progressively worse as the 1997 coalition government that was ousted had only 13 parties.) The regularity of turnover is extremely disruptive for policy-making - when the last parliament was dissolved in 1999, 106 bills pending in the lower house (Lok Sabha) were discarded.ii
The Coalition Government and Consensus-Building
The problem with such a fractious coalition government is not the failure of the Democracy. The fact that the government has been overturned 3 times since 1996 through peaceful, legal and legitimate elections, initiated by a government of popular consent, suggests that the parliamentary democracy and all of its requisite checks and balances are fully institutionalized. India truly is the world's largest democracy. Regarding the "quality" of India's democracy, the 1998 Indian elections lured 61.97% of the voting population to the poles, while the United States, arguably the world's most successful democracy, coaxed only 49.08% of its voters to the poles during the 1996 presidential election. And the trend in India has been increasing over time. [Exhibits III.A.1 and 2]. The problem is that a coalition government's existence is at the mercy of small political parties' very specific interests. For instance, the 3/4 of Indian society that is agrarian will continue to use their political will to ensure that high government agricultural subsidies continue for their products, their electricity supplies, and their tax breaks. They have the power to request a vote of no confidence and catalyze a new round of elections should the present government attempt to cut those subsidies. And due to the fractious nature of the coalition, many different interest groups maintain the power to do the same. [Exhibit III.A.3.]
This lack of consolidated leadership slows progress to a crawl. (The first and last major economic reforms came between 1991 and 1993 - over 6 years ago). This first round of reforms marked a real departure -- an opening of the Indian economy to the world. The current coalition leader is still the Bharatiya Janata Party (BJP) as it remains the largest party in the coalition.iii Although the new government has acted in favor of reform in its early days in office (by opening the insurance sector, liberalizing the FX management regime and allowing the trade of derivatives on stock exchanges), regardless of its beliefs, it will still be held prisoner by the nature of coalition politics.
B. Labor Policy
Snapshot
From the labor market perspective India faces very good growth prospects mainly due to its current low levels of salaries and capital stock. Cheap labor is abundant and markets are poorly served which can represent a significant opportunity for investment. Nevertheless, sustainability is an issue for public policy is not being conducted as to achieve productivity growth. Note that productivity has a broad definition encompassing all factors that make the combination of labor and capital more efficient: infrastructure, processes, human capital/education, technology, regulatory environment. India clearly falls behind in the overall productivity level with an inadequate and overloading labor regulation for the potential employer.
Status and Barriers
Labor and wages
One noted exception to the very good data collection system in India is the absent set of reliable data on employment and unemployment. According to a compilation of official data provided by ISI Emerging Markets Data, unemployment rate as a percentage of total labor force is 1.89%, an extremely low figure for international standards not endorsed by industry specialist, labor experts and local managersiv. It is important to understand, however, the definition of an unemployed person so that we can conclude that such figure is heavily underestimated. As per India's criteria, unemployment rate is based on "usual status" defined as a person not working, and either seeking work or available for work in the major part of a reference year. The usual status is considered the chronic open unemployment. Most important however is to understand that only 8% of the total labor force are employed in the so-called organized sector and thus counted in the statistics. The remaining 92% are a part of a massive contingent of workers that make a living either through part-time occupations, seasonal jobs (agricultural, e.g.) or underemployment (approximately 6%), not to mention illegal occupations.
Pattern of population growth: One other important point, not completely captured by official statistics is the growth of the unemployment rate resulting from the increase of the adult population (2.5% per year according to official figures) not met by the current rate of job creation (2.3%). While this gap seems small, there is a significant reason for concern for only now the labor market will feel the consequences of the population boom of the 60's and 70's (despite population growth of 1.9% on average between 94 and 98, labor force will grow by more than 60 basis points). To India, this gap represents an increasing challenge because six million jobsv will have to be created every year for the next two to five years in addition to the number of jobs that have already been created in past years. This challenge is even larger for six particular states according to estimates of the Planning Commissionvi. While workers in Kerala, Punjab and Tamil Nadu face few opportunities because employers prefer to settle on States with lower costs (these States have the highest level of minimum wage in the country), those in Uttar Pradesh, Rajasthan and Bihar seem to lack proper skills and training. Contrary to the former, the latter cannot rely on relocation as a means to escape from unemployment and will probably have to depend upon government initiative (through education and training) to enter the labor force.
As a result of a controlled foreign exchange policy, there is a significant gap between the Rupee exchange rate and the purchase power parity in terms of dollars. According to estimates from The Economist Intelligence Unitvii, a dollar can purchase RS 43 in currency but only RS 10.71 in goods. This imbalance accentuates the low cost of labor for potential foreign investors but, on the other hand, hurts the revenue line with the reduction of purchase power. According to a study by C.K. Prahalad and K. Lieberthal from the University of Michiganviii, the income distribution in India results ...
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As a result of a controlled foreign exchange policy, there is a significant gap between the Rupee exchange rate and the purchase power parity in terms of dollars. According to estimates from The Economist Intelligence Unitvii, a dollar can purchase RS 43 in currency but only RS 10.71 in goods. This imbalance accentuates the low cost of labor for potential foreign investors but, on the other hand, hurts the revenue line with the reduction of purchase power. According to a study by C.K. Prahalad and K. Lieberthal from the University of Michiganviii, the income distribution in India results in approximately 80% of the population being "economically unattractive" (Exhibit III.B.1)
Regulatory Environment and Social Security
As already mentioned above, the regulatory environment can be very harmful for the achievement of full employment. The establishment an inflated minimum wage is not the only piece of regulation to blame. The Industrial Dispute Act of 1948, for example, states that all employee lay-offs within firms that have more than 100 employees have to receive permission from the government even for the closing of a business unit. When the government intervenes in the lay-off, companies find loopholes in the law (for shutting down a factory, for instance, employers would stop to pay electricity bills).
As of today, more than 125 different pieces of legislation coexist in India, most of them completely outdated and some pieces from the last century that originally were meant to be temporary but became definitive.
Government is failing to protect workers not only through the lack of a unified and modern labor law code but also through an inefficient and poorly run Social Security system -one that only increases the costs of doing business in India and does not provide any benefit for the 92% of workers that are not part of the organized labor force. The red-tape is so rampant that foreign companies find joint ventures with local groups a safer and easier way to learn the "India way of doing business", which can vary on intensity from the use of influence in dealing with government officials to the payment of bribes.
Another important point is the decreasing but still significant power of unions. Since 1991, unions have been realizing that meddling in the labor markets was a necessity. The alternative for a more liberal approach would be the repetition of the phenomenon observed in Calcutta, where unions are to be partially blamed for the migration of whole industries to other states, only now the country as a whole will be at risk.
Education
With the increasing liberalization of the markets and the opening of the economy, India will face the employment challenge from a different perspective. Low wages will now be only part of the equation completed by a better-trained work force able to compete with low-cost labor from other countries competing for the same dollars from foreign investment. Moreover, national producers will have to improve the quality of their products to compete with imported goods.
The government is targeting three areas with varying intensity: training, basic, and higher education. We fear that government is not optimizing its resource allocation.
First, professional training as it is conceived is a responsibility that has to be the responsibility of private companies. By trying to impose the hiring of apprentices through more regulation, the government solely creates additional costs for firms to do business in India. On the other hand the emphasis on funding institutions with alternative curricula such as professional degrees would be a reasonable action to be taken.
Second, a country with a labor force, comprised 70% of either illiterate or educated below the primary level, cannot continue to invest a disproportionate sum on higher education rather than on basic education.
C. Privatization and Liberalization of Key Industries
Snapshot
Severe inefficiencies and lack of investment plague all areas of infrastructure in India. Exhibit III.C.1 shows the lack of investment in all areas of India's infrastructure. This lack of investment has resulted in the following:
* Telecommunications: The waiting list for basic telephone service amounts to 2.8 million. Current telephone penetration is 1.72% (i.e. 1.72 telephone lines/100 people). Furthermore, just over 50% of all Indian villages has public telephone service by March 1998.ix Liberalization of the Long Distance market is currently delayed as a result of federal regulatory barriers.
* Power: The SEBs (State Electricity Boards), at a minimum, fail to meet power demand by 11% during peak times and 18% during non-peak times.x
* Transportation: The roads and public transportation network requires significant investment both within urban areas and intra/interstate roads as well.
Initiatives
The Indian government's initiatives have occurred mostly at the state level. At the federal level, the government passed legislation that permits privatization to occur at the state level.
* Telecommunications: Private basic telephony operators introduced service in the Madhya Pradesh and Maharashtra regions. Private cellular operators offer service throughout most of the urban areas country.
* Power: In 1993-94, the government established the SEBs, separating the distribution, generation, and In the power industry, the states of Carnartka, Agra, Jupi, and Hariana are all in the process of privatizing their SEBs.
* Transportation: As a result of the 1982 Asia Games being held in Delhi, the government built seven highways during 1981-82. Most importantly, the government began offering incentives to the private sector to privatize certain roads. If private companies build roads, they are exempt from paying taxes for five years after finishing the project. At the same time, the government regulates the maximum tolls allowed on the private highways.
Barriers
By introducing competition prior to privatization, the government has only managed to meet the needs of a wide group of constituencies and bring in minimal revenue into the federal government. Having maintained the state-run companies and their management, there remains significant inefficiencies in the operations as well as in the regulation of the industries. The government's plans for disinvestment will not result in an overhaul of the management and the need to make "difficult decisions". Therefore, if private companies enter the scene full force, the incumbents will have little chance of survival.
While the government has introduced incentives to increase the prospects for private investment, the incentives have not been sufficient, particularly in the transportation segment. In telecom, companies paid high license fees and agreed to certain revenue-sharing agreements with an expectation for larger markets than they were able to attract. As a result, private companies are seeking to renegotiate their terms in order to survive in the market place. While the government was ultimately responsive, the credibility of the system was placed into question.
Numerous barriers span across sectors of infrastructure. The most significant barriers are the following:
* Regulatory Bodies: The government has slowly been separating the regulatory bodies from the operations of the utilities. As seen in Exhibit III.C.2, the regulatory structure of the telecom industry is incredibly complex and lacks clarity and, therefore, accountability. While the government has made attempts to separate the DoT's regulatory and operational functions, the lines remain blurred, with the state-owned operating companies still having tremendous influence on the regulations of the industry. Furthermore, the regulatory functions of the DoT and TRAI are also blurred, resulting in severe organizational inefficiencies. Similar challenges are present in the power industry.
* Subsidization: Large amounts of financial resources are wasted on unpaid bills and subsidies, particularly for those who do not need them. The subsidization has created a culture whereby citizens see utilities as a right and not as a service. As a result, private companies face unique challenges and therefore remain ambivalent about entering into the Indian utilities markets, should they not have high levels of revenue protection.
* Corruption: Individual interests remain to regularly interfere with the regulation of the utilities/infrastructure sectors. This has slowed the liberalization process and caused foreign companies to leave the Indian market, particularly in the telecom industry.
* Regional Disparities: By selecting a model that allows for privatization of state-run companies, India could face an environment whereby 30% of the country has privatized operators and the remaining is state-run. This presents challenges at the national level as the need for interconnection and sharing of resources is essential. Furthermore, national leadership fails to set a national goal or model for the country and thus does not take advantage of potential economies of scale.
Each of the sectors has its unique barriers to development as well.
* Telecommunications: By introducing competition in basic telephony prior to the privatization of the state telecom companies, India is 1) decreasing the value of the state companies when they ultimately are privatized and 2) slowing down the performance of the existing operators. Key legislation is necessary for growth of the cellular industry. In particular, the adoption of Calling Party Pays and a reduction of import tariffs on cellular handsets.
* Power: Currently, 50% of the energy consumed in India is unpaid. This makes the privatization of the distribution network all the more necessary but also worrisome for potential purchasers.
* Political Barriers: The Indian population remains naive about the implications of privatization. In fact, because of popular opinion, the government must use the term disinvestment rather than privatization. As a result, the models adopted do more to bring in short-term revenue for the government, than provide strategic investors an opportunity to contribute to long-term growth of the privatized company.
D. Financial Reforms and Foreign Direct Investments (FDI)
Snapshot
Looking back to the year 1991 when the Narisimham Committees published its first recommendations, India seems to have traveled quite far on the road of financial reforms. However, the journey is halfway through and there is still a long winding way to ahead. The essential agenda of financial reforms in India is to establish a solid financial system, which is not subordinate to its fiscal policy and is capable of effectively allocating scarce capital in order to sustain steady economic growth. As it is the common case among developing countries, India had to subordinate its financial system to finance fiscal deficits emerging from state-led industrialization based on Socialist-fashion planning. After having nationalized its major commercial banks in 1969 and 1980 to finance public sectors, the Indian government had regulated interest rates, charged higher reserve rates (40 - 63.5%xi) on banks, and controlled capital allocations, which hindered development of a healthy banking system in India.
By lowering reserve ratios, deregulating bank rates (1991) and introducing Treasury Bill auctions (1992), the government has been promoting Reserve Bank of India (RBI), its central bank, to conduct independent financial policies. In addition to that, the government introduced Ways and Means Advances (WMA)xii in 1997 to replace issuance of ad-hoc Treasury bills to cover fiscal deficits. After the first generation of those reforms, India is now striving for the second step mainly in three sectors: securities markets, banking and insurance.
Status
Securities market : Indian securities markets realized an amazing leap in 1999. In particular, Foreign Institutional Investors (FIIs) returned to portfolio investment in India (Exhibit III.D.2). Shares in some sectors such as Information Technologies, pharmaceutical and entertainment are performing formidably attracting more capital from abroad. Overall, the MSCI India Index, India's equity benchmark, performed 64% return in 1999xiii, which is one of the best performers in the world.
The only concern at this moment, if any, was the fact that, there is no instrument listed to hedge stock investments such as derivatives. With those improvements ahead, portfolio investment in Indian securities seems to be the safest way to invest in India. Right now, most FIIs are satisfied with investment in high-growth stocks in knowledge-based sectors within foreign ownership ceilings. But a real challenge for India is to attract more capital to other sectors for long-term economic growth
Insurance sector: After heated political debates over 6 years, finally India passed the Insurance Regulatory and Development Authority (IRDA) Bill in December 1999. At last, insurance monopolies by state ended and private and foreign enterprises are ready to participate. It seems to be a big leap forward in the Indian insurance sector. At the same time, there are already lots of questions as to whether the insurance sector reforms will bring benefits both to firms and consumers. Over all, the passing of the IRDA Bill itself does not guarantee the success of insurance reforms in India. In particular, the last minuet amendments (see Initiatives and Barriers) have increased negative sentiment in this industry.
Banking reforms: Perhaps the state-banking reform is the biggest challenge for India among all financial reforms. The government's focus in this sector is twofold: 1) eliminating bad assets and 2) restructuring the inefficient branch system and overstaffing in order to effectively allocate lower cost of capital. After being strictly controlled by the government, banks spend an inordinate effort on the management of operations. Without a sound financial system, India will not achieve sustainable economic growth.
FDI : Over the last few years, Foreign Direct Investment (FDI) has not been performing as well as was expected.(Exhibit III.D.1) FDI in India has been hit by several economic sanctions as a result of its nuclear testing in 1998 and continuing border disputes with Pakistan. Furthermore, the country lacked political leadership in 1999. The stronger political foundation of the current coalition government, combined with a series of recent fruits of diplomatic achievement (Clinton's trip to India and Vajpayee's trip to Germany etc), will probably increase future FDI in India to some extent but will be limited to certain industries.
Initiatives and Barriers
Securities Market
* Deregulation of foreign institutional investors (FIIs) by gradually lifting foreign capitalization ceilings.
* Improvements in securities markets infrastructure (settlement and custody) reduced transaction costs and risks though dematerialization of securities and reliable clearing systems based on advanced computing technologies.
* The 1998 establishment of the SEBI-Securities and Exchange Board of India (SEBI), which regulates securities markets and enhances corporate governance.
Insurance sector
With last minutes modifications under political pressure from the opposing Congress party, the following amendments to the IRDA Bill were made:
* Insurers are required to invest in so-called "socially oriented sectors" to some extent.
* Health insurance providers in rural areas will be given preference in license issuance.
These final adjustments were quite disappointing, as no geographical restrictions had been expected and the compulsory investments were also higher than anticipated. General Insurance Corp (GIC), with Life Insurance Corp (LIC) had argues that there should be a level playing after privatization, in which either private firms should also be required to invest in rural areas or the GIC and LIC shall be freed from this burden. To get the Bill passed, the BJP-led coalition government had to compromise on those points, which made the bill less powerful in pushing insurance reforms forwardxiv.
* The 24% cap of foreign capitalization will cause some difficulties, as domestic insurers have to raise 74% equity. It had been previously discussed and agreed among possible domestic and foreign market players that at least 40% of foreign capitalization would be necessary for market liberalization. Now with the 24% foreign cap, two or more Indian insurers will have to form a joint venture with one foreign partner.
* Access to lucrative urban markets remains to be seen at this moment. Apparently, the government does not want private insurers to take only the, upper and upper-middle class in cities, at the expense of poor rural residents. Thus some foreign insurers are questioning if it is wise to invest in India. For example, recently (After the IRDA Bill was approved) Manulife (Canada) withdrew from the Indian insurance market to focus on new investments in China, Vietnam and Eastern European countries.xv It is still uncertain as to how much insurance reform can tap large amounts of domestic saving (22% of GDPxvi) and channel them into infrastructure development. "The risk is that the private insurers might fall short of expectation, as has happened with private telecommunications operators."xvii
Banking reforms
* In the Union Budget 2000-1, the required minimum holding by the state in banking was reduced to 33%.
* The main obstacle in banking reform is restructuring overstaffed branches. The current labor laws and policy prevent state-banks from excessive lay-offs of employees.
* Labor unions, which also possess strong political influence in India oppose banking reforms.
* There is no efficient legal system for debt recovery and bankruptcy in India.
* Public finance is crowding out capital costs for private sectors.
FDI
* The government has been relaxing restrictions in direct investment though lifting a ceiling on foreign capital (e.g. lifted up to 74% in pharmaceutical) and promoting more automatic approval of investments.
* Long-term strategic planning evoking structural reforms has been lacking in India's privatization projects. Previous privatization projects (or more precisely "disinvestments") have been organized with a myopic view mainly to finance public sectors by selling assets.
* Foreign investors have started realizing that the world's largest untapped market is far more complex than they had imagined. This is particularly true for some multinational consumer producers. Thus, companies already in India are struggling to gain market share, to establish brand equity, and to capture consumer's minds. Market expectations were deteriorated partly by cheap labor in India. (e.g. it is cheaper to let someone to do laundry for you rather than buying a washing machine.)
* The government is gradually relaxing some regulations, mainly infrastructure where they need foreign capital investments desperately to clear a bottleneck for further economic growth. However, India will not change their Swadeshi policy due to mostly political and somehow sentimental issues.
E. Information Technology Sector
Snapshot
In March 1999, a prominent Bangalore software consulting firm called Infosys Technologies caught the attention of the Indian information technology sector when it became the first Indian firm listed on the U.S. NASDAQ exchange. However, its subsequent phenomenal success on NASDAQ captured the attention of the general public (increasing as much as 2000% by March 2000 and maintaining a 957% gain after the recent downturn of technology stocks). Yet Infosys' "overnight" success was the result of the progression of two decades of IT sector growth in India. Subsequently, and partly inspired by Infosys, countless software consulting firms and Internet start-ups have emerged and government regulations and fiscal policy changed to encourage the IT sector and entrepreneurs.
Status
Indian IT success began with software consulting services in the 1980's. Indian software consulting services filled the needs of European and U.S. companies for programming, maintenance and customer support. During this era, computer use in business was increasing rapidly and rapidly changing technologies quickly became outdated. Consequently, there was a large need for skilled labor to maintain older, legacy systems (like mainframes, client-server systems). However, the demand for skilled computer labor in the West far outstripped the supply, sending wages sky-rocketing and enabling adept programmers to choose not to service the unglamorous legacy systems in lieu of more cutting-edge technologies. Indian software companies became attractive because of their perennially low cost of labor, and also - due to the high cost of hardware - Indian programmers were often well-acquainted with what was considered outdated hardware in the West. Thus, Indian software services filled a world demand while utilizing skilled Indian resources and reaping large amounts of foreign capital.
Indian resources were ideally suited to the needs of software consulting in myriad ways. The legacy of highly competitive Indian science and engineering higher education institutions (such as the Indian Institutes of Technology) was a large pool of technically-educated, English-speaking employees.xviii Due to the quality of the educational system, Indian IT output, in contrast to many other Indian industries, was of world-class caliber. Additionally, the software consulting business required low capital investment and produced an easily exportable product (through private networks and later, the Internet). Even demands on infrastructure were low due to the availability of battery-powered electricity backups to combat India's notoriously unreliable power (India is now the world's largest market for continuous power supplies).
Overseas Indians/Human Capital
An additional factor in the success of IT in India is the influence of overseas Indians. Research by Berkeley professor, AnnaLee Saxenian, shows that 9% of Silicon Valley firms were headed by overseas Indians during 1995-1998. This remarkable statistic indicates their prominence in the world IT industry, and also points out an enormous source of inspiration, financing, and knowledge transfer for the domestic Indian software and Internet industry.xix Prominent overseas successes include Sabeer Bhatia (who sold Hotmail to Microsoft for $750M), Kanwal Rekhi (who sold Excelan to Novell for $350M), Suhas Patil (founder of Cirrus Logic), and K.B. Chandrasekhar (founder of Exodus Communications). These overseas Indians in particular exert influence in direct ways by investing in Indian firms through starting a venture capital fund which hopes to raise $1B for investment in Indian technology firms. Also this same group of entrepreneurs toured India in January, meeting with SEBI officials, Chief Ministers and PM Vajpayee to lobby for venture fund tax breaks and relaxation of regulations preventing recently privatized insurance companies and pension systems to invest in venture funds. These prominent overseas Indians also exert indirect influence by legitimizing entrepreneurship, startups and self-employment in a traditionally conservative society.
Less prominent overseas Indians also influence the Indian IT sector. Our research found many Indians educated in the U.S. who would return to India to transplant experience and capital into the nascent Indian Internet market. These young, transcontinental entrepreneurs would leverage their educational credentials, U.S. Internet industry experience, and often times substantial family backing into new Internet startups for the Indian market. Additionally some, with U.S. citizenship or contacts, create mirror companies in the U.S. to facilitate logistics, marketing, accounting and sales.
States and Regionalism
In the aftermath of the Infosys rise, countless software consultancies and Internet start-ups have been formed centering primarily in the technology and business centers of Bangalore, Hyderabad and Bombay. IT activity is heavily concentrated in these regions due to their educational endowments, political advocacy, and financial well being. Some state leaders have become prominent advocates of the industry like Andra Pradesh Chief Minister, Chandrababu Naidu (aka Cyberbabu who has championed foreign IT investment in Hyderabad which attracted Intel and Microsoft and fathered the creation of Hi Tec City, a state-of-the-art IT industrial park). While nearly all politicians have jumped on the IT bandwagon, the leaders of the above mentioned states have been effective in enacting real measures to attract investment.
The results of this fortunate confluence are impressive. As a whole, the Indian IT sector (including the software, hardware, peripherals, training, maintenance and networking products and services) averaged 31% annual revenue growth during the period 1994-1999. However, looking at just software exports yields an average annual growth of 52% over the same time period. (See Exhibit III.E.1) In contrast to modest growth in the domestic software and hardware sectors, the export-focused software sector is a clear engine of growth.
Impact on Investment Potential
While a small part of the economy, the rapidly growing information technology (IT) sector has captured the attention of the government and popular imagination. By capitalizing on this attention, we predict that the IT sector will lead the charge toward reforms in:
* venture capital funding (as embodied by the Chandrasekhar-led SEBI committee
* public equity funding (currently require 2 years profitably before public offering)
* easing of export rules and import tariffs
* easing of foreign ownership rules (acquisitions of foreign firms with stock are limited to $100M, Infosys has requested $1B)
* adoption of U.S. accounting methods
* use of stock options for employee compensation and retention
* creation of the Indian Institutes of Information Technology (similar to the IITs)
These reforms will pave the way for increased human capital, availability of investment capital, competition, and transparency in other sectors, all of which bodes well for near-term and long-term investment prospects. Additionally, the IT sector's export focus and world-class technical skills may open foreign doors for other Indian technology-oriented exports.
Barriers
Though the industry is lobbying for finance and tax reforms, the results so far have not been unscathed successes. In the recently announced 2000 budget, for example, venture funds avoided capital gains taxes, however the funds are subject to 20% income tax on distributed income. Thus we should expect regulatory reform to be generally positive yet not overnight or without miscues, again due to the vagaries of political reform in India.
IV. Variable Mix
Please refer to Exhibit IV.I for an illustration of variable interactions. The nature of the coalition government and the difficulties it causes for consensus-building on any and all matters of policy-making and implementation is the umbrella factor under which all other factors herein operate. Domestically, the bureaucracy is one tremendous white elephant - there is rampant corruption and gross over-employment.
The consensus environment in the political system has made privatization of national "strategic industries" a heated issue throughout the country. In an effort to appease many constituencies, the government selected a model whereby competition is introduced but government ownership is maintained: a proven failing model. The introduction of competition in areas of infrastructure has presented great opportunities for FDI. Again, politics have interfered because the models 1) limit allowances of foreign ownership and 2) fail to provide a framework that would attract large scale interest of foreign investors. Recognizing this, the government put in additional incentives to attract more foreign investment, but did not do so without protecting the interest of certain political groups.
Like privatization, labor reform, or the lack thereof, owes itself in part to the difficulty of consensus-building in a coalition government of people trying to protect their own jobs. Although their power is decreasing, most labor unions backed by political parties stand strongly against a series of public sector reforms, in particular, insurance and banking.
The labor environment has created strong unions, which indirectly thwart privatization efforts. With the support of civil servants, the other major group of Indian citizens vehemently opposed to reform (for fear of losing their comfortable jobs) the labor unions help fracture the government which in turn perpetuates its inability to enact privatizations.
Meanwhile, labor demand is directly impacted by the enhancement (or lack thereof) of Indian infrastructure and the increase in productivity it can potentially bring. The impact of infrastructure, if made more efficient through privatization, would be stronger on traditional sectors than on new sectors like IT mainly because the former, by nature, are more labor-intensive and consequently are a much larger source of employment than the latter.
Job creation certainly affects overall welfare, enhances political stability and for the current state of India, it is unlikely to negatively impact foreign investment due to increasing wages -- there is significant slack in the labor market (and, in terms of Rupee, labor is still relatively cheap). This level of unemployment will only be reduced with the same set of measures that would attract foreign investors: less government intervention in the economy, clearer and enforceable regulation and an increase in the educated segment of the population.
Strict labor policy is not only a major barrier to restructuring an overstaffed and inefficient government but also to an employee-bloated state-banking system, which controls 90% of the sector. India possesses the sophisticated technologies necessary to establish efficient banking networks (ATM, electronic payment and transfers, etc). However, it cannot implement those technologies in the short term because intractable labor policy inhibits their ability to lay off excess personnel. Under current labor policy and laws, they have to wait until older employees gradually reach retirement age before they can be replaced with ATMs, electronic banking or other automated, manpower-reducing technologies.
The domestic market for IT products and services will continue to lag behind the foreign market due to the low income of the vast majority of the population. Additionally, relative to the average income, the cost of computer equipment (which are largely built on imported components) is prohibitive. Consequently, despite the heralded computerization of the Indian Railways in 1986, IT is unlikely to provide much of its potential productivity gains in the greater Indian economy. While there is certainly room for productivity gains, popular sentiment and regulations against layoffs and dislocations is likely to hinder efficiency gains through office automation.
And finally, the IT sector has succeeded, in no small degree, due to its independence from India's deficient infrastructure. Successful IT firms typically bypass the limitations of the national infrastructure through the use of battery-powered backup systems and satellite network downlinks. Additionally, the nature of software consulting with its largely foreign customer base, easily exported product, and largely unregulated industry, frees Indian IT firms from the weaknesses of the domestic market and infrastructure. It will be through these industries, which want to compete globally, that the most pressure exists to overhaul the country's infrastructure. The IT sector uses its new found political and financial clout to encourage the relaxation of FDI, finance and securities restrictions. In turn, it is believed that the privatization of the insurance industry could allow the prodigious assets of insurance companies to be invested in venture funds and/or established IT firms to finance growth.
V. Conclusion
Please refer to Exhibit V, for a comprehensive look at pessimistic, realistic, and optimistic scenarios for each of the variables discussed in this report. Such disparities among the different scenarios create tremendous risk for potential investors. Given that the pessimistic scenarios usually result from extreme government intervention and barriers, investors must seek certain government guarantees or stick to those sectors which are already privately led.
"Should we invest in India? Is India a good place to invest today? If no, what will have to change?"
Despite its appealing and massive potential as a market, India is not a sure bet for foreign investors. The business opportunities in this market are hard to be measured, and the market and society structure is too complex to be cultivated as a whole. Although there are glimmers of hope in the Indian economy such as successful IT sectors and initiatives in privatization, overall, benefits and profitability from investments in India are small enough to be set off by its uncertainties and risk.
Nevertheless, certain industries and geographical areas are worthy of further consideration. If potential investors have strategic considerations as for example, to obtain first mover advantage, and funds can be committed subject to initial success, India presents positive prospects.
"If invest, How/Where?"
Even though it is hard to tap the entire market, foreign investors can target and invest successfully in specific sectors or locations. To put in concretely, foreign investors should consider the following factors carefully and strategically when they plan an investment in India:
. An industry which has been less controlled by the government.
Some industries relatively new such as IT industries are good examples. Because of its newness and amazingly fast-paced growth, the government has not yet intervened in the development of this sector, and on the contrary, IT sectors have successfully become one of the most powerful and influential lobbying groups, particularly surrounding taxation issues.
2. An industry that has been promoted for FDI or been opened to foreigners and down side risks of such an investment could be hedged.
Like Enron's power generation project, investors should seek either government guarantees or any other sorts of "insurance" for possible unfavorable situations for their investments. Infrastructure is the most serious bottleneck to further developments in India and is the area where India desperately needs foreign capital.
3. States which promote foreign investments or private industry aggressively
The attitudes towards economic reforms at local government levels differ from state to states. Some northern states (Rajasthan, Uttar Pradesh and Bihar - a.k.a. Hindu belt), which are not enthusiastic about economic reforms, lag far behind some southern states (Andhra Pradesh, Maharashtra) which aggressively promote foreign investments and private industry. Additionally, quality of education levels and infrastructure varies widely. The potential growth in these progressive states is much higher and certain, and the gap between states will be further widening in future.
"Barriers / warning signs: What specific political or economic issues (variables) should we be concerned about?"
Political stability will be essential for economic reforms to progress. Strong initiatives of current coalition government will be required to take two steps forward after each step back in reforms. The government is also required to find middle ground to satisfy its majority of people between its Swadeshi sentiments and progress toward globalization. The major obstacles are bureaucracy and political strongholds, which stand against economic reforms. The current BJP-led government is a coalition with 24 partners, and there are still many parties with unique interests. In this sense, its too successful democracy is a significant barrier to India's economic growth.
Some burdens of socialist planning economy remain heavy in the way. Tardy reforms and restructuring in public sectors are hindered by socialist, impractical attitudes towards downsizing. Furthermore, great political pressure makes it nearly impossible to lift subsidies. Subsidies and other bureaucratic inefficiencies, inherited from the socialist regime of more than 40 years, continue to plague India's progress.
Several successful industries and states, which are benefiting from the early fruits of economic reform can take strong initiatives to thrust the second generation of economic reforms to persuade some of lagged sectors and states. Healthy financial system and further reforms are urgently required to push more fuel into economic growth. Still private sectors, compared with public sectors, have not received enough funding to engine economic growth. How fast India can reform its banking sectors and can receive foreign capital through portfolio investments will be a good indicator.
VI. Appendix I: Exhibits
Exhibit III.A.1: The Lok Sabha Elections -- General Summary 1952-1998
952
957
962
967
971
977
980
984
989
991
996
998
Electorate (Lakhs)
732.1
936.5
2176.8
2506
2740.9
3211.7
3639.4
4001
4989.1
4983.6
5925.7
6058.8
Valid Votes (Lakhs)
059.4
205.1
151.7
458.7
466
889.2
978.2
2496.2
3007.8
2752.1
3348.7
3683.7
Invalid Votes (Lakhs)
n.a
29.5
47.4
68.6
49.3
53.5
49.3
67.1
82.8
74.9
84.3
70.7
Turnout (%)
45.7
47.7
55.4
61.3
55.3
60.5
57
64.1
62
56.7
57.94
61.97
Total Seats
489
494
494
520
518
542
542
542
543
543
543
543
Contested
479
482
491
515
517
540
529a
541
528b
521c
543
543
Uncontested
0
2
3
5
2
0
0
0
Number of Candidates
874
519
985
2369
2784
2439
4629
5493
6160
8699
3952
4750
*Information taken from the official Bharatiya Janata Party website: http://www.bjp.org/election'99/elesummary.htm
Exhibit III.A.2: National Voter Turnout in US Federal Elections: 1960-1996
Year
Voting Age Population
Registration
Turnout
% T/O of VAP
996
96,511,000
46,211,960
96,456,345
49.08%
994
93,650,000
30,292,822
75,105,860
38.78%
992
89,529,000
33,821,178
04,405,155
55.09%
990
85,812,000
21,105,630
67,859,189
36.52%
988
82,778,000
26,379,628
91,594,693
50.11%
986
78,566,000
18,399,984
64,991,128
36.40%
984
74,466,000
24,150,614
92,652,680
53.11%
982
69,938,000
10,671,225
67,615,576
39.79%
980
64,597,000
13,043,734
86,515,221
52.56%
978
58,373,000
03,291,265
58,917,938
37.21%
976
52,309,190
05,037,986
81,555,789
53.55%
974
46,336,000
96,199,020*
55,943,834
38.23%
972
40,776,000
97,328,541
77,718,554
55.21%
970
24,498,000
82,496,747#
58,014,338
46.60%
968
20,328,186
81,658,180
73,211,875
60.84%
966
16,132,000
76,288,283^
56,188,046
48.39%
964
14,090,000
73,715,818
70,644,592
61.92%
962
12,423,000
65,393,751+
53,141,227
47.27%
960
09,159,000
64,833,096x
68,838,204
63.06%
Definitions: % T/O of VAP=Percent Turnout of Voting Age Population
*Registrations from Iowa not included
#Registrations from Iowa and Missouri not included
^Registrations from IA, KS, MS, MO, NE, and WY not included. D.C. had not independent status.
+Registrations from AL, AK, DC, IA, KS, KY, MS, MO, NE, NC, ND, SD, TN, WI, and WY not included
xRegistrations from AL, AK, DC, IA, KS, KY, MS, MO, NE, NM, NC, ND, OK, SD, WI, and WY not included
Data drawn from Congressional Research Service reports, Election Data Services Inc., and State Election Offices
Exhibit III.A.3
*Based on information from the most recently updated CIA World Factbook. Numbers herein do not reflect the results of the October 1999 election but remain illustrative of the problem of consensus-building in a coalition government.
Exhibit III.B.1: Purchase Power Parity
Exchange Rate
Purchase Power Parity
Population in million (% of total)
Greater than U$5,000
Greater than U$20,000
7 (0.78%)
U$2,500 to U$5,000
U$10,000 to U$20,000
63 (7.04%)
U$1,250 to U$2,500
U$5,000 to U$10,000
25 (13.97%)
Less than U$1,250
Less than $5,000
700 (78.21%)
Exhibit III.C.1: India Telecoms Regulatory Structure
Exhibit III.C.2: Infrastructure and Other Investments, as% of GDP (Private Sector Investment)
981/82
985/86
991/92
992/93
995/96
996/97
997/98
Gross Domestic Investment
23.1 (13.4)
23.5 (13.0)
21.0 (12.4)
22.0 (13.6)
24.0
(16.7)
21.4 (14.7)
22.4
(15.5)
Infrastructure
4.8
(1.4)
4.8 (1.2)
5.4
(1.4)
5.2
(1.6)
4.2
(1.0)
4.4
(1.5)
4.6
(1.6)
Electricity, gas, water
2.5
(0.4)
2.6 (0.2)
2.9
(0.3)
2.6
(0.5)
2.0
(0.2)
.8
(0.2)
2.0
(0.2)
Railways
.6
(0.0)
0.6
(0.0)
0.5
(0.0)
0.6
(0.0)
0.4
(0.0)
0.4
(0.0)
0.3
(0.0)
Other Transport
.3
(1.0)
.2
(0.9)
.4
(1.0)
.3
(1.0)
.4
(1.1)
.4
(1.2)
.3
(1.1)
Communications
0.3
(0.0)
0.4
(0.0)
0.5
(0.1)
0.7
(.1)
0.4
(0.0)
0.7
(0.1)
0.9
(0.3)
Other
8.4
(12.0)
8.8
(11.8)
5.6
(10.9)
6.8
(12.1)
9.9
(15.7)
7.0
(13.2)
7.9
(13.9)
GDPmp (Rupies billion at current prices)
728.1
2836.6
6671.6
7635.6
2179.6
4098.5
5635.52
Source: National Accounts Statistics
Exhibit III.D.1
Exhibit III.D.2
Exhibit III.E.1 IT Sector Revenues for 1994-1999 (source: NASSCOM)
994-95
995-96
996-97
997-98
998-99
Rs. m
US$ m
Rs. m
US$ m
Rs. m
US$ m
Rs. m
US$ m
Rs. m
US$ m
Software
Domestic
0,700
350
6,700
490
24,100
670
35,100
950
49,500
,250
Exports
5,350
485
25,200
734
39,000
,083
65,300
,750
09,400
2,650
Total
26,050
835
41,900
,224
63,100
,753
00,400
2,700
58,900
3,900
Hardware
Domestic
8,300
590
35,600
,037
37,800
,050
44,970
,205
42,350
,026
Exports
5,500
77
,200
35
0,300
286
7,430
201
55
4
Total
23,800
767
36,800
,072
48,100
,336
52,400
,406
42,505
,030
Peripherals
Domestic
4,590
48
6,720
96
6,530
81
8,330
229
3,600
329
Exports
80
6
210
6
520
4
680
9
730
8
Total
4,770
54
6,930
202
7,050
95
9,010
248
4,330
347
Training
3,310
07
4,970
45
6,600
83
9,420
263
2,500
302
Maintenance
4,400
42
5,920
72
6,560
82
8,240
221
9,780
236
Networking & Others
,120
36
2,40 0
710
5,590
56
7,150
93
9,800
237
Grand Total
63,450
2041
98,920
2886
37,000
3805
86,620
5,031
247,815
6052
Exhibit IV.1: Variable Interactions
Coalition Politics/Leadership Void
Labor Policy
Financial Sector Reforms
Privatization (of Infrastructure)
Information Technology Industry
Exhibit V. Alternative Scenarios
Pessimistic
Realistic
Optimistic
Foreign Political Climate
Officially declared war between the two nuclear powers of India and Pakistan, further halting domestic progress in both countries and destabilizing the region in general. On the nuclear front, tensions with the United States and other western nations committed to a non-proliferation regime could escalate, with further sanctions imposed upon India for its 1998 nuclear tests and with political ostracism
Neither war nor peace. The two countries will continue skirmishing at the Line of Control, diverting funds and attention away from domestic issues. In the meantime, tensions over India's "illegal" nuclear tests will slowly diminish, with Western sanctions systematically lifted and a gradual acceptance over time of India's "need" and "right" to retain its nuclear arsenal
A settlement for Jammu and Kashmir will be reached, bringing peace between India and Pakistan and thus removing a major destabilizing force in the region. In addition, international tension over India's 1998 nuclear test and acquisition of a full-scale nuclear arsenal will completely dissipate as India is accepted into the fraternity of nuclear powers
Domestic Political Climate
The current BJP-led coalition government will overstep its bounds and invite yet another vote of no confidence, ringing in another weak coalition that will also fail to build consensus for reform (or worse, that will be replaced by a coalition led by forces actively opposed to reform)
The current BJP will, in fact, remain in power but will be constrained by the need to build consensus on every tiny issue - this will not halt reform, but will slow it to the point where India might miss a major window of opportunity for enticing foreign investment.
The current coalition government will somehow remain in power for its full five-year term AND will manage to push through painful reforms (as it did in its first 100 days in office) by beating the odds and building consensus on privatization and government downsizing
Infrastructure
The states planning to privatize their SEBs do not go through with their planned privatizations. The DoT does not privatize in any states. The transportation dept. fails to provide sufficient incentive to private roads operators.
The four planned SEB privatizations are successfully completed. A handful of states privatize their DoT operations. Some key states attract private investors to build up to five interstate roads.
Privatization is put forth at the federal level in the power and telecom industries. The government selects a model that allows for strategic investment in these industries and not just disinvestment.
Labor Market
Unions regain power and more regulation increases potential employers' burden.
Very regulated environment deters India to achieve full employment. No significant improvement
Increase in formal employment without
significant increase in wages. Illiteracy rate
falls to more acceptable levels..
Financial Reforms and FDI
India accelerates financial reforms in banking reforms bearing some pains in restructuring. Capitals to gear up further economic growth are more available thorough a sound banking system, a privatized insurance sector and foreign investors (direct and portfolio investments)
Financial reforms evolve steadily at the current slow speed. It takes a long time for India to establish a sound and effective banking system as intermediaries. India still suffer from insufficient capitals to be allocated effectively to all sectors despite constant inflows of foreign investments.
Financial reforms slow down due to delays in banking reforms, to inadequate privatization in insurance, and decreasing foreign investments. Capitals are scarce and are allocated ineffectively to private sectors, which drag down economic development in India.
Stock Markets
Continue to boost by successful few sectors like IT industries, more and more foreign investors invest through Portfolio
Moderate growth with ups and downs in markets, heavy investments to traditional sectors by FIIs have not yet happen
Markets plunges by global markets crashes caused by falling high-tech stocks or by other sort of country risk
Insurance
Booming! the market really opens, huge portion of capitals flying into social infrastructure investments
Open slowly like other privatization
Some last minutes amendments to the IRDA bill make this sector's reform failed
Banking
Establish an efficient banking system, which pumps needed capitals for steady economic growth
Reform progress slowly like other pubic sectors
Strong oppositions by unions labor hinder banking reforms
Foreign Direct Investment
FDI more open to more sectors.
"Indian fever" among foreign investors
Maintain the current level $2 billions of FDI inflow
Net outflow of FDI, foreign investors leaving India after being disappointed or losing creditability in the government
IT Sector
As successful Indian software services companies grow, they will begin to branch out beyond their traditional services in labor intensive, un-glamorous roles (like mainframe programming, customer support, software porting, year 2000 debugging) into higher margin areas like packaged software and full-service consulting (including strategy and marketing). Some, notably Infosys Technologies, are rumored to be interested in acquiring established American full-service consultancies (in Infosys' case, Cambridge Technology Partners). In order to facilitate marketing efforts and to gain a better understanding of their client's businesses several firms have opened U.S. offices (Infosys, Wipro, Trigent).
It is most likely that we will see a combination of the pessimistic and optimistic scenarios. Specifically, select firms (like Infosys, Wipro and Satyam) will succeed to some degree in branching out into high margin areas like packaged software and full-service consulting. However, it is unlikely that Indian firms without substantial resources will be able to make that transition. Additionally, the costs for retaining highly qualified personnel will rise with demand, causing price pressures for Indian firms. Compounding this problem will be other lower cost countries, who are certain to emulate the Indian model and compete for the foreign IT service revenue.
Yet the strength and stability of technical education will continue to provide a long-lasting competitive advantage for Indian firms in the information technologies, though they may not be continue to be the low cost leader.
* Straying from traditional technically-oriented services into marketing-dominated packaged software will face marketing, support, logistic, and communication difficulties
* Strategic consulting will be at a disadvantage due to lack of brand equity in the industry
* Domestic Indian market will yield low demand due to the relatively small class of computer owners, poor electrical infrastructure, slow Internet access. This leaves the industry subject to fluctuations in foreign demand, import and visa restrictions.
* As the Indian IT firms (and the economy as a whole) succeeds, costs will rise and other low cost providers in Israel, Ireland, Singapore, Russia and Eastern Europe will become increasingly competitive.
* Reliance on stock options makes employee retention vulnerable to stock market fluctuations.
End Notes
i The NPT is the document through which nuclear states offer regulated technology transfers of sensitive nuclear technology to non-nuclear nations for civilian-only nuclear power generation. In return, these non-nuclear nations pledge not to seek construction of their own nuclear arsenals.
ii The Indian system of governance is based on the British Parliamentary system. The government is led by a Prime Minister (currently Atal Bihari Vajpayee) and a cabinet that are responsible to the lower house of parliament known as the Lok Sabha which means "house of the people." The 13th, or current Lok Sabha is comprised of 545 seats (including the speaker). The formal head of state is the President (currently K.R. Narayanan) whose real responsibilities arise only during states of emergency or when there is a change in government (as there was in October 1999). The President is elected indirectly by elected members of Parliament.
iii The BJP is known as India's Hindu Nationalist Party, though as the coalition grows it is having to shed some of the more divisive aspects of that nationalism as they rely more and more heavily on the swing votes of small ethnic and religious political parties.
iv Although there was no consensus among interviewees - two local CEOs, one labor specialist, one banker, two representatives of American companies - all agreed that the official unemployment rate was much below the actual one, certainly a double-digit number.
v Financial Daily from The Hindu, June 8 1998
vi Financial Daily from The Hindu, Monday February 22, 1999
vii EIU, February 25 2000
viii The End of Corporate Imperialism, CK Prahalad and K.Lieberthal, Harvard Business Review, July-August 1998
ix World Bank Report on India, 1999.
x Ibid.
xi Saving ratios (CRR and SLR) are equivalent to advance forwarded government expenditures. As the ratios rise, private sectors receive less capital from banks. Only 35% of bank deposits are to be lent to private sectors in 1991 when total deposits rates is 63.5%. (Shoji Ito, Tachiagaru Indo Keizai (Tokyo: Nippon Keizai Shinbun Press, 1997), p.70-71.
xii Ways and Means Advances: Lending from its central bank to cover temporally mismatch of revenue and expenditure. The cap of lending amount is to be placed and repayment period is to be set. WMA interest rate is to be set close to market rate. This scheme is to increase flexibility in RBI's financial policy and to promote independence in financial policy from fiscal policy.
xiii "Capital efficiencies and overseas inflows drive spectacular Bull Run" Financial News, November 01, 1999, page 20.
xiv "India: Insurers Wait in the Wings" Best's review Life/Health Edition, November 1999, p38+
xv "Canada's Manulife to pull out of India Despite market Opening", Bestrwire, March 24,2000, p. n/a.
xvi "India: Insurers Wait in the Wings" Best's review Life/Health Edition, November 1999, p38+
xvii "India: Insurers Wait in the Wings" Best's review Life/Health Edition, November 1999, p38+
xviii "Surveys of the IITs shows that a very large fraction of postgraduates enters [sic] the IT sector, in some cases as many as 90%" Ashish Arora, "The Indian Software Industry", Heinz School of Public Policy and Management, Carnegie-Mellon University
xix The standard Silicon Valley joke is that IT stands for "Indians and Taiwanese".
