The Future of India Inc.
September 29, 2011
Focus: a relentless high-cost environment
India has been amongst the fastest growing regions of the world. It has also been seen to offer the dual advantages of being a low-cost destination with abundant availability of talent. However, irrespective of the nature of business, every senior executive in the country would know that the cost of setting up and doing business in India is rising unabated. Inputs, raw materials, energy and funds are all more expensive; but India’s big advantage with people is also under pressure and finding, attracting and retaining quality talent are now among the most urgent concerns.
According the latest report on ‘Doing Business’ by the World Bank, the cost of setting up and doing business in India is among the highest in the world: India ranks 134th out of the total 183 countries assessed for ease of doing business. While this is one rank higher from last year’s 135th, it is a poor ranking for a country rated as among the world’s top three destinations for Foreign Direct Investment (FDI). The World Bank report also highlights that the cost of setting up a business in India – recorded as a percentage of the economy’s per capita income – is among the highest in the world (see figure). Other research studies reveal a similar trend. While latest estimates are not available, a report publish by Citibank titled ‘India Equity Strategy’ reveals that ‘business inflation’ i.e. rising input costs like wages and salaries, raw materials, power and fuel, was as high as 35 percent between 2005 and 2009, far ahead of the headline inflation averaging at 10-11 percent during the same period. Rising costs like that of raw materials and salaries are some of the reasons to blame.
Similar trends are being witnessed in the post-2009 crisis. The total operating expenditure for more than the 1500 companies (excluding banks and financial institutions) assessed for this article, ballooned by 23 percent from 2009 to 2010. Raw material cost – the biggest cost component – increased by 25 percent. While companies recorded strong sales growth, rising costs prevented them from translating this high growth in sales into enviable profit growth. Consequently, operating and net profit growth witnessed a sharp slowdown. The other rising cost component in recent months is the ‘interest cost’. With inflation stubbornly high at around 9-10 percent over the last one year, the Reserve Bank of India (RBI) has been on a monetary tightening mode to curb demand. It has raised key interest rate (repo rate) from 4.75 percent in March 2010 to 8.25 percent. As a result, quarterly interest cost has been increasing since September 2010, from a 10 percent increase in that quarter to almost 33 percent by the quarter ending March 2011. Going forward, average interest costs are likely to see further spikes as fresh borrowings would be at higher rates.
Investors and industry officials who had expected the RBI to be nearing the end of its tightening cycle in July were caught off guard when the RBI hiked its key interest rate by another 50 basis point on 13th September 2011. Some observers criticised the RBI for acting too aggressively.
Inflationary pressures are likely to continue
India’s oil dependency has increased from 70 percent in 2004 to almost 85 percent today. With international oil prices running above the US$ 100 mark, and likely to remain so for the next one year, much of this increase in oil prices in the international market will be imported into the economy, pushing up costs further. While much of the domestic economy is shielded from the volatility in international oil prices, the government, with its current fiscal position cannot shield the economy forever. In fact, it has already hiked the domestically-administered oil prices thrice in the current calendar year. Given the known spiralling effects of domestic oil price hike, costs for corporate India, from salaries to raw materials, will rise further.
Adding to the list of concerns is the rising level of uncertainty in the economy. While some continue to assert the domestic economy’s resilience, India – with its growing importance in the world economy – cannot be isolated from the side-effects of the economic debacle unfolding in the European Union (EU) and the US. Taking all this into account, uncertainty seems to have become the new normal for India, as well.
Politicians in India like to maintain that all is well in the economy and that that the future business potential of India remains intact. For instance Finance minister Pranab Mukherjee is still hopeful that India’s economy will expand at 8.5 percent in the current fiscal, despite the current environment. His optimism is in stark contrast to the assessments of the economists quoted above who have pegged India’s growth at closer to 7 percent. Looking at his press briefings in recent months, Mr Mukherjee’s assessment of the economy is that investments have not stalled; inflation will moderate by the end of the monsoon season and drop to 6-7 percent by year end; reforms will continue and that the current fiscal deficit is manageable.
However, according to Federation of Indian Chambers of Commerce and Industry’s (FICCI) latest ‘Business Confidence Survey’ the same level of optimism is not shared by India Inc. Findings of the survey between April and September indicate that the confidence level of corporate India continues to be marred by concerns over high inflation, the slowdown in growth, continuous rise in interest rates and the incessant increase in input prices.
A majority of survey respondents also feel that the growth target for 2011-12 set by the Ministry of Finance will not be achieved. The proportion of companies citing weak demand as a constraining factor to overall business performance has also gone up to 34 percent in the present survey from the previous one released in February 2011. Rising cost continues to be a major point of concern for members of corporate India and about 85 percent of the respondents said that high raw material costs are acting as a constraining factor for them.
Given global developments, the outlook for international oil prices and commodities is not very encouraging. Hence inflationary pressures will continue for the coming months. While the interest rate hike has already had its moderating impact on growth, the RBI is likely to continue its monetary tightening policy. Rising cost will exert further pressures on corporate profits and – with sales projected to grow at 20 percent – growth in profits will be 15-20 percent. All things considered, GDP growth for the current year will be between 7-7.5 percent.