Tuesday, May 13, 2008

The challenges facing Indian corporate sector

The honeymoon with globalization is slowly fading into the mists of time. For the last decade, we had been luxuriating in the after-glow of the spectacular economic growth, burgeoning trade and foreign exchange reserves, booming consumer market, and rising stock markets. Our knowledge professionals were in great demand from Tokyo to Texas, software and biotech companies had become the trendsetters in their fields, and a new breed of outwardly oriented corporate groups, with world beating ambitions were scouting abroad for good buys. Inflation was low, fiscal deficits brought under control and our macroeconomic policies were being applauded by multi-lateral agencies for bringing about stable and broad-based economic growth.

But in the space of a few months, sensex has tumbled, rupee has appreciated, export growth has declined, economic growth is facing strains, and inflation has reared its ugly head. We are now facing the first cyclical downturn of the global business cycle after we integrated with the global economy in the nineties. Questions are now being asked, as we face a reality check. Price controls, export bans, lowering import duties, input subsidies, tax concessions and so on are now being dusted up from the cupboards and placed at the policy making tables. The whole spectrum of economic regulation is coming back with a vengeance.

It was not so long ago that commodity producers used to complain about the terms of trade weighted against them, and manufacturers were enjoying the benefits of low input costs. Now the pendulum has swung to the other extreme, and manufacturers are complaining about high input costs.

The software exporters bemoan their falling competitiveness in the face of sharply appreciating rupee, rising wages, and ending of the STPI tax concessions. Textile and other manufacturers despair that the rising rupee has taken away their markets. Real estate developers who were hitherto wallowing in the spectacular "unearned land value increments", brought about by the booming economy, are now wailing about high steel and cement prices.

The software companies, manufacturers, textile exporters, builders all have joined a bandwagon calling for government intervention to save their respective sectors from marauding external forces. Patriotism and every other tool of expedience has became an ally in mobilizing Government intervention.

For far too long, our businesses have enjoyed massive and unprecedented growth rates, with apparently little cost and effort. Little did they realize that these bloated profit margins were built on the plentifully available natural profit opportunities - cheap labour, less demanding domestic market, too few suppliers and manufacturers, pent up demand, booming equity markets, cheap land values, weak environmental and labour standards, arbitrage opportunities etc. There were inefficiencies everywhere to be exploited and too few competitors to take advantage of them. In many ways these distortions were a form of internalized hidden subsidies, whose benefits were shared among the businesses and their consumers. It was also a natural consequence of the sudden opening up of a massive economy, shackled with restrictions and regulations for decades.

This good fortune was magnified by benign external conditions - an era of robust global economic growth, a US consumption boom, global savings glut induced low interest rates, weak rupee, massive capital flows into the emerging markets. All this was superimposed on a global economy where trade in goods and services were expanding and in which individual economies were liberalizing and globalizing.

This natural process of development was similar to that experienced by many countries in their respective growth phases. The large and very obvious inefficiencies and latent profit opportunities were exploited by the eneterprising early movers, who made massive capital investments and deployed the plentiful supply of skilled human resources. Indian corporate sector, especially in knowledge based services, enjoyed explosive growths, and many of them emerged as world beaters.

This fortunate coincidence of circumstances was too good to last and had to end. The crisis in the global financial markets, rising commodity prices and the US recession have combined to bring an end to the good times. Industrial production slowed, inflation rose, software profits fell, and predictions of economic growth rate falling to 7-7.5%. The cassandras of doom started singing and the backlash started.

We cannot always have competitive export environment and cheap imports, low inflation and low interest rates, fixed exchange rate and autonomy in monetary policy. Our skilled manpower cannot enjoy ever higher wages without their employers parting with a greater share of their profits, and thereby taking a cut in their bottomlines. The farmers cannot hope to get better returns on their produce, without the consumers having to pay a higher price. The demand for consumer durables and other manufactures cannot be sustained without the manufacturers passing on a part of their profits by way of lower prices.

These trade-offs are a part and parcel of any open, competitive economy, much less a global market economy. There are no free lunches! The good comes with the bad as a package in an open economy. The cheaper rupee and low wage skilled labor force were the foundations on which the recent successes of our knowledge based and other manufacturing industries were built.

Where are the profits now going to come from? While newer markets and new products and services will always keep becoming available and continue to provide high margins, the more sustainable basis for growth has to come from productivity improvements, process upgradation, embracing latest technologies, lean inventories, and investments in Research & Development. In the fast changing global economic landscape, firms will have to be nimble enough to adapt effortlessly to the changing market preferences and expectations. More importantly, our corporates, especially in the knowledge based space, have to realize that the age of the stratospheric 30-40% growth in profits are a thing of the past. We are moving into an age of more realistic growth rates.

Mukesh Kacker has an excellent analysis of the real estate market in the ET, where he writes, "Surely, if a sector makes 65-80% profits while other sectors are happy to make 25-30%, there is something amiss. So what makes this sector and its players so stupendously efficient? Have they unveiled new, path-breaking managerial practices or just serendipitously stumbled upon the elixir of eternal profit-making at super-normal levels? "

We cannot remain immune from the global trend of rising commodity, energy and foodgrain prices. Some commentators argue that we can keep food prices under control only if we invest heavily in agriculture and attain self-sufficeincy in foodgrain production. While the presciption is surely desirable and even necessary, I am not sure we will be able to achieve our objective of controlling prices even with this.

In the final analysis, we need to make a choice. Do we deviate from the inexorable global trend and remain as a closed autarkic economy, and be satisfied with the cliched Hindu rate of economic growth? Or, do we open our economies, albeit at our pace and sequence, and share in the massive wealth creation that is happening across the world, and thereby continue to enjoy the near double-digit growth of the past decade?

If our choice is the later, then we need to be prepared to compete in an extremely competitive global economy. Every participant in this economy - firms, employees, farmers, traders, artisans, investors, borrowers, and governments - should appreciate the reality that there is a complex interplay of market forces in process that are beyond the control of any individual country or even groups of countries. Governments have an important role to play in sequencing and phasing the opening up of their economies, but also suffer from severe limitations about their powers.

In such a context, the role of the Government should be to give each participant every opportunity to compete on an equal footing in the global economy, and also provide a basic social safety net to cushion those losers and victims of this process from the adverse impact of this opening up. The later is especially important in the case of countries like India with our large numbers of poor citizens, who are ab-initio dis-enfranchised form competing in the global wealth creation machine, for various reasons like deficiencies in education, health care, and skill development trainings. The Government has an important role in insulating them from the sharp shocks and dislocations that are a consequence of such movements of the global economic cycles and also providing them with the access to all the basic opportunities necessary to compete in the global economy.

Given the events of the recent past, the Government also has a critical role to play in easing supply side constraints in agriculture and infrastructure, so as to create the enabling environment for sustaining economic growth. But there is precious little governments can do to reverse cyclical global trends, especially in an increasingly integrated global economy. Governments can only ride the business cycle, it is powerless to drive it!

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