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'Re-coupling' theory, IT and more...

Feb 15, 2008

  • After a difficult start to 2008, most emerging market investors are now beginning to unwind their 'de-coupling theory' into a 're-coupling' one. Forced out of their complacency by massive fund withdrawals from the asset class (dedicated emerging market funds had over US$ 15 bn in redemptions in January, after US$ 54 bn in inflows in 2007 - source Bloomberg), investors are finally taking a reality check. Prior to January 2008, the script was very clear; irrespective of what happens in the US, the emerging markets were economically decoupled and thus would be able to evade the US slowdown. Reams of research were written on how China was a more powerful driving force for the emerging economies than the US, and how intra-emerging economies trade was growing much faster than emerging economies' exports to the developed world. Economists also pointed out the strong domestic growth prospects and the huge infrastructure and capex cycle currently underway in India, China and select other emerging nations were sufficient to withstand the setback. With continued strong consumer and corporate confidence, the dent in the growth rates was not expected to be more than 1% to 2% of the respective GDPs.

    Their false perceptions having been proven wrong, investors are crudely reminded of the old adage that if the US sneezes, the world catches a cold. The valuation gap between the emerging nations and the US based companies have now become unfathomable resulting in investors refusing to pay 20 to 25 times trailing 12-month earnings for an Indian company, when they can buy US MNCs at cheaper valuations. Investors accept the higher growth thesis, but are not willing to pay for it beyond a point.

  • To counter the dip in profitability due to an appreciating rupee, Indian software majors are increasing the utilisation of their manpower for quicker execution of projects and adding workforce for entry-level and high-margin projects. For Infosys, the utilisation rates have gone up by 2% in 3QFY08 to 75%, while for TCS, the same have gone up from 78.2% in 2006 to 79.4%. This means that projects undertaken by the IT companies would be executed at a faster rate. Since January 2007, the rupee has appreciated against all major currencies such as the US dollar, the euro, pound sterling and the yen. The rise has been the most significant against the US dollar (about 9%). Currently, top Indian IT companies derive about 60% of their revenues from the US. IT majors are also ramping up their headcount with TCS and Infosys together adding about 58,000 employees in FY08.

  • With the deadlines for Basel II compliance and the RBI's roadmap for opening up the banking sector to foreign players getting close on the heels, players in the sector have adopted inorganic strategies to acquire scale and growth momentum. Mergers and acquisitions volume in India's banking industry increased significantly to US$ 10.5 bn dollars through 38 deals in 2007. Against this, the sector had witnessed 23 deals worth US$ 707 m in 2006. Globally, banking M&A volume has increased to US$ 369.5 bn through 853 deals (up 18% YoY) from US$ 313 bn in 858 deals in 2006. Interestingly, the average deal size has reached about US$ 692 m, up 14% from US$ 607 m in 2006.

    The current regulations allow foreign banks to acquire majority stake in only weak domestic banks identified by the RBI. Contrasting this, globally, banks have witnessed consolidation by way of mega amalgamation deals like the one struck between Standard Chartered Bank and ANZ Grindlays or the Citibank-Travelers merger. Also, many foreign banks (including Citi, HSBC and Standard Chartered) have invested billions in picking up large stakes in Chinese banks and insurance companies. Thus, it could be quite a different story after April 2009, when the foreign banks have greater freedom for inorganic growth in the country. What they have done in Singapore, Hong Kong, China and elsewhere in recent years is rather indicative of the same. Their handicap of limited penetration and concentration in a niche customer segment could also be overcome with greater liberty from the RBI.

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