Tuesday, August 30, 2011

We don't need no education

Come July and on most university campuses across India, the fear is as palpable as the excitement. For weeks altogether, students-to-be rush from college to college desperately scanning admission lists for their names. Never before has India offered a shot at a better life after graduation. But again, never has getting a seat been so difficult. And for those who do land a spot, ironically the troubles are just beginning.

Though by all standards, the long-term prospects of the Indian economy and job markets are promising, the university system, which has been struggling for years, has recently hit a full-fledged crisis. Our post-secondary schools today only have enough seats for about 7% of college-age citizens (half the Asian average) and face a dire shortage of faculty. According to a recent regulatory report, 25% of teaching positions nationwide are vacant, and 57% of professors lack either a Master’s or a Ph.D. degree. Curriculums are outdated; infrastructure is crumbling even at the reputed Indian Institutes of Technology, where once cutting-edge laboratories are now dinosaurs. And incompetent (or, as many allege, corrupt) regulators have let fly-by-night colleges run riot while keeping out elite foreign universities keen to enter a highly attractive education market (the size of which according to bullish estimates will be about $70 billion by 2013 and $115 billion by 2018).

In the same breath as America fighting its own economic battles with rising unemployment, Europe grappling with the 50:50:50 paradigm which suggests that 50% of the population in Europe would be 50 years or older by 2050, and Japan and the East coming to terms with the Silver Century, much mention is made of India’s “demographic dividend.” With a median age of 25 years, and about 35% of the population under the age of 15, it is estimated that around 25% of the global workforce will be Indian by 2030. What this means is that the quality of education that young Indians receive today will impact us all in the near future.

For this, the Indian polity has committed to significantly enhancing outlays for the education sector and has even come up with some radical, interesting proposals for education reform. Indeed, there has been spirited debate in the country on the measures needed to be taken but the government is yet to walk the talk on key policy decisions. There is, for instance, considerable opposition to allowing foreign investment in higher education.
Unsurprisingly, the government has responded by commissioning studies and setting up a maze (haze?) of committees to decide the best course of action. These are but convenient tools to delay any sort of commitment and to buy time. And unfortunately, an arcane regulatory framework and a fractured political class only help matters in this case. It would be difficult to overstate how important it is for India to act swiftly in order to reap the full benefits of its demographic slant. The scale of education reform required in India is massive and, yes, sustainable change will take time as well as a broad-based consensus. But to get the ball rolling, there are a number of short-term steps that the government can begin immediately:
Commit to spending more on QUALITY education: Way back in 1968, the Kothari Commission recommended that India spends 6% of its GDP on education; but in the 43 years since, India’s total educational outlays have never exceeded 4.3% of its GDP in any given year! Setting aside more funds for education is a critical first step that will demonstrate the government’s commitment to educational reform. But hamstrung by India’s unwieldy bureaucracy and by ideological opponents, we may manage to dramatically expand the size of our higher education system without addressing many of its underlying problems. For example, the Prime Minister has promised to open 72 new post-secondary schools over the next five years, including eight new Indian Institutes of Technology, seven new Indian Institutes of Management, five new Indian Institutes of Science Education and Research and 20 new Indian Institutes of Information Technology. To fund them, the government’s higher education spending will be boosted nine-fold, to $20 billion annually. But these changes may wind up addressing India’s quantity problem without affecting its quality crisis. About 75% of India’s 400,000 annual technology grads and 90% of its 2.5 million general college grads are unable to find work – this is not due to a lack of jobs, it is due to a lack of skills. While the employment issue may have been addressed, the employability problem also needs a solution. Loosening the purse strings will undoubtedly help improve infrastructure and expand access for students, but it will take more than money to solve the faculty shortage, revamp outdated courses, encourage innovation and crack down on diploma mills. Rapid expansion could exacerbate these problems.
Fix PRIMARY education first: There are two major tasks here: raising enrollment to 100% in urban as well as rural areas; and then minimizing drop-outs. Both need to work in tandem to be meaningful. In Mumbai, for instance, enrollment rates are very high – above 95% — but only a fraction of these students actually finish school due to absurdly high drop-out rates. In addition, eliminating gender gaps at this early stage must be a priority. In rural areas, thousands of young girls do not attend school because there are no separate toilets for them – disgraceful, but true nevertheless. Other girls do not attend because the walk to school – often in a neighboring village – is unsafe. Yes, part of the answer is building more schools with better infrastructure. Here it is encouraging to see the number of NGOs that are rushing to help and address this void but most efforts are still confined to urban areas and large metropolitan cities – there are quite literally many more miles to go.
Prioritize SCHOOLING over higher education: In the first half of the 1950s, Jawaharlal Nehru, India’s first prime minister, laid the foundations of India’s higher education platform to compete technologically in the Cold War era. Institutions such as the Indian Institutes of Technology were expanded and the country focused on producing more engineers and scientists. But the expansion of higher education was accompanied by a neglect of school education. This elitist system of education continues even today, with new engineering colleges mushrooming every day. Schools are often viewed as little more than a means to gain access to a solid engineering program. This remarkable trend has had far-reaching effects. What we need to realize is that it is impossible to produce high-quality graduates who are capable of competing globally, not just in the Indian economy, without sturdy foundations at school. We need a paradigm shift in how we view education in the first place, and focus on building it from the bottom up – not the other way round.
Begin to AUDIT regulations:  In 2005, a dream team of academics, planners and business executives were appointed to the National Knowledge Commission with a mandate to redesign India’s entire education infrastructure by this October. This commission published a comprehensive set of recommendations in January 2007, focusing on “expansion, excellence and inclusion.” Among its proposals, the commission advocated not only expanding the state university system but also diversifying sources of financing to include private participation, philanthropic contributions and industry links. It also suggested introducing frequent curricular revisions, moving away from the present system of standardized university-wide exams in favor of internal assessments of students by their professors, and setting up an independent regulatory authority. While the government has allocated a huge sum for building more universities and improving inclusiveness by expanding the quota system, it has yet to make progress on the crucial regulatory elements of the commission’s plan. That could prove disastrous. At present, India has no less than 16 different supervisory bodies for higher education, few of which are independent and all (sic) of which are of questionable efficacy. Mostly due to bureaucratic inertia, they’ve so far blocked attempts to modernize curriculums and methods of evaluation. They haven’t done a good job at policing, either. Shoddy for-profit colleges have proliferated even as internationally respected foreign providers have been barred from opening up branch campuses and have struggled to get their joint programs certified. The All India Council of Technical Education, for example, has approved thousands of substandard private engineering colleges – many of them founded by profit-minded politicians. But it has refused to recognize the Indian School of Business. And political wrangling at the parliamentary level has stymied legislation to allow foreign universities to set up campuses, even though Cornell, Columbia, and Stanford universities have all sent high-ranking delegations to the country on exploratory missions.

Perhaps the most important piece of the Indian education puzzle is a change in mindset. This, finally, will be the crucial lever in reforming the system and creating sustainable change. How do we view education? What should we expect from it – at school and, later, at university? These are questions which are inevitably fuzzy but which will require serious thought and introspection – not just among ordinary citizens, but among politicians and bureaucrats as well.

Make no mistake – we are in the midst of a severe education crisis. And it is for this reason that we need to be talking about the subject more and encouraging debate. Because let us be sure that, without a significant change in mindset, education reform is a non-starter and the “demographic dividend” will just remain a fancy term confined to political journals. And we need to do it before our mantra is: “We don’t need no education!”

Saturday, August 6, 2011

America's (alphabet) soup

All that the Finance Minister of the world’s tenth largest economy had to say after the downgrading of the US sovereign credit rating to AA+ by Standard & Poors was: “The situation is grave – we need to analyze”. I could have done better.

S&P cut the US credit rating for the first time in history, from the first-class AAA to one notch below at AA+. The rating’s agency said that the US politicians were increasingly unable to handle the country’s huge fiscal deficit and debt load. Going from bad to worse, it added a negative outlook, saying there was a chance the rating could be downgraded further within two years if progress is not made in cutting the huge government budget gap. S&P said the “political brinksmanship” of recent months shows that governance in the country is becoming “less stable, less effective, and less predictable,” raising the risks that one day it might not honour its debt. The move - which came late Friday after US markets closed, allowing the world to digest the news over the weekend - was the first time the US was downgraded since it received an AAA rating from Moody’s in 1917. Predictably, the White House called S&P’s analysis of the economy deeply flawed and politically-based. A Treasury spokesperson alleged that there was a “two trillion dollar error”, arguing that S&P admittedly used the wrong baseline and erred on spending plans and debt projections.

S&P had first warned Washington of a possible downgrade in April. Then in July, during the protracted political standoff over raising the government’s debt ceiling, S&P placed the United States on credit watch and warned of a possible cut within 90 days. The White House, Democratic and Republican lawmakers battled for months until the country was on the precipice of default last week before they finally agreed to a deal to raise borrowing limits and slash the deficit. The fiscal consolidation plan finally agreed calls for $US917 billion in cuts over 10 years, but also mandates an as-yet unnamed Congressional panel to come up with another $US1.5 trillion in cuts by the end of the year. That fell short of what S&P has been saying would merit retaining the AAA rating: $4 trillion in deficit reduction over 10 years that includes both cuts and revenue increases, which Republicans refused to accept.

Let’s put these numbers in perspective – using the present $14.772 trillion US economy as the baseline, an average annual expenditure cut of $91.7 billion is about 0.6% of the total size of the economy. With the projected GDP growth as 2.8% and inflation at 2.1%, in my “simple” model this ipso facto means a stagnant US economy (with all else being constant). Of course, I am willing to reconsider my figures once the Congressional panel figures out what to do for its $1.5 trillion in cuts.

And for those who wish to trash my “simple” model, let me digress a bit. Milton Friedman defended models with untrue premises by suggesting that it does not matter how unrealistic the assumptions of a model are, as long as those models predict accurately. An analogy might be Newton’s laws of motion which depend on false assumptions about how the world works compared to quantum mechanics. Nonetheless Newton's laws of motion are practically useful for some applications, especially since those are much easier to intuitively understand and use rather than quantum mechanics. What matters, or so argues Milton Friedman, is the truth of the predictions produced by the model more than whether the premises built into the model are true.

Now what effect would this 0.6% spending cut have on India’s trade figures with the US?

The final figures on Indo-US trade in merchandise goods for 2010, which were released recently, are both encouraging and sobering at the same time. But, first, the hard, cold statistics: the volume of trade in goods between the world’s richest country and the 10th largest economy was worth $48.8 billion last year; US exports to India accounted for $19.2 billion and its imports from the country totaled $29.5 billion. Exports to the United States comprised roughly 14 percent of India’s exports last year, and its imports from the United States were just under 7 percent of its overall imports. Significant numbers, but yet not large enough for India to press the panic button.

Now whilst the much anticipated $50 billion milestone was missed by a whisker, 2010 turned out to be the best year for bilateral trade in goods. This $48.8 billion was a 30 percent increase over the previous year, when for the first time in many years the bilateral trade declined mainly because of a nearly $5 billion dip in US imports from India, in the aftermath of the financial meltdown. The good news is that Indo-US commerce is more or less a two-way trade, with the balance of trade – which is in favor of India – a manageable $10.3 billion.

Trade with India accounted for 1.5 percent of all US trade in goods, which totaled $3.2 trillion. In comparison, its trade with China accounted for 14.3 percent of America’s overall trade in goods. In November last year alone, the United States and China traded in goods worth $45 billion, close to a whole year’s worth of India-US trade. Last year, India was America’s 12th largest goods trading partner, sandwiched between the Netherlands at 11th and Singapore at 13th, both much smaller economies. The Dutch GDP is approximately half the size of India’s and Singapore’s less than a sixth. I suspect the Dutch and the Singaporeans should be worried more than the Indians.

Trade in services with India (both exports and imports) totaled $22.3 billion in 2009 (latest data available for services trade). Services exports were $9.9 billion, with imports of $12.4 billion. The US services trade deficit with India was $2.4 billion in 2009, again manageable.

The sobering aspect of last year’s trade data is that, while the Indo-US merchandise trade is on the upswing, the two countries have not been able to put it on a fast track. Though India recognizes the importance of the US market, its size and scope for the expansion of exports, it is struggling to meet even the modest goal of increasing its market share to 2 percent. Ironically (and possibly perversely) this is good news today.

Some other numbers: India received the maximum FDI from Mauritius, Singapore, and the US pegged at $56.31 billion, $13.25 billion and $ 9.71 billion, respectively, during April 2000-May 2011. In the last year, about 36 per cent of FDI came via Mauritius – mainly because most of the investors want to take advantage of the double taxation avoidance agreement between Mauritius and India and Mauritius-based investors do not have to pay capital gains tax in India. Singapore was the second largest contributor of FDI after Mauritius, accounting for nearly 9 per cent of the investment during the same period. Japan came in third with 8.3 per cent, followed by the Netherlands and the USA with 6.1 per cent each, and Cyprus with 4.5 per cent. So what are we looking at for the US? Just about $1.1 billion of the total FDI inflows of about $27 billion.

Yes indeed, I agree one can never overestimate the role of US consumers in underwriting Asia’s rise as a global, should I say, production house. And oh, I also do know about globalization and free markets and financial debris cascading across borders et al, but I daresay tongue-in-cheek, India needs to focus on S&P’s rating for Mauritius and Singapore, and not lose too much sleep over America’s (alphabet) soup! That’s for the Chinese.

Any thoughts Mr. Finance Minister?                                              

Friday, July 29, 2011

Could I have the bill please?

What ails India Incorporated? In the 12 months of the last financial year, overseas investments by Indian firms touched a staggering $44 billion, an unprecedented 150% rise from $18 billion the year before. At the same time, inward direct investment from foreign firms was $27 billion, 25% less than that of the previous year. Indeed, it is strange for the world’s second-fastest growing economy to have disparately higher capital outflows vis-à-vis inflows. And it becomes even stranger when balanced with inward remittances of $55 billion that the 27 million Indian diaspora made last year – the highest globally.

Not strange so far? According to a report released by Global Financial Integrity (GFI) late last year, it is estimated that because of tax evasion, crime, bribery, kickbacks, and corruption, India has lost gross assets worth US $462 billion (adjusted) during 1948-2008, at the phenomenal average rate of $19 billion per year from 2004-2008. About 68% of this aggregate illicit capital loss occurred after India’s economic reforms in 1991, indicating that deregulation and trade liberalization actually contributed to/accelerated the transfer of illicit money abroad. And quite evidently, High Net-Worth Individuals (HNWIs) and private companies were found to be the primary drivers of illicit flows out of India’s private sector. India’s underground economy is also a significant driver of illicit financial flows. Without meaning to be an alarmist (or a pessimist), substantial as these outflows are, they are likely to be understated given that economic models cannot capture all channels through which illicit capital can leave the country.

So again – what ails India Incorporated? Faster rates of economic growth since economic reform started in 1991 led to a deterioration of income distribution which led to more illicit flows from the country. It was the unleashing of an economic barrage, pun intended, without the sluice of corporate governance. Moreover, this poor state of governance is more than aptly reflected in a growing underground economy which in turn has fueled more transfers of illicit capital from India, stagnating levels of poverty and an ever widening gap between India’s rich and poor. While in absolute percentages (and not numbers), overall poverty may have declined from 35.8% to 27.5% for the country during 1991–2008 , income inequity measured in terms of the Gini coefficient actually increased – from 0.303 in 1991 to 0.368 in 2008 (the last year for which statistics are available).
Despite this (or because of this), indeed the rate of return on investment in India is higher than abroad, so obviously this increasing global footprint is more than just “routine expansion of business”.  Over the last year, Mukesh Ambani’s Reliance Industries invested $5 billion in Africa and the US, and now has plans to double its investment abroad in four years. Anil Ambani’s Reliance-ADAG has invested $3 billion globally in 2011, and also wants to double that to $7 billion by 2015. Ratan Tata (the Tata group has 65% revenues generated overseas) has invested more than $1 billion internationally this year. The Essar Group expects to invest $6 billion overseas by 2015. Sunil Mittal’s Bharti Airtel spent $8.2 billion acquiring Middle East-based telecom firm Zain’s Africa operations last year. Could it be that earlier, investing abroad was a risk diversification but the current impasse in governance makes it a necessary evil (sic) for companies to look elsewhere?
Yes I know, I haven’t answered the question at the crux yet, what ails India Incorporated. For that let’s glance at an “abbreviated to-do” list for the netas and babus.

Land acquisition and rehabilitation and resettlement bill: As a much-needed successor to the Land Acquisition Act of 1894, this Bill will ensure that the private sector directly acquires as much as 70% of total targeted land directly from farmers. Our farmers will get a better price, and the rehabilitation and resettlement provisions might even address opposition from those who resist selling out.
Mines (amendment) bill: With the insertion of a clause that will make it mandatory for mining firms to share profits and royalties with affected tribals, the Bill can remove the most significant hurdle to an expansion of mining activity. After much debate and an inordinate delay, it has been cleared by a GoM and awaits Cabinet approval.
Banking laws (amendment) bill: Introduced in Parliament in 2005, this Bill proposes to open up India’s relatively closed banking sector. It will give shareholders in banks the right to vote in proportion with their shareholding. Currently, shareholders have a maximum of 1% vote in a public sector bank and 10% in a private sector bank irrespective of actual equity holding.
Insurance laws (amendment) bill: On the table in Parliament since 2008, the Bill will allow up to 49% (up from 26%) FDI in domestic insurance companies.

Pension fund and development regulatory authority bill: First introduced in Parliament in 2005, the Bill will allow up to 26% FDI in pensions. It will also grant statutory status to the independent regulator.
Companies bill: A much needed successor to the Companies Act 1956, this will permit shareholders to file class action suits against fraudulent promoters. This amendment in company law is pending since the Satyam scandal broke out more than two years ago.

Direct taxes code bill: By lowering corporate and income tax rates, this should increase compliance and raise revenue for the Government. Most importantly, it will do away with the Government cashing in on its powers to grant exemption. But sadly (and predictably), the Government has failed to achieve consensus among stakeholders.
Constitution (115th amendment) bill (GST bill): It will overhaul India’s indirect tax system which in its current form imposes multiple, cascading taxes on the same good or service. Like the direct taxes code, it will abolish exemptions and lower rates, hopefully increasing compliance and revenue for Government. Again, the Government has failed to persuade all states.
Of course, there are many others in a long laundry list (the latest of which is the Lokpal conundrum), but I guess our netas and babus don’t want to wash dirty linen in public! This list is not a panacea, perhaps just Band-Aid on what appears to be a festering wound. Maybe the Government is “damned if it does, and damned if it doesn’t”. But someone needs to yell from the floor of the hallowed (hollowed?) House. Else I will. “Could I have the bill please?”

Monday, July 25, 2011

And the giants come marching in

The oil and gas industry is still recovering from the greatest global economic shock in more than 75 years. As we begin 2011, economic uncertainty remains, but a mood of cautious optimism has emerged. The current surge in commodity prices suggests that an average oil price of $90 or more per barrel over the year is seen as increasingly achievable. As a result, oil and gas exploration companies are beginning to look again at new frontiers of exploration and unconventional fuel resources in a bid to regain momentum. So where does India fit into this trend?
India is and will remain energy hungry. The country is currently the fifth largest energy consumer in the world and given its targeted GDP growth, fuel needs are likely to expand at a significant rate – up to 40% over the next decade according to some estimates. India’s per capita consumption of energy and electricity is well below that of industrialized nations and the world average, meaning that there is scope for rapid expansion. These facts perhaps explain two distinct initiatives from the Indian government. The first is an ongoing pressure for India to compete in the strategic race for global energy resources with other developing economies such as China and Brazil; late last year India’s Ministry for Petroleum and Natural Gas again publicly issued a call for Indian companies to flex their muscles overseas and contribute to the country’s energy security.
The second initiative, which is the focus of this article, is a clear requirement to maximize India’s own domestic natural resources. India already imports over 70 per cent of its crude oil requirements and around 15 per cent of its natural gas. It is with this context in mind that the Indian government launched its New Exploration Licensing Policy (NELP) in 1999, part of its Hydrocarbon Vision 2025 master plan, with a related goal of attracting $40 billion in oil and gas investment by 2012.
With some recent major discoveries hitting the headlines, a range of tax and investment incentives announced by the Indian government, and an estimated 22% of India’s prospective territory remaining so far unexplored, India seems on paper at least to be an attractive market. Yet the most recent sale of exploration rights (NELP 8) drew a less than overwhelming response from foreign bidders, and the ninth round, launched in October last year, is unlikely to fare much better. And although a number of European companies such as BG Group, BP and ENI have established businesses in India, other majors – particularly from the US – have so far stayed away. What are the risks that they perceive which are currently holding them back from exploring India as a new frontier?

Domestic production on the rise
The two major discoveries in India in recent times, namely Reliance Industries’ natural gas find in the offshore Krishna Godavari (KG) fields, and Cairn India’s heavy crude find in the deserts of Rajasthan, have provided a major boost to the domestic oil and gas sector in India. Indeed India’s fuel import bill in 2009-10 was around US$82 billion – significantly lower than expected due to the commencement of production from these two projects. The timing was also fortuitous given that several existing oil and gas fields experienced a decline in production in the same period as they near maturity.
Increased levels of exploration activity have also meant good business for oilfield services companies. Providers of seismic surveys, drilling rigs and ships, well-logging and so on have witnessed robust growth and this is likely to continue, particularly given the focus on deep-water blocks and frontier basins. Nonetheless, many of these blocks come with significant ‘below ground’ risks, a fact tacitly acknowledged by the Petroleum & Natural Gas ministry in the terms offered in the , and the major players are likely to stay away until reserves are proven and production has started.
Policy uncertainty
In terms of ‘above ground’ risks, the extent of State involvement and uncertainties in the direction of energy policy are important considerations. Foreign bidders will no doubt have concerns at the levels of participation in the rounds by State-owned companies such as the Oil & Natural Gas Corporation (ONGC) and Oil India, both of whom receive subsidies from the Indian government and may be perceived as being at an unfair advantage. The extent to which ONGC dominates the Indian oil & gas landscape should not be underestimated, with many existing operators and services companies citing the organization’s cumbersome bureaucracy and slow decision-making as a major negative factor of operating in the market. Its influence as an instrument of government policy is also clear, particularly in its recent moves to block London-listed Vedanta Resources from buying Cairn India.
Nowhere is this issue more clearly illustrated than in the dispute between the brothers Mukesh and Anil Ambani, who control Reliance Industries and Reliance Natural Resources respectively, following an acrimonious split of the family empire. The long dispute centers on the price of natural gas that Mukesh’s RIL had agreed to sell in 2005 to RNR. In 2007, the Indian government decreed that the price should be increased by some 80% in line with the Administered Pricing Mechanism (APM), the government’s price-setting tool for natural gas, a decision that was eventually upheld by the Supreme Court in 2010. The idea that the government has the power to set prices for natural resources is naturally off-putting for oil and gas companies. The ruling is also likely to worry investors across the board in that it appears to undermine the sanctity of contracts in general.
Furthermore, and in line with many other developing countries facing a sharp decline in tax revenues due to the economic slowdown, India is likely to target oil and gas companies with increased tax rates and other fiscal measures. The latest round, for example, will be governed by the proposed new Indian Direct Tax Code which has suggested that business income be computed for each E&P block separately. This could result in the block-wise ring-fencing of expenses and as a result companies being obliged to pay tax on the profits of each block, without the ability to offset against losses in other blocks.

Infrastructure and technology constraints
As in many other parts of the world, hydrocarbon reserves are not always found in the easiest of operating environments and India with its concentrations in remote areas in the north-east of the country and offshore, sometimes in deep-water blocks, is no exception. Ensuring sufficient access (with supporting infrastructure) to oil and gas reserves at a reasonable cost will remain a significant challenge. Infrastructure remains a key business limitation in India for many industries, in terms of transport and communication networks, but particularly for the oil and gas industry. The expansion of the natural gas industry in India will inevitably be constrained by India’s relative lack of pipeline network, especially in the south and east of the country.
For onshore blocks, dealing with land acquisition and the kind of communal issues that have recently dogged other natural resources companies such as Vedanta and POSCO in the east of India, will also require careful thought and long-term planning. For some foreign companies, this is reason enough to leave operatorship to a local partner or to avoid the onshore market altogether.
The shortage of human capital and availability of equipment affecting the entire oil and gas industry also applies in India. Indian companies themselves are starved of technology, particularly in the unconventional technologies space, and this will continue to drive cross-border deals by Indian players looking to buy in that expertise from overseas. The most notable deal last year in this field was RIL’s purchase of a stake in Atlas Energy’s Marcellus project, which gives them exposure to the North American market as well as access to shale gas technology.
An unconventional future
Despite the poor showing in recent rounds, the government is pinning its hopes on unconventional fuel resources as a bright spot on the horizon. India is known to hold huge potential shale gas reserves in the east of the country, as well as in the north-east and offshore, and a number of pilot shale gas projects have already begun. A framework for the new shale gas policy is currently under preparation by the Indian upstream regulator, with a first round of auctions due by the end of 2011.
At the same time government policies are becoming noticeably more investor-friendly. Recent moves towards more transparency in gas pricing have led some experts to predict that the Administered Pricing Mechanism will be dismantled in the near future. Caps on visas for expatriate employees in the oil and gas industry have also been removed after lobbying by the industry in the past 12 months. The sum of which may prove enough to tempt the major foreign players to India’s new gas frontier after all - so will the giants come marching in?
(Author’s note: This article was published in “Asia-Pacific Risk Watch” – the quarterly newsletter of Control Risks Pvt Ltd in January 2011; subsequent to my writing this (and not because of!), the Reliance-BP deal was cleared on 21st July).

Sunday, July 24, 2011

Opening of the shutters

For a country where the GDP is consumption driven, ironically only 4% of India’s shops occupy a space of more than 500 square feet. In grocery stores, young boys perch precariously on ladders to fetch jars from remote crannies. In bookshops, browsers brush bottoms as they jostle and squeeze past each other in crowded aisles. Posh boutiques are reached up narrow, winding staircases. And people hand-pick their fresh fruit and vegetables from hand-cart hawkers and pavement vendors.

Most Indian shopping still takes place in millions of independent grocery shops, or kirana (corner) stores, manned by the owner and perhaps an assistant or two which belong to what is known, quite accurately (and perhaps euphemistically), as the “unorganized” sector; small, family-owned shops surviving on unpaid labor and, often, free land for a small stall. “Organized” retail, such as hypermarkets, supermarkets and department stores, accounts for only 4-5% of the country’s $322 billion market.

India is again pussyfooting with the idea of opening the shutters of its retail market to foreigners. If it does, then plenty of global retailers will be lining up. It is rather easy to see the magnetism of the Indian market. Rapid economic growth in the past decade plus has increased the disposable income of the middle class. It is this urban consumer that the global chains are eyeing. With the Committee of Secretaries giving its nod for 51% FDI in multi-brand retail a few days back, the nodal Department of Industrial Policy and Promotion should be preparing a Cabinet proposal soon. But the deal is far from done.

With nary a doubt, opening up the retail space to foreign investment would help in overhauling the country’s antiquated supply chain. Shortcomings in the distribution systems have created huge differences between wholesale and retail prices. Inefficiencies are common. The government estimates that 40% of the fruit and vegetable production in country is lost due to inadequate storage and transport infrastructure. Waste of this magnitude, troubling in the best of times, is appalling as the country battles double-digit inflation. Yet, despite a consensus among policymakers that opening up of the retail sector to foreign investment has benefits both in the near and long term, the government has been comatose in a decision.

The reason behind this hesitation is the political clout of existing traders. The government’s move is fraught with political risk because retail deregulation is a divisive issue in India. An estimated 35m people or 7.3% of India’s workforce are employed in the unorganized retail sector. With domestic inflation rising, there remain widespread fears that the entry of global retail giants could hurt these kirana stores. The traders have been very vocal about their opposition to any form of organized retail and have regularly conducted mass protests and ransacked supermarkets to make their sentiments known. They fear that the arrival of big-box retailers will price the corner grocery stores out of business.

There is some truth to this. When an organized retailer opens nearby, small retailers typically lose about 23% of their sales in the first year. But after five years they are more or less back to where they started. This was also the case in Thailand, which opened up to foreign retailers after the Asian crisis in 1997. In the short term, according to a report, “the entry of foreign players in a recessionary economy adversely affected all segments—wholesalers, manufacturers and domestic retailers.” However, there were also benefits. The foreign invasion led to the development of organized retailing (now 20% of the Thai market); producers had to become more efficient; foreign retailers started buying more Thai goods.

Despite more pros than cons, will the government be willing to rock its already floundering political boat even more by antagonizing the trader’s cartel?  Or with this being India, will the rules be well shrouded in uneasy compromises? Will the shutters open or the Pandora’s Box?

I don’t think we’ll open the shutters – at least not just yet.