Investing in India – Opportunities and Challenges

Investing in India – Opportunities and Challenges

2©2005 KPMG, the Indian member firm of KPMG International, a Swiss cooperative. All rights reserved.

The India OpportunityThe India Opportunity


The transformation…

• Slow rate of growth

• Bureaucratic

• Protected and slow

• Small consumer markets

• Weak infrastructure• One of the world’s fastest growing

economies

• Reasonably proactive

• Opening up of sectors for investment

• Promising consumer markets

• Infrastructure needs improvement

Yesterday

Today

India is the world’s largest democracy


India today…

• Has world-class recognition in IT, bio-technology and space

• Is the largest English speaking nation in the world

• Has the world’s largest single-location forging facility

• Has the second largest petrochemical facility in the world

• Is the lowest cost steel producer in the world

• Is the largest 2 wheeler manufacturer in the world

• Is the second largest tractor manufacturer in the world

• Is the fifth largest commercial vehicle manufacturer in the world

• Is among six countries that launch satellites and does so even for Germany, Belgium, South Korea, Singapore and EU countries

• Is one of the few countries that has built its own Supercomputer


Strong fundamentals

34 35 3337

45 44

53

64

39 41 4250 51 51

61

77

0

10

20

30

40

50

60

70

80

90

1996-97

1997-98

1998-99

1999-00

2000-01

2001-02

2002-03

2003-04*

US

D b

n

Exports Imports

6.1

4.4

5.8

4.0

8.5

6.9

0

1

2

3

4

5

6

7

8

9

2000 2001 2002 2003 2004 2005

Indian economy in a

resilient mode in terms of

GDP growth…

Growth Oriented GDP (%) 1

Source: Indiastat.com

Increasing International Trade 3

Increasing share of services in GDP 2

Strong Forex Reserves 4

Source: Central Statistical Organisation

…along with rising forex rate and reserves

…and has an increasing

share in international

trade

With Services Sector gaining importance….


… resulting in a transitioning Indian demography

24 MILLION

households

32 MILLION

householdsSource: The Marketing Whitebook, 2003-04 by Business World

1994-95 1999-00 2005-06The Classes

Rich (Above USD 4,600; INR.2,15,000)

Consuming (USD 970 – 4,600; INR. 45,000-2,15000)

Climbers USD 470- 970; INR.22,000 – 45,000)

Aspirants(USD 470 - 347; INR.16,000 – 22,000)

Destitutes (Less than USD 470; INR.16,000)

3 MILLIONhouseholds

6 MILLIONhouseholds

1 MILLION

households

48 MILLIONhouseholds


33 MILLION

households


66 MILLION

Households

75 MILLION

Households

66 MILLION

Households

78 MILLION

Households


17 MILLION

households


Four sectors underline the Indian growth story

Information Technology

Auto-components

Pharmaceuticals

Textiles

• Major hub for outsourcing IT-based business processes

• Driven by cost effectiveness• India’s wealth of man power

• Rapid integration with global industry

• Foreign manufacturers seek to cut costs

• India has high engineering levels and established productions plants

• Entering a paradigm shift with new product patent regime

• Availability of highly skilled scientists

• Removal of quotas will unleash significant potential

• Advantages include availability of raw materials and low-cost production


Today India is well-positioned as an offshore processing destination

Source: NASSCOM – McKinsey 2002

Location Attractiveness

• Time zone• Geopolitical factors• Infrastructure

Hig

h

HighLow

Lo

w

ChinaIndia

UK

Mexico

Philippines

Ireland Australia

Singapore

Note: Size of circle indicates resource availability

People Strength• Skill availability• Language(s)• Cost advantage


Time

• Faster turnaround using

time zone differences (US

10-12 hrs, Europe 4-6 hrs)

• Ability to implement a 24X7

service model

Scale Cost

Scope Quality & Productivity

• 10% - 15% productivity improvements

• Lower error rate, quicker turnaround

• Greater quality visibility

• Large proportion of SEI-CMM, COPC,

ISO9001 certified service providers

and 6-sigma practitioners

• Wide scope of functions - low to

high value skills

• Offshore opportunities span

entire value chain across

industries

• Large, qualified and young

workforce

• Easy availability of skills

• 14 million graduates, 1 million

technical resources

• 40% - 50% net cost savings on labour

and skills intensive activities and

processes

• Additional benefits through low cost

process improvement, consolidation

and automation

Companies enter for

cost, but stay and

expand for quality and

enhanced

competitiveness

India’s value proposition: Cost-effectiveness and high quality


The India ChallengeThe India Challenge


India

GDP: USD 3,319 bn

Area: 3,287,590 sq km

Population: 1,080,264,388

Languages: 18

Per Capita Income: USD 3072

European Union

GDP: USD 11,650 bn

Area: 3,976,372

Population: 456,953,258

Languages: 20

Per Capita Income: USD 25,494

Companies attracted to India must do more than merely transplant strategies…

• India is approximately 82% the size of the EU

• Its population is more than double that of the EU

• Almost the same number of languages (India has several dialects as well)

• India and the EU have large variations in demographics vis-à-vis paying capacity

…given India’s regional diversities of continental magnitude and interstate variation


Challenges companies face in India

Infrastructure and environment

•Complex business environment

•Poor physical infrastructure (roads, ports, airports)

•Weak rural infrastructure

•Bureaucracy

•High cost of and unreliable power

•Low urban penetration levels

•High cost of entry / exit

Regulatory / Governance

•Regulatory changes impacted by coalition politics

•Restrictive labor laws, e.g. exit options

•Laborious and time-consuming process to start a business

•Slow legal process

•Politicization of investment decisions

Market-related

•Under-developed consumer markets

•Low penetration levels due to low urbanization

•Widely varying consumer tastes across regions

• High price / value sensitivity


Navigating through tangles of bureaucracy in business and procedures

A change is taking place in the regulatory environment…

• FDI allowed in almost all sectors

• Import duties rationalised

• Single window clearance

• Expediting clearances through escalatory mechanisms

• Greater transparency brought about through e-governance

Days taken to start business

Level of complexity

According to Transparency International’s ’04 Corruption Perception Index India’s score is 2.8 out of 10. India ranks 90 out of 145 on the

Transparency International Corruption Perceptions.

Coalition politics have impacted the pace of reforms


Note: Rigidity of Employment Index is an average of the following three indices – how difficult it is to hire a new worker, how rigid the regulations are on working hours, and how difficult it is to dismiss a redundant worker. Values are assigned between 0 and 100. Higher values represent more rigid regulations.

• Labour regulation is a disincentive to grow businesses, reduces flexibility in operations, and increases exit costs.

• Business with over 100 workers have to secure the permission of state governments to close businesses or lay off workers

• Difficult to redeploy workers in reorganisations without unanimous agreement of workers.

• Downsizing strategies that include large-scale job cuts are difficult and achievable only with local government support

• Most large manufacturing companies continue to be seriously overstaffed for want of a transparent “hire and fire” policy

• Terms relating to labour conditions, attendance, flexibility, and days lost through disputes vary hugely from state to state.

Rigidity of Employment Index

Restrictive labour policies can impact flexibility in business

While it is difficult to fire workers in India…

Source: Doing Business, The World Bank

While it is difficult to fire workers in India…

Source: Doing Business, The World Bank

• Relatively easier to hire

• Flexibility to work longer hours

• Lower cost of laying-off

Indicator India RegionalAvg (Asia)

Germany

Difficulty of Hiring Index 33 37.0 44

Rigidity of Hours Index 20 36.7 80

Firing costs (weeks of wages)

79 84.7 80


Infrastructure investment has not kept pace with the needs of the economy

In 2003, India’s infrastructure spending was just US$35 billion

Low spend

A meaningful impact on overall growth will require consistent investment of at least US$60-80 bn p.a.

Immediate requirement

In the past 10 years, government has cut capital expenditure as a percentage of GDP5.6% (in F2004) from 9.3%

Low infrastructure development

Private investment (domestic and foreign) in infrastructure projects

Demographic trends can lift household savings and channel them into infrastructure projects

Improvement on the Infrastructure front…

• FDI up to 100% in select projects

• Mega road projects

• Port sector opened for private participation

• Introduction of a regulatory authority framework

• Developing rural distribution networks

• Public Private Partnerships


• The Indian privatization process has been very slow

• Total amount collected in last 14 years was just US$11.9 billion

• Few companies have transitioned into private hands

Weak results from Privatization

• Estimate of market value of government companies (excluding infrastructure assets) ~ US$150–175 bn

Fairly large size of assets

• Privatization has been mired with controversy of being anti-labour and non-transparent

Politicization

The Indian success story has to be objectively viewed from another perspective as well…


Complex group structures – difficult to unwind, ‘hidden’ owners especially other factions of the family -especially true for promoter owned and managed companies

Fiefdoms’ – decision making concentrated

‘Associated companies’ may need to be consolidated which may bring in more liabilities

Minority interests may have a disproportionate amount of power

Unwinding the Corporate Veil might be a challenge

Related party supplier / customer relationships on non-commercial terms

No formal arrangements with related parties

Funds deployment in non-core activities

Sacrifice of shareholders’ interest for promoter gain

Non Arm’s Length Transactions with

Related Parties/Group Companies

Corporate Governance is gaining acceptance, albeit gradually…..

Implementation ranges from academic/ cursory to robust, depending on management philosophy

Reliability of internal and external audit report may be questionable

Statutory audits by small time auditors run the risk of being an eye wash

Spirit behind Implementing Corporate Governance

Measures may be Questionable


Aggressive tax management (tax planning vs. tax avoidance)

Tax litigation is common, Final resolution of issues time consuming

This could result in cash outflows at the outset and inflows later if company

successfully defends: impacts cash flows given lengthy legal process

Continued availability of tax benefits/ incentives post transaction (needs careful

analysis)

Aggressive Tax Positions Continue to Find Favour….


Need to pay attention to the operating environment and to cultural aspects

Foreign Investors should…

• Develop an ‘India’ strategy;

- Have a long term view

- Choose the right Joint Venture partner

- Choose the right regional model

- Use global best practices

- Conceptualise India-specific products

• Optimally blend expatriate management with local talent

In India ‘everything goes’


Source: KPMG research

Faster implementation of reforms needed

Redefinition of roles of public and private sectors.

Urgency to revamp infrastructure

Sun-rise industries establishing themselves internationally.

Reforms consistently moving in the same direction.

Indian manufacturing sector becoming globally competitive

Investment opportunities driven by:

Existence and growth of marketsAvailability of resources and global

competitiveness

In conclusion…

…India today offers an early mover advantage

Documents

Investing in India – Opportunities and Challenges