Commentary

Indian Investments Abroad
What Explains the Boom?
The Tata-Corus and Videocon-Daewoo deals are the most recent and largest of Indian investments and acquisitions abroad, but the trend has been in evidence since the early 2000s. There are domestic reasons and international factors propelling Indian outward flows; and industry specific factors have also contributed to the trend. Success, however, is not guaranteed.
R NAGARAJ
he year 2006 will probably end on a unique note, with private capital outflow from India exceeding inflow of foreign direct investment (FDI). According to Dealogic, a consultancy firm tracing cross-border investments, in the first nine months of 2006, investment outflow from India was estimated to be $7.2 billion, up from $4.2 last year (Financial Times, October 3, 2006). What started as a trickle in 2000 has grown into a flood with Tata Steel catapulting itself to become the world’s fifth largest steel manufacturer by acquiring the Anglo-Dutch company, Corus. This has been closely followed by Videocon Industries acquiring Daewoo’s electronics manufacturing facility in South Korea to become the self-proclaimed “Indian Multinational”. According to news reports, prior to the Corus deal the Tata group alone had made 28 overseas acquisitions since 2000, investing $1.4 billion in eight major acquisitions spread across the world in industries ranging from steel to beverages (Wall Street Journal, October 7, 2006). The recently released World Investment Report 2006 notes that India is not alone in experiencing a boom in outward flow; this is true of developing countries as a whole. However, while most of the investments from developing countries are into other developing countries and in services, recent Indian acquisitions have been, one, mainly in the advanced economies and, two, the acquisitions are now concentrated in manufacturing (software being the exception). Cumulative capital outflow from India between 2000 and 2005 was $8.1 billion. Since 2001, Indian firms have made 30 to 60 overseas acquisitions per year, as per the Centre for Monitoring the Indian Economy’s (CMIE) information on international acquisitions and mergers. About 40 per cent of them are of less than $ 10 million each. Ten deals are of a value of over $100 million each, while financial information regarding 38 per cent of the acquisitions is unavailable. up from 94th in 2000. Even among the developing economies, Indian investments are modest as the country does not figure in the top 15 outward FDI countries. Of course, these are figures for 2005, and Indian acquisitions abroad have exploded in 2006 with big ticket items like the TataCorus and Videocon-Daewoo deals. This is likely to make India leap in the rankings for 2006. After netting out investments between China and Hong Kong, the two countries together would account for a substantial share of capital outflow from the developing economies, that is, many times the value of investments from India. While much of China’s investments are in search of oil fields and industrial raw materials to sustain its rapid growth, India’s investments, in contrast, are seeking markets for their products in developed economies, in the manufacturing sector and in mature industries, like machinery, automotives, textiles and pharmaceuticals. What explains the boom in FDI from India? There are domestic reasons and international factors propelling outward flows; and industry specific factors have also contributed to the trend. In the face of investment and trade policy reforms, Indian industry underwent a major restructuring in the 1990s – lay offs and retrenchments, domestic mergers and acquisitions, hike in promoters’equity holdings to ward off threats of hostile takeovers, and so on. There was a surge by incumbent firms in fixed investment to expand manufacturing capacity and distribution networks to face external competition. But with the sharp downturn after 1995-96, the industrial sector was saddled with huge excess capacity. This experience taught Indian business the perils of excessive dependence on the domestic market in an increasingly open economy. The bigger and more successful Indian companies also sought to establish businesses abroad so that they would not be dependent on the fortunes of a single (i e, domestic) market. In this gloomy scenario, the success of Indian software firms demonstrated India’s advantage of low cost skilled workforce in exploring international market. November 18, 2006

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Software Focus
Software is the single largest industry of acquisition, followed by pharmaceuticals and the automotive industry. Over 40 per cent of the acquisitions are made in the US, followed by continental Europe, the UK and Asia, in that order. Although information technology (IT) and the information technology enabled services industry (ITES) lead the number of acquisitions from India, these are quantitatively small in value. About 300 Indian firms are reported to have set up representative offices in London, and India currently ranks third in FDI inflow in the UK. London is apparently the first port of call; this is natural given the long-standing business and social connections, and access to its financial market and commercial expertise. Though capital outflow from India appears large, it is still modest by international standards. According to the WIR 2006, FDI outflow from India ranked only 88th in 2005 in world outward FDI,

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One of the decisions the government took during the depressed investment scenario (operative from the mid-1990s until 2002-03) was to allow Indian firms to invest abroad up to twice their domestic net worth, enabling them to target acquisitions in advanced countries where industrial assets were available at a discount on account of the global economic downturn in the early 2000s. In principle, such acquisitions allowed firms to combine their low production costs at home with low interest rates in international capital markets to emerge as low-cost producers accessing the world market. By acquiring running businesses, they got ready access to customers and markets, closely knit supply chain networks and consumers’ brand loyalty. Such investments have enabled Indian firms to produce labourintensive parts/subassemblies/processes in India and use the factories and firms in advanced countries to undertake capital or technology-intensive investments in their business. The speed with which Indian firms went overseas over the past five years was also perhaps driven by the desire to get a toehold in a variety of markets divided into trading blocs. However, the foundation for overseas expansion was laid a long time ago. It is well worth remembering that given the large size of the domestic market, India had acquired international competitiveness in many industries, mainly based on the low cost of skilled workforce. It is worth recalling the words of late Sanjaya Lall, who in 1982, described TELCO (now Tata Motors) as “…(the) first real automotive multinational to emerge from the Third World with its own trade and technology…” (Sanjaya Lall, Developing Countries as Exporters of Technology, Macmillan, London, 1982: 41).

Positive Externalities
Now in the 2000s, in an increasingly open world economy, large and efficient firms in India would want to expand overseas, to secure external markets, to extend their intangible assets like brand names into newer territories. For example, Asian Paints, which has been setting up plants or acquiring paint-making factories and firms abroad for some time now, has apparently emerged as the world 10th largest producer operating in 24 countries. This follows its acquisition of Berger Economic and Political Weekly

International in Singapore in 2003. Asian Paints’ efficient manufacturing and distribution systems seem to be the source of its success. As the firm has developed technology to produce paint intermediaries, export of these goods add value to the firm. Such overseas expansion could, in principle, have a positive externality as it augments domestic production capability, promotes backward and forward linkages, and also increases employment opportunities. Coming to industry specific reasons, in pharmaceuticals many firms have proven their capability to produce generic drugs at a fraction of world prices. This is clearly the result of the Patents Act of 1970 (that promoted process patenting and facilitated reverse engineering), and import substituting industrialisation that encouraged local technology and skill development. Indian firms now perceive an opportunity to produce a large number of drugs that are going off patent. Although it may be cheaper to produce many of these drugs in India, by acquiring firms abroad they get access to the prescription drug markets, which are often restricted to firms belonging to the country or trading bloc like the EU. Getting access to specialised R&D firms to speed up the drug discovery process is another reason for such investments. In the case of the automotive spare parts industry, some efficient domestic firms have received international recognition for quality (e g, Deming award for Sundaram Fasteners) that gives them access to firms like General Motors. As the automotive industry has a tightly knit supply chain across the world, Indian firms perceive their growth prospects in becoming a part of such supplier networks to original equipment manufacturers (OEM). Bharat Forge and Sundaram Fasteners are two examples of such suppliers. Though most Indian suppliers at the moment operate at the low end of the spectrum, they expect to move up the value chain to supply complete sub-assemblies with the help of their external acquisitions. In telecom, the boom in the telecommunication industry in the second-half of the 1990s created huge capacity, but with the collapse of the dot com bubble and the implosion of firms like Tyco and WorldCom a significant amount of surplus capacity became available. As the prices of these “unlit” fibre optic cable network plummeted, large Indian telecom firms like

Tata VSNL and Reliance have competed to get hold of the networks to augment long distance telephony and data transfer capacity to meet the growing requirement of the IT and ITES industry. In IT, after the late 1990s bust, many firms have set up new offices and made outright purchase of software firms abroad to move up the value chain, building on their strength of low cost and credibility of their services. After the 2001 terrorist attacks in the US Indian software companies are apparently investing in “mirror sites” or parallel locations in places like Singapore to ensure uninterrupted services to their clients in the west. Many of these acquisitions in the US are mainly from nonresident Indians, perhaps reflecting prior business and social ties.

Risk Factors
The great Indian outward movement does not, however, mean success is guaranteed. While internationalisation of business represents natural progression in an open economy, it faces many risks and uncertainties. Allowing large domestic enterprises to tap the international market for funds to fuel the acquisitions exposes them to the volatilities of the global financial markets with attendant risks. Many of the recent large acquisitions are predominantly financed by debt finance (leveraged buyouts), raised from the global capital market; success depends on augmenting cash flow in international currency to service the huge debt. In the event of an economic downturn – which is not a question of if but when – servicing such debts could pose serious challenge for these firms. Moreover, the experience from developed countries suggests that about one-third of mergers and acquisitions fail to add value to the firm and the shareholders. More fundamentally, industrial organisation literature suggests that it is still an open issue about whether or not corporate mergers improve efficiency and profitability (F M Scherer, ‘A New Retrospective on Mergers’, Review of Industrial Organisation, Spring 2006). What are the policy implications of growing outward investment from India? Given the scarcity of industrial resources in relation to India’s size, there is perhaps a need for strategic initiatives to encourage public and private sector firms to seek scarce natural resources, including energy, to facilitate industrial development at home.

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Since the policy-makers in their preoccupation with market-oriented reforms during the last one and half decades, took their eyes off energy security, there is now an urgent need to refocus on India’s longterm investments in exploration and development of mineral and energy resources, just as China has done to invest in Australia and more recently Africa. For this purpose, it may be desirable to be open to forming joint ventures with firms in developed economies to acquire technology and design capabilities. More recently, with oil prices reaching unprecedented levels over the past two years, Indian policy-makers have begun to emulate China and make frantic effort to acquire oil and gas exploration rights to ensure energy security. Public sector firms like ONGC have also made considerable investments to acquire oil fields in countries like Sudan, Russia, Vietnam and Kazakhstan to augment supply of petroleum for domestic use. Some Indian firms, public and private, have also picked up stakes in mining operations in Australia. Access to long-term finance at reasonable interest rates is imperative to enable Indian firms to exploit external opportunities. Development finance institutions need to open special windows to promote international business – just like China’s policy banks systematically do so for their domestic firms. Exim Bank of India has a window for this purpose, but it appears a feeble and nominal initiative to be of much consequence. Given the sizeable foreign exchange reserves of $160 billion, India could probably consider setting up an investment arm like the Temasek Holdings of the Singapore government to strategically invest globally to secure resources for rapid industrialisation and access to external markets. The boom in the outward investments is likely to increase external pressure on India to quickly reduce tariffs and dismantle the remaining restrictions on capital inflows. Calibrating these moves without foregoing the interests of the vast unincorporated sector enterprises and the rural economy would remain a challenge for policy-makers. EPW Email: nagaraj@igidr.ac.in
[This is an abridged and updated version of the author’s San-Ei Gen lecture delivered at the University of Edinburgh Management School and Economics in November 2005.]

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