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Saturday, October 11, 2003

Best Guessing the Future of India and China

It seems that everyone who is anyone these days has been busy posting about the recent Goldman Sachs study on the so-called BRICs (Brazil, Russia, India, China). Matt, for example, over at Fistful of Euros, Reuben at Zoo Station and, of course Brad over at Semi Daily Journal. I think everybody I've mentioned agrees that this paper contains something important, or at least something which is obvious but which needed making explicit. India and China are set to become the biggest players in the global economy, and this is inevitable simply from the demographics. Brad takes issue with the inclusion of Brazil and Russia, while Reuben no-no's Russia. I think Reuben is right. Russia's demography mean it's GDP is more likely to shrink than to grow, but Brazil is a different case. It may not be as big a thing as China and India, but it is arriving at the good moment, and it will make it's presence felt, especially in Latin America. In fact I would probably strip out Russia from the list and add-on Turkey, but here we are talking of a different order of magnitude completely (although Turkey will possibly overtake Russia). How could GS get this bit so wrong, I think because they look principally at dependency ratios and not especially closely at absolute numbers. Russia's situation is possibly even worse than it appears to be, since in addition to the fact, as Reuben points out, that it isn't immigrant friendly, it is actually experiencing emigration. This will only make the position with its working age population worse.

So back to the good news. It is now 'official': India and China are on the way up. But again, another quibble. What GS state is really pretty obvious. What is rather less obvious is the value of trying to make economic, not demographic, projections about all this. We are still arguing about what will be end of year GDP numbers for 2003, we have only vague guesses about what the numbers might be for 2004, and from there on out we are just plain guessing. The orders of magnitude of errors in projections forward over 50 years are just mind blowing. So I think it is a serious error to try and give a kind of 'pseudo scientific' veneer to all this by printing out long pages of numbers. This is quackery.

But since we are guessing, let me make my guess. Reuben says he thinks that numbers offered by GS may in fact be unduly pessimistic. I agree completely, here's my reasoning. The only thing we have to go on really is the technical change and the demography. Now what if the demography means the OECD world hits protracted deflation. This possibility isn't even considered by GS. But it must be one of the alternatives, and if we do have deflation (and I think we will) then the GDP's of the OECD countries may well reduce, Japan style. At the same time if we move out of the zone of the economists and into that of the technologists, we find something even more interesting: Ray Kurzweil's 'law of accelerating returns', or as Edward puts it 'things are getting faster, faster'.

The differences between Europe and India/China have as we know built-up over only 200 years. Now if we look for a minute at the macro-structure of change we find it took 10,000 years from the agricultural revolution to the industrial one, but only 200 years to get from the industrial to the information one. What I am trying to say is that what took 200 years to accumulate will take a lot less to reverse, in my view, at the pace we are going a lot less than 50, although clearly I don't know just how long. This, as I said, is only a guess, but it is an educated one, and it seems to me to be as valid as the GS version.
NASCOMM: The Impact of Global Sourcing on the US Economy

The National Association of Software and Service Companies (Nasscom) has just released a report (jointly prepared with Evalueserve) on the impact of Indian outsourcing on the US economy. The report is enormously upbeat, pointing out, among other things, that such outsourcing will plug the hole in the US labour market produced by the retiring of the baby boomers. The figures for $143 dollar return for every $100 dollar spent may seem exaggerated until you take into account the positive feedback effects of growth in India. This activity leads naturally to increased internal demand in India itself, and hence to increased markets. Of course, what proportion of this market goes to the US is another question, there are remember new competitors arriving, like, for example, Huawei. To be able to take advantage of the new Indian market US companies need to become cost competitive. This, of course they can do, by outsourcing manufacturing to China, but then, with their own ageing workforce might they not succumb to the 'Japanese illness'?

The report outlines the cost-savings and increased flexibility that global sourcing will provide to US companies, thereby keeping them competitive in the global marketplace. Forecasts for the US indicate an annual GDP growth of 3.20%, which will lead to an increased demand for labor. However, the US will face a domestic labor shortfall of 5.6 million by 2010 due to an aging population, which can potentially cost the US economy $ 2 trillion if appropriate measures are not taken well in time............

The report also found that offshoring keeps US businesses competitive, creates new markets for US goods and services, and fills the shortfall in services labor that the US is expected to face in the next seven years."

Over the next decade, the US economy will mirror the growth of the 1990s leading to an increased demand for labor. There will be a domestic labor shortfall of approx. 5.6 million workers by 2010 due to slow population growth and an aging population

If the labor shortfall is not met, the US economy will lose out on growth opportunities resulting in an estimated cumulative loss of $2 trillion by 2010. Global sourcing in the form of immigration, temporary workers and offshoring can overcome this shortfall

For every $100 of call-center work offshored by US firms, $143 is invested back into the US economy in the form of repatriated profits, increased sales of telecom equipment and cost-savings

Similarly, the amount invested back into the US economy (for every $100 of work) is $133 for IT services, and $142 for high-end knowledge services like equity research, underwriting, tax preparation and risk management

Offshoring of IT services has enabled US workers move to specialized and creative roles while moving process oriented programming to offshore locations. The proportion of specialists in the US IT workforce increased from 38% in 1983 to 74% in 2002

Utilization of offshore facilities results in the growth of the local economies and an increase in the disposable income leading to the expansion of the global market for US goods and services. For example, in India the proportion of the consuming class in the overall population expanded from 14% to 30% in the 1990s and is set to reach 40% in 2006-07. The Indian retail sector is expected to grow from $180 billion in 2003 to $300 billion by 2010

There will be a short-term impact on the US labor force. About 1.3 million jobs will move offshore between 2003-2010, impacting about 1 million US workers. Of these, about 0.7 million (0.4% of the labor force) will be unemployed for a short duration. Over 8 million jobs are reallocated every quarter in the US economy and hence, the reallocation process will not be a strain for those who are temporarily unemployed

About 0.3 million workers (0.2% of the workforce) will be unemployed for more than 3 months due to offshoring. This segment will require re-training and redeployment

Turning a Bane into a Boon

These statements from NASSC president Kiran Karnik are fascinating. We'll leave aside for the time being that he has picked two of the OECD countries with the least manpower problems looming - the US and the UK both have fertility not too far from the 2.1 replacement level (thanks largely to immigration). We can also leave aside the fact that we do not know what exaclty the consequences of demographic ageing are going to be (although the Japanese experience doesn't look too positive), the key question is that India's population - thanks largely to a steady reduction in fertility, is about to turn into its most precious asset. This moment is termed by the UN 'the demographic window of opportunity' and it is one of the reasons I am so optimistic about India's future. What can and should be the relations between India and the OECD at the man-and-woman power level I will leave for future posts. Meantime Reuben has a useful post on a Bhagwati essay about the Indian economy and international migration.

The major economies around the world, including the United States and the United Kingdom, will fall short of human resources by 2020 and they would turn to India to 'import' human power from the country, according to National Association of Software and Service Companies president Kiran Karnik."The high population in India, which was thought to be its bane will, in turn, become its boon," said Karnik, who was speaking a seminar jointly organised by Federation of Indian Chambers of Commerce and National Institute of Industrial Engineering in Mumbai on Friday.

The country's population, which had been a reason for ridicule, would come to its rescue, he said, adding, 'body shopping' would become a preferred trend, resulting in a win-win situation to the importer and India. Talking about manufacturing in India, he said: "The future is bright for 'Made in India' brand," and added that designs would be more in demand than software and programming skills. The Nasscom president also said that 'India Inside' or 'Conceived in India' "would drive the country's growth." Elaborating on India Inside, Karnik said that even though the brand names would point to companies other than India, the product would be thought of, conceived and designed in India.

Earlier, inaugurating the seminar, titled 'An Indian Evolution, A Global Revolution?' Lok Sabha Speaker Manohar Joshi said India needs to focus on three capabilities -- innovation, volume generation and globalisation -- to emerge as the leading nation by 2020. He also called for a strong fiscal policy, power reforms and a special emphasis on provisions for institutional finance, apart from thrust on infrastructure and roping in foreign direct investment. "We also need directions from educationists and policy leaders," Joshi said, and cited the example of Bharat heavy Electricals Ltd, which has carved a name for itself in the international market.
Source: Rediff.Com

Wednesday, October 08, 2003

Both Wall Street Journal (priced subscription) and New York Times had stories this week on Wall Street research jobs going offshore to India. (WSJ link via Barry Ritholtz's Big Picture). This is important for a couple of reasons. I would try to come back and post my thoughts on this later.

A few weeks back I talked about the stalled divestment of HPCL. Things have gotten more confused since then.

Since then GOI had floated the the idea of splitting Indian Oil Corporation (IOC) into two or three different entities and selling off their retail arm. IOC is India's only Fortune 500 company. IOC obviously did not like the idea one bit. They have since offered to take HPCL off the government's hand in order to let them meet their divestment targets. This is probably a slightly better suggestion. Business Standard rightly noted in today's editorial:

"Even on the face of it, the government's decision to split Indian Oil Corporation (IOC) into two parts, and sell off around half its marketing outlets, if it is not possible for it to sell off Hindustan Petroleum (HPCL), is a classic case of the cure being worse than the ailment — the ailment in the current case being the Supreme Court's ruling that neither HPCL nor BPCL could be sold without prior permission of Parliament.

For, the retail outlets account for roughly 40-45 per cent of not just IOC's profits, but those of any refining-cum-marketing outfit like even HPCL and BPCL.

Cut off this vital arm, and it is not just the profits, but a significant part of IOC's viability that is under a shadow — from where, then, is it to sell the output that comes out of the eight refineries it owns?

It is in fact this very realization, that stand-alone refineries are not viable without an accompanying retail distribution network, that led the government to set up the Nitish Sengupta committee in 1999 which recommended that the four stand-alone refineries like Madras Refineries and Bongaigaon be merged with retail firms like IOC and BPCL. After the Sengupta recommendations, in fact, these refineries were merged.

It is, of course, true that the Supreme Court's ruling is debatable, especially since we've seen just what happens when a company with such large resources is left at the mercy of the country's politicians — the petrol pump scam is the most obvious manifestation of the evil that results.

But, like it or not, this is something the disinvestment ministry, and the entire country, will have to deal with in the correct manner, that is by approaching the Court once again, and if that fails, by approaching Parliament.

The decision to simply break up a well-run firm, sell off one part and then merge the other with either HPCL or BPCL (or both!) to create a completely unwieldy structure is a very sad reflection of the completely cavalier manner in which such vital economic decisions are taken.

Read the history of any merger/demerger in the corporate world, and it'll be obvious that it takes months, if not years, of careful planning and execution to carry off a successful exercise — it's not done with just the stroke of a pen, or with a few wise men meeting over a table."

Rediff has a very good resource for tracking the divestment story.

Tuesday, October 07, 2003

More on Business Process Outsourcing in India

Clearly, as the authors of this piece from Rediff conclude, the party is only just beginning, and, oh yes, everyone is invited.

Stories about US infotech professions losing their jobs to Indians on the worldwide web are mushrooming by the hour. Anti-outsourcing websites, some of which claim to have been constructed purely by American labour, are choc-a-bloc with the financial and emotional distress outsourcing has caused in the US. And with presidential elections round the corner, the heartburn is all set to snowball into a national issue. Is it the beginning of the end of outsourcing? Far from it. A string of recent studies suggest that the phenomenon will not only get deeper with more MNCs outsourcing their infotech requirements to India but will also spread to new areas like automobile components and clinical research.

Consider this: Big Pharma can pare the cost of developing a new drug, currently estimated at between $600 million and $900 million, by as much as $200 million if development work is outsourced to India, according to consultancy firm McKinsey & Co. "The overall cost advantage in bringing a drug to the market by leveraging India aggressively could be as high as $200 million," McKinsey associate principal Peter Pfeiffer said at the inaugural session of a two-day conference on "Clinical Research: Roadmap for India" organised recently by the Confederation of Indian Industry. According to Pfeiffer, pharmaceutical companies in the US and Europe will be pushed to offshore development (clinical trials) of new chemical entities on account of the declining productivity of R&D in those countries.

McKinsey analysis shows that overall R&D productivity has declined by 24 per cent between 1991-95 and 1996-2000. "While R&D spending has increased five-fold between 1986 and 2001, filing for new molecules have increased modestly and development of new chemical entities has remained flat during the period," he said. The decline in R&D productivity, according to Pfeiffer, has happened because of rising development costs, tightening of the regulatory environment and the emergence of complex organisational designs because of the mergers and acquisitions in the sector. At the same time, development is accounting for more and more of the total investment in a new chemical entity. According to McKinsey, while development was 42 per cent of the total cost in 1976, it has risen to as high as 60 per cent by 2000.

"India clearly provides an opportunity for western pharmaceutical companies as a catalyst in addressing the productivity challenge because of the availability of large patient populations, access to highly-educated talent and lower cost of operations," Pfeiffer said adding: "The potential opportunity for savings is $120 million to $200 million on a drug development base of $550 million to $900 million." Pfeiffer says that barriers to outsourcing still exist. These include a lack of real cost pressures as there are still too much "low-hanging fruit" to be picked. For a start, there are existing systems in western pharmaceutical companies and emerging public policy concerns about outsourcing to India. Besides that there's the threat posed by India's generic drug companies.

It isn't only pharmaceuticals where India could score in a big way. The prospects appear equally bright for the automobile component companies -- nine out of ten automotive manufacturers and suppliers surveyed in North America say they intend to move certain non-manufacturing business processes to low-cost offshore locations, according to a recent survey of 40 senior automotive executives conducted by the Global Automotive Practice of management consulting firm A T Kearney. Drivers for the growing momentum in this migration of labour includes fierce competition in domestic and foreign markets; continuing cost reduction pressures; and an industry-wide strategy calling for local presence by automakers seeking growth in emerging markets, such as Asia and South America, and by suppliers in support of their customers.

A T Kearney estimates that the North American automotive industry, including manufacturers and suppliers, spends approximately $9 billion annually on business processes with the potential to be offshored, representing an enormous opportunity for cost reduction and profitability improvement. "Done right, offshoring for select engineering, information technology and other support functions to India, for instance, can reduce automakers' and suppliers' costs by nearly 50 per cent compared with doing the same functions in the US," said Richard Spitzer, vice president in A T Kearney's Global Automotive Practice and co-author of the study.

India emerged as the most popular destination for the migration of business processing activities, according to automotive executives responding to the survey. While 24 per cent of the respondents put India on top, 15 per cent voted for China, 13 per cent for Mexico, 10 per cent for Brazil and 8 per cent for the Czech republic. "India is clearly the destination of choice for business processing services across all industries," said Nagi Palle, co-author of the research and a principal at A T Kearney.

At the same time, IT offshoring is taking deeper roots in the country. Leading IT companies like IBM Global Systems and EDS and consulting majors like PricewaterhouseCoopers, Cap Gemini, Ernst & Young and Accenture have decided to add substantially to their numbers in India. "At the moment, outsourcing accounts for 23 per cent of Accenture's turnover in India. We plan to raise it to more than 40 per cent in the next three years," Accenture country managing director Sanjay Jain told Business Standard. Even the IT-enabled services companies are growing by leaps and bounds in India. For example, GE's original target for its IT enabled services operation in India was 10,000 people by 2005 -- it has now been revised to 20,000 by 2003 end.

"Savings to the US economy by offshoring to India could be $10 billion to $11 billion in 2003-04. In fact the total benefits to the US economy including savings, hi-tech imports from the US to India and contribution by Indian IT professionals to the US social security is projected to be about $16.8 billion, " a recent Nasscom study has pointed out. Outsourcing to India has helped US companies to save as much as $8 billion in the last four years, said the leading market research firm Inductis in a recent study.

So far as the proposed bills banning outsourcing to India by certain states in the US are concerned, Nasscom president Kiran Karnik says there will be no immediate impact as these outsourcing bills have just been introduced and will need to pass through various stages in order to become laws. In fact, outsourcing is now at the heart of all business organisations, says a new book called Rebuilding the Corporate Genome, authored by three top A T Kearney functionaries Johan C Aurik, Gillis J Jonk and Robert E Willen. As a result, business organisations will become smaller in scope, though not in size, as outsourcing occupies centrestage. This, the authors say, is the next stage in the evolution of business.

Corporates the world over are evolving from being organised around strategic business units to organisations driven by their business capabilities, focused on functions, which are crucial and in the discharge of which they have high capabilities, while outsourcing the rest. "These changes are driven by digitisation and connectivity," said Aurik, who was in India along with Willen in the last leg of their tour of Asia to promote the book. While Aurik leads A T Kearney's Benelux unit, Jonk and Willen are principals at the consultancy firm.

The authors have developed a matrix on which a company can plot its functions on the X-axis according to their criticality and its capabilities on the Y-axis. "The criticality of functions could range from necessary to beneficial and crucial, while capabilities could range from laggard to world class performance," Aurik said adding: "A company should stick to what is crucial and where it has world class capabilities and outsource what is necessary but where it does not have high capabilities." Clearly, the party has just begun.
Source: Bhupesh Bhandari and Bipin Chandran, Rediff.com

India Riding the China Boom?

Indian materials export to China is booming. The starting base may not be particulary high, but the growth rates are spectacular.

Powered by a record growth rate in the iron and steel sector, India's exports to China grew by an impressive 101 per cent during the first seven months of the year, latest Chinese customs statistics show. During the January-July period, India exported iron and steel products worth $709 million to China, compared to $64 million during the same period last year, registering a whopping growth rate of 1008 per cent.

With construction work for the 2008 Beijing Olympics picking up, China's demand for steel has surged, allowing top Indian steel companies to find unprecedented opportunities in the huge Chinese market, industry sources said. According to statistics released by China's General Administration of Customs, Indo-China bilateral trade during the first seven months of 2003 crossed the $4 billion mark, well on target to break the $4.96 billion achieved in 2002. Total trade during the period amounted to $4.087 billion, up 62 per cent.

Of this, India's exports amounted to $2.331 billion, up 101 per cent. The country's imports from China totalled $1.756 billion, up 29 per cent. India also enjoyed a favourable trade balance of $575 million during the period. Based on the current trade figures, one can safely assume that the two-way trade would cross $7 billion by December 2004, senior director and head of East Asia representative office of the Confederation of Indian Industries, Piyush Bahl said. Bahl said if this trend persists, the targeted bilateral trade figure of $10 billion by the end of 2004 is also attainable.

The basket of Indian exports to China comprised mainly iron and steel, ores, plastics, organic chemicals, cotton, mineral fuels, natural or cultured pearls, fish and paper. Apart from the excellent performance by the iron and steel sector, the ores, slag and ash exports from India also contributed to its impressive export growth to China. Ores, slag and ash exports during the first seven months amounted to $644 million, up 77 per cent over the same period last year. Plastics was another star performer, with its exports reaching $173 million compared to $128 million last year, registering a steady growth rate of 35 per cent. Organic chemicals sector exported goods worth $167 million, up 25 per cent over the same period last year. The exports of inorganic chemicals to China netted $79 million, registering an impressive growth of 229 per cent. Paper and paperboard exports also rose steadily, with this sector witnessing 78 per cent increase during the seven-month period. Compared to $18 million during Jan-July in 2002, this year saw Indian exports in the sector worth $32 million. However, cotton exports to China from India saw a steady fall of 42 per cent during the first seven months.

The major items in the Chinese export basket to India were electrical machinery, organic chemicals, mineral fuels and silk. China's top export item to India continued to be electrical machinery. Exports from this sector were worth $376 million, up 38 per cent over the first seven months of 2002. Second in the list were organic chemicals, which amounted to $346 million compared to $294 million last year, a growth of 18 per cent. Other machinery exports to India were worth $146 million, up 34 per cent. Chinese silk exports registered a marginal growth of 5 per cent. Total exports during the period amounted to $120 million compared to $114 million in 2002. Chinese export of plastics witnessed 142 per cent growth at $29 million, while man-made filaments sector also registered a 135 per cent rise, with China shipping goods worth $47 million.
Source: Rediff.com

Monday, October 06, 2003

The Power of Monetary Policy

Brad has recently been posting on the powerful impact of monetary policy. Well here's a piece from Rajiv Lall in the Business Standard (thanks to Rueben at the zoo station ) about just how powerful the effect of declining interest rates might be in India.

Ten, five, even three years ago I would have, and did, make the bet that China's growth rate would outperform India's. Today, I would have to be more circumspect. My bet is that India will begin to outperform China within the next five years. What accounts for this change in perspective? Sustained improvement on many fronts including the development of physical infrastructure (especially roads, ports and telecommunications), trade and tax policy reform, and the coming of age of a new generation of Indian entrepreneurial talent all add up to impressive change.

But, by far the most significant development in the Indian macro story is the declining cost of capital. It is difficult to exaggerate the impact that falling interest rates have had on the functioning of the Indian economy. Over the past three years, borrowing rates have declined by about 600 basis points for most medium to large sized enterprises in the country. Whereas such companies were paying 14 per cent on one-year loans three years ago, today they are paying only 8 per cent. Borrowing rates for some of the largest corporates are up to 200 basis points lower.

In part, the declining interest rates reflect a fall in the rate of inflation. But even in real terms, interest rates have fallen sharply. What is key is that this does not reflect merely a cyclical adjustment, although that is part of the story. It is in fact largely the result of the progressive dismantling of a system of administered interest rates in the country. To be sure the system is still not fully disbanded. Rates on small savings deposits are still fixed by administrative fiat. But now there is at least greater flexibility and pragmatism in how they are set. So what we have seen is a significant structural decline in interest rates that has the potential to trigger fundamental improvements elsewhere in the economy.

First, compared to China and the rest of East-Asia in its high growth phase, India’s manufacturing sector is much smaller (16 per cent versus 35 per cent of GDP). The popular perception, until very recently, has been of an uncompetitive Indian manufacturing sector hobbled by poor physical infrastructure and rigid labour regulations. It turns out that perhaps the most serious handicap faced by Indian manufacturing has been the relatively higher cost of capital. Between 1997 and 2000 real interest rates on the average five-year loan fell from 7.8 to 4.9 per cent, whereas in India they actually rose from 6.4 to 7.8 per cent (due to a decline in the domestic inflation rate).

Since 2000, however, the trend has reversed thanks to several cuts in the administered interest rates in India. For the first time that I can remember, real interest rates in India are lower than in China. And the effects of this are dramatic.Consider the following: Every 10 per cent fall in interest rates leads on average to a 30 per cent increase in profits before tax (PBT) for larger Indian corporations. For firms in manufacturing that operate with higher levels of debt relative to the average for all companies (companies in the less asset intensive service industries can operate with lower debt-equity ratios), the impact on PBT of declining interest costs is likely to have been even larger.

Given that borrowing costs for larger corporates have fallen as much as 40 per cent in the past three years, profits before tax for these companies have more than doubled, raising returns on equity to well above the cost of capital. Suddenly, even manufacturing activity is looking like an attractive proposition in India. Second, India's predominantly state-owned banking system has been capital constrained for many years, weighed down by non-performing assets created during the investment boom following the initial years of economic reform in 1993/95. As a result banks have become risk averse tying up more than three-quarters of their balance sheets in government securities. The decline in interest rates has handed this passive banking system a salutary bonus in the form of enormous paper gains on their portfolio of government securities.
Source: Business Standard