OPEN FOR BUSINESS

Global Finance, Sep 2004 by Chaze, Aaron

In its attempts to bring investment to India, the country's new government is facing a host of challenges. If it stays the course, its efforts should pay off.

For years, the phenomenon that domestic and global corporations and fund managers worried about most when considering investments in India-even more than its vacillating politicians and avaricious bureaucrats-was the unpredictability of the monsoon and the effect it has on India's GDP growth.Their concern was hardly surprising: With 25% of India's GDP and over two thirds of its population being directly dependent on the monsoon, the engine of the economy is fueled by rainwater.

During the fiscal year 2003-2004 (April-March), the Indian economy grew by 8.2%, driven by a 9.1% jump in agricultural production as a result of an abundant monsoon and higher industrial output. This year the rains have not been so abundant, and it looks like the resolve of investors may be tested again. Already GDP growth expectations have been sealed down to 6.5% for fiseal year 2004-2005. But this figure assumes that there will be some agricultural growth. If the agricultural sector shows a negative growth for the year, the overall GDP growth number may have to be scaled down further.

The monsoon failure joins a string of unexpected events in 2004, ranging from the electoral defeat of the pro-reform NDA government to potential reversals on privatization, electricity and banking reforms-and promises of increased subsidies from a left-leaning government. While these developments rattled stock market investors, things are not as bleak as they appear. Within the ruling alliance there ts no fundamental objection to continuing with the reform process, for example."It is the pace of reforms which has changed and not the direction, and so far there has been no loss of confidence among investors," says Ajit Ranade, group chief economist at the diversified industrial giant Aditya Birla Management Corporation. While the monsoon has an indirect impact on industrial demand, there are several mitigating factors. Both the industry and services sectors, which make up 75% of GDP, have proven to be very resilient and in recent years have shown strong growth even when monsoons have been poor. In 2002-2003, for example, India suffered the worst drought in 15 years, but GDP still grew by 4%, despite a 5.2% shrinkage in the agricultural sector. In fact, as India's economy modernizes, the impact of die monsoon is diminishing significantly.

The failure of this year's monsoon might throw macro calculations oft for the next year, but it does not mean that foreign investment interest will decline. "There is no dearth of opportunity in the Indian marketplace," says Mahesh Vyas, managing director of the Center for Monitoring the Indian Economy (CMIE). "Investors, foreign and Indian alike, will have to see the opportunity for themselves and that the opportunity is much larger than they think."

In sectors such as telecom, banking, insurance, IT-enabled services, petroleum and auto ancillaries, there has been a deluge of foreign investments. Recently, Singapore Technologies and Malaysia Telekom announced they would invest $220 million for a 33% stake in IDEA Cellular, India's fifth-largest cellular company, the latest example of big-ticket investments in the Indian services sector. "Thanks to a robust manufacturing and services sector, the economy can safely grow at 6.5% even with a poor monsoon, and this growth rate is above the long-term trend-line growth," says Ranade.

Export Market Flourishes

Potential investors are also reassured by the fact that India's economy is becoming increasingly export driven, as companies achieve the scale and confidence to expand into new markets. For example, from a base of almost zero a few years ago, the automobile sector, including ancillaries, now exports $3.5 billion worth of vehicles and components. The petroleum sector has seen similar growth: Now it exports $3 billion worth of value-added products annually, including motor and aviation fuel.The IT sector has gone from a few hundred million dollars of exports in the mid-1990s to $10 billion m exports for 2003-2004.

Figures like these have helped India achieve 17% compound annual growth in exports for the past two consecutive years to reach $60 billion a year. This year has been even better: During the first two months of fiscal 2004-2005, exports grew by 25% over the same period last year. Export performance has been so buoyant that India has been running a current account surplus for the past three consecutive years, which, according to the Reserve Bank of India, reached an all-time high of 1.4% of GDP.

Unfortunately, the new government's efforts to attract FDI and portfolio flows are being hindered by contradictory statements emanating from the different factions of the ruling alliance. The finance minister, Palaniappan Chidambaram, has announced increased equity ceilings in telecom to 74% and in civil aviation and insurance to 49% and the sale of a 5% stake in power company NTPC. But the government's communist allies, backed by the trade unions, want these rescinded and further restrictions imposed on foreign investment. Undeterred, the government is sticking to its revised $15 billion annual FDI target-although it does not acknowledge that against the current target of $10 billion India received just $5 billion last year.