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India's shock absorbers and more...

Sep 4, 2008

In this issue:
» Are our reserves optimal?
» Small car leaves behind big problems
» Textiles in trouble
» A booster shot for the pharma sector
» Life after Reddy
» ...and more!

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Are our reserves optimal?
A recent paper released by the IMF delves on this topic and gives interesting insights on whether the brimming foreign exchange reserves of Asian economies are really 'optimal'. The foreign exchange reserves of Asian economies have quadrupled since the end of the 1997-99 financial crises. Even after excluding China, reserves had more than doubled in nominal terms by 2007. Further, IMF states that even as a percentage of GDP, there has been a significant increase in reserves, by about 10%, to 36% of GDP by 2007. However, what needs to be looked into is how far are the actual levels of reserves from the necessary and optimal levels. As a thumb rule, the IMF suggests that every economy is necessitated to maintain reserves worth atleast three months of imports. However, a majority of the Asian nations far exceed even their optimal levels.

The opportunity cost of reserves is the difference between the return on reserves and the return on an alternative investment. The opportunity cost of reserves can, therefore, be viewed as the return that the government has to pay in excess of the return on liquid foreign assets to finance the purchase of reserves. In other words, it is the net of interest on foreign reserves and domestic interest rates. While countries like China and Singapore enjoy a positive return on the forex reserves maintained by them, India and Hong Kong are actually losing some of their GDP due to the excess reserves maintained by them. Countries like ours must therefore be all the more careful in terms of inviting short term forex inflows that not only bring in excess liquidity but also increase our reserve costs.

Small car leaves behind big problems
Tata Motors' Nano plant at Singur, West Bengal is spread over 1,000 acres. The company has already invested Rs 15 bn into the project that would produce 250,000 units per annum.

However, the opposition from a section of farmers, led by Trinamool Congress, which wants a restoration of 400 acres earmarked for ancillary units has brought the project into problems. The company has suspended production due to the continued confrontation and agitation. Further, Tata Motors is preparing a detailed plan to relocate the plant.

However, for every farmer who is opposed to the plant, there are several others who are looking forward to the project and the livelihood it would generate. In fact, 80% of the 13,103 farmers took government compensation and do not support the protestors. Another section, which is not happy with the relocation, is the building materials suppliers and labourers. The company's decision the move the plant means only one thing for them - loss of jobs.

The Trinamool Congress will meet the State government at the governor's residence for talks tomorrow. We hope better sense prevails and the people of the state looking forward to job opportunities do not end up being disillusioned.

  • Also read- Tatas find the going tough

    India's shock absorbers
    It accounts for nearly one out of every three rupee that flows to national exchequer and has become India's torchbearer of growth since the early 1990s, when forces of capitalism were fully unleashed. We are talking about India's corporate sector. One more aspect that has fully shone through over the past few years is the corporate sector's great resilience at withstanding the macroeconomic shocks. A detailed account of the same can be found in CRISIL's economic review for the month for September wherein India's top rating agency has examined the impact of three macroeconomic variables viz. the cost of labour, energy costs and interest payments on the profitability of the Indian corporate sector.

    Sifting through data compiled since FY02 on both the manufacturing as well as the services sector, it has come to the conclusion that the gross profit as well as the net profit margins of both manufacturing and services that had been rising upto FY08, have come down marginally in 1QFY09, a reflection of the worldwide trend. Nevertheless, the Indian corporate sector has done a brilliant job of improving its margins till FY08 due to a combination of factors like higher productivity, reduced reliance on debt funding and greater energy intensity (efficient use of energy). It has however sounded a word of caution on the mismatch in the availability of human capital. On one hand, while skilled labour in certain service industries has been putting pressure on margins due to disproportionate rise in wages, abundant supply of unskilled labour is leading to falling share of wages in the manufacturing sector. Hence, in order to improve productivity further and enable the economy to grow faster, enhanced focus needs to be given to tackle this mismatch.

  • Also read- Corporate India's result scoreboard

    In the meanwhile...
    Failing to sustain the momentum witnessed on Tuesday, the Indian markets went through a subdued session today as concerns over Tata Motors' decision to relocate its plant from West Bengal, the repercussions thereof and the unpleasant developments on the Indo-US nuclear deal, kept investors on the sidelines. While the BSE-Sensex ended with losses of 1%, the Singapore and Taiwan markets turned out to be biggest losers with losses of nearly 2.9% and 2.6% respectively. Amongst the other Asian markets, only the Shanghai Composite managed to close flat. The European markets have opened on a negative note.

    With the fears of devastation from Hurricane Gustav tempering off, crude oil prices have started showing signs of softening. However, global auto makers continue to report lower sales and poor growth numbers. The Fed's statement that it expects economic troubles to persist into 2009 and that Mr. Bernanke and his colleagues are all but certain to leave the key interest rate at 2% (without any rate cuts) have kept the outlook on the US market weak as well.

    Textiles in trouble, in India and China
    The fastest and the second fastest growing nations in the world, India and China, have more in common besides their populous demographics. These countries are both the largest manufacturers and exporters of textiles thanks to their skilled and cheap labourers.

    Over the past decade, as the divide between the compensation levels of workers in the East and the West became wider, there was drastic migration of textile production from the US, Europe and Japan to countries such as China, India, Pakistan and Bangladesh. This was also due to the fact that some of the latter were the largest producers of cotton and silk. Currently, more than 70% of world's cotton is consumed in Asian countries, with China holding a dominant share of 42%. China and India, particularly have become the largest exporters of superior quality fabrics and made ups and are also the sourcing destinations for some of the best-known brands globally.

    However, what started as an advantage is now becoming the reason for adversity as mindless and highly leveraged capacity expansions have landed the textile manufacturers into trouble. Particularly denim, which has a vast unorganised market, has lost its pricing power with global capacity (7.7 bn yards) far outstripping its demand (6.5 bn yards) per annum. While Indian textile manufacturers are bearing the brunt of high leverage cost and shortage of power supply, the Chinese ones are losing their competitive advantage of cheapest labour cost to other emerging producers such as Bangladesh and Vietnam.

    The revered Chinese textile industry is reeling under an 18% rise in the value of its currency since 2005, as well as higher costs of labour, fuel, electricity, chemicals, cut in domestic tax rebates and pollution curbs. Labour costs in China are now double those in Indonesia, Vietnam, Pakistan and Cambodia. Many mills have been forced to switch from exports to domestic sales, which now account for 79% of production. In addition, big retailers such as Wal-Mart have developed distribution channels around the world, which has lent them enormous bargaining power, thus squeezing the margins of manufacturers. Its time for Indian textile companies to do some rethinking before things get worse for them as well.

  • Also read- Porter's analysis of textile sector

    Going nuts!
    Although coconut plantations contribute merely 0.2% of India's GDP, India has emerged as the largest producer of coconuts in the world (producing approximately 15.8 bn nuts) in recent years, pushing Indonesia and Philippines to the second and third spots respectively as per the Coconut Development Board (CDB). Good monsoon in India helped increase production while the 'tsunami effect' in the largest coconut producing countries led to fall in output there. The southern states of Kerala, Tamil Nadu and Karnataka account for 90.3% of the area and 91.1% of the coconut production in the country. Thus, it is largely only in these states that coconut oil is considered edible, while the rest of the country considers it to be only hair oil.

    The prices of edible oils have seen a sharp rise in the last six months due to increase in palm oil prices globally. Therefore in order to bring down the prices of the essential commodity, the Government was planning to offer subsidy of Rs 15 per litre on edible oil and to sell it through the public distribution system. While palm oil has been selling at much cheaper rates than coconut oil, a further subsidy would make it a bigger challenge to coconut oil producers. However, with the record production of coconut, the prices of the same are expected to cool off. Further, the CDB has urged the Centre to ensure that Vanaspati manufacturers use a certain percentage of coconut oil. This will be not only good news for consumers but also the companies present in the segment, especially Marico, which is the largest producer of the coconut oil in India. The company increased the price of its flagship brand 'Parachute' at the end of April 2008 by about 5%, in addition to the 3% price hike taken last year. This 8% increase was expected to absorb about 16% increase in copra costs witnessed by the company.

    Attrition rates mar BPOs
    Known as the back office of the world, India positions itself firmly amongst the fastest developing nations in the world due to its USP of offering high quality services at cheaper rates as compared to those in the developed nations. However, the BPO Special Sector Survey 2008 reveals that attrition rates in India's business process outsourcing (BPO) industry are about 7.8% higher than in other industries. The report states that in general, staff turnover in India is 15.7%, but in BPO companies, attrition rates are at 23.5%, followed by Communications (22%) and Retail (18%). The report explained that one of the factors of employee dissatisfaction is that the remuneration structure design is not as attractive when compared to other industries in India. This coupled with working shifts, lack of career development and monotonous tasks has led to high turnover rates.

    The BPO industry is a critical sector in the Indian economy, valued at approximately US$ 11 bn and employing over 2 m people. However, if the industry is to achieve the projected US$ 30 bn size by 2012, it will have to tackle this talent attrition issue more proactively.

  • Also read - Outlook on Indian IT sector

    A booster shot for the pharma sector
    While stocks from the pharma sector have not exactly been the apple of the investors' eye for the last three years, the growth prospects for the industry going forward are immense. Interlink, a business and management-consulting firm in the pharmaceuticals and healthcare industry, has quantified market growth of six specific growth drivers. These include middle class population, health insurance facilities, under-penetrated markets, marketing efficiencies, generics and brand development. Further, the firm expects the pharmaceutical market to grow at 19.6% every year by 2015.

    A rise in the middle class population and increased penetration in the rural markets will be the key factors to drive growth in the domestic market. Infact, many of the Indian pharma companies including the MNC ones are now increasingly focusing on extending their distribution reach to the rural markets. This will not only make medicines accessible to the poor but will also enable companies to bolster volumes. Besides this, rising incomes of rural people are likely to make them steady consumers of old products.

    Employee productivity is another factor that will drive growth. Many of the pharma companies have been restructuring their sales force and creating divisions depending upon the therapeutic areas in order to boost employee productivity and boost margins. Branding will also play an important role going forward. Those companies that have differentiated products having better efficacy will be able to brand the same and thereby enjoy higher revenues and profitability. As a result, many of the domestic pharma companies, while having a presence in the US and important markets of Europe, are gradually laying more emphasis on the emerging markets. This is because generics there can be branded enabling companies to garner higher margins. On the pricing front, growth is likely to remain stagnant given the stringent pricing policies of the government in the domestic market. Infact, even in the international markets, pricing pressure is not likely to ease anytime soon due to rising competition and changes in healthcare reforms by various governments, which are under pressure to reduce healthcare costs.

  • Also read - The link between Olympics and pharma

    Life after Reddy
    Dr. Y.V. Reddy's replacement as the governor of the central bank has kept people debating as to whether the new governor will use the same monetary tools and have similar inflation handling strategies as the incumbent one. However, what is not being highlighted is whether or not the new governor will stick to the reformist measures adopted by the governor with regard to creating a roadmap for foreign players, consolidation of the industry and making the PSU banks more efficient and accountable. Thus, it is for us to see in which direction the new captain of India's financial governance vehicle steers the wheels.

    Today's investing mantra
    "You are neither right nor wrong because people agree with you. You are right because your facts and reasoning are right." - Benjamin Graham

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