December 30, 2007

Dun & Bradstreet India’s outlook for the year 2008

Subprime crisis may affect capital inflows into India

The over-riding theme for the Indian economy in 2007 seems to have been the consolidation of the idea of globalisation. Indian economic players seem to have moved from the notion of just fitting-in to the world economy towards the idea of making strategic in-roads into it.

An obvious metric of this idea is the size of Mergers & Acquisitions (M&A) deals struck during the year. 2007 started with the finalisation of the Tata – Corus deal, and till August 2007, the economy had already witnessed 460 M&A, 267 PE deals totaling to 727 deals as compared to 782 in the entire year 2006. These deals comprise of inbound, outbound and domestic M&As and private equity deals.

Another example has been the march of the BSE Sensex, which has risen almost 38% since the start of the year to December, led in a large way by net FII inflows, which stood at approximately Rs 313 bn during the year 2007. These quantum of inflows have meant that India had to grapple with the issues of an open economy, and the management of the monetary policy involved the fine balancing of the exchange rate, interest rates and inflation. Given this, the idea of de-coupling seems to be debatable, as this aggressive integration with the world economy is likely to play out in the coming year.

Estimates of World economic growth for 2008 by the World Bank stand at 3.6%, which is slightly higher than 3.3% expected in 2007. It is expected that growth in Europe and Japan will mitigate any slow down of growth in the US economy, which itself is expected to eliminate the drag from the housing sector, thus leading to a revival in investments. Therefore, given these estimates, it would seem that any risks to India’s economy from global growth fortunes are likely to be minimal. This is as much owing to the reasonably positive prospects, as well as to the fundamental domestic resilience of the Indian economy. 

D&B’s expectation for India’s GDP growth rate for FY09 stands between 8.7-8.8%, following expectations of growth of 8.7% for FY08. We expect that industry will grow by 9.8% in FY09 and services by close to 10% in FY09. We expect to see a continuation in investment buoyancy; D&B expects Investment (as a % of GDP) to be close to 37% in FY09, financed by Savings of approximately 35.5% of GDP in FY09.

On the exports front, certain export-oriented sectors such as Textiles & Garments have felt the heat of the appreciating rupee in the year gone past. We expect that by the end of 2008, we would witness only a marginal appreciation of the Rupee versus the Dollar and would settle around 39.2 – 39.4. Given this, we expect that most sectors would have factored in the stronger Rupee, and exports will grow by close to 20% (in dollar terms) in FY09; imports will be marginally higher at around 25%.

On the inflation front, 2007 brought about monetary tightening early in the year to bring inflation under control. The policy seems to have succeeded in achieving its goal, with inflation (WPI) averaging at about 3% over Oct – Nov 2007. However, given that much of the high cost of crude oil has not been passed through, we expect that inflation will touch 5% by March 2008. At present, money supply continues to be well above the intended rate; therefore, we expect to see a CRR hike in Jan or Apr 2008.

However, we expect that money supply will come down to 18% by end of 2008, as interest rates impact credit lending. Capital inflows, the other much discussed source of funds into the Indian economy in 2007, had intensified the issues of regulating money supply in the economy, particularly given the Rupee-Export sensitivity. The policy makers’ ability to continue to absorb these flows is limited due to the possible fiscal impacts.

We believe that policy efforts towards liberalising capital outflows may gain some momentum in the coming year. On the other hand, it is also possible that capital inflows into India in 2008 may be affected due to the subprime crisis.

Sectoral Outlook:

In terms of sector specific expectations, with regard to the IT industry, Services, which account for 65% of the industry earnings, is expected to drive the growth. Rapid growth in ITES is expected, which in all probability would lure further MNC investments in India. Focus on Tier II and III cities is likely to grow, and with the advent of the Internet and the IT usage being increasingly pervasive, IT spending across verticals is bound to be rampant. The IT industry will enhance its focus on the domestic market, as much as for reducing export market vulnerabilities as also for exploiting the opportunities it offers.

The budget for FY09 is expected to have a special bearing on the Indian IT Industry, given the expiry of the STP Scheme due in March 09. The industry expectations are that the tenure of the Scheme should be enhanced so that the firms continue to enjoy the benefits of the Scheme.  The industry is also looking forward to the repeal of the Fringe Benefit Tax on ESOPs issued by companies. Given the strong case made by the industry as to the use of ESOPs as a retention mechanism in a scenario of high attrition, it is possible that it finds mention in the Budget.

With regard to the Textiles & Garments industry, we expect that more garment exporters would shift their focus towards domestic retail to tap the growing domestic market. As such, large investments are likely to take place in garment retailing and branding initiatives of companies are also expected to gain momentum. The industry could see greater consolidation in the next few years, not only amongst the large players but also amongst the small and mid-sized players in the industry as it has turned out to be a fast track mode for expanding and benefiting from the rising domestic growth opportunities.

In case of automobile industry, the healthy double digit growth of scooters and mopeds is expected to arrest the decline in demand for two-wheelers to some extent and we expect the sales to remain flat or marginally negative. While the passenger vehicle segment, driven by strong sales of passenger car, is expected to sustain its healthy double-digit growth levels during FY08, demand for commercial vehicles is expected to grow at a low single digit levels, driven by bus and truck segments. In the forthcoming budget, most of the passenger car manufacturers are seeking reduction in excise duty to 16% from current 24% on all categories of vehicles.

Although some international player in the two wheeler segment are looking for import duty concession to avail of cheaper imports, any change in tariff structure by the Ministry of Commerce  in the forthcoming budget is unlikely as per media sources. The overall prospects for the passenger vehicles industry look bright, with domestic sales expected to grow by a robust 12.5% in FY09. Wealso expect 11% growth in domestic sales of MUVs in FY09.

In the forthcoming budget the auto-component industry seeks direct tax breaks for exports and investments above the set threshold level of Rs 500 mn, reduction in excise duty on components for small cars and two-wheelers to 8% (from 16%), correction of the inverted duty structure arising from the FTA with Thailand and promotion of investment in the sector by introducing an incentive structure similar to that prevalent in some competing countries like China and Thailand. 

We expect the auto component industry to continue to witness growing exposure in the area of acquisitions and joint ventures both in India and abroad. India will stand to gain as low cost manufacturing destination and would attract foreign companies for alliances with Indian players. Infusion of funds and technical know-how from the international players will increase the industry’s competitiveness. Revenue through exports and diversification of product range is expected to the focus for the coming year.

With the economy being on a high growth path, the chemical industry is likely to experience higher rates of growth with demand for basic organic chemicals like acetic acid and downstream petrochemicals expected to grow at around 7%. The reduction or elimination of tariffs on imports of more than 500 products from Singapore w.e.f. December 1, 2007 would lead to an increase in imports of chemicals. There have been reductions in basic customs duty for organic chemicals, inorganic chemicals, plastics and plastic articles, and pigments and preparations in the past two budgets. A long standing demand of various chemical industry associations has been the reduction in excise duties for various chemicals and catalysts. An announcement towards this for certain chemicals could be expected in the budget 2008-09.

The Indian drugs and pharmaceutical industry is expected to witness an impressive growth on account of increase in domestic demand (owing to an increase in population) and increasing size of generics market worldwide (due to expiration of some major product patents in the next few years). The low-cost of manufacturing and clinical trials, enhances the potential of Indian pharma industry to attract outsourcing opportunities. However, the major concern revolves around the pricing policy of the Government, which – although would put pressures on the margins – can be mitigated with increasing scale of production by leading player.  While the previous budget accommodated most of the demands raised by the Indian drugs and pharmaceuticals industry, we do not expect any significant measures in the forthcoming budget. The industry, nonetheless, seeks a reduction in excise duty from 16% to 8%, increase in the weighted deduction relating to R&D expenditure from 150% to 200% along with extension of these provisions for indefinite period, full exemption of customs duty on life saving drugs and increase in the abatement from the assessable value for excise duty purpose from 40% to 52%. 

With regards to the cement industry, consumption is expected to be robust during FY08-FY09. Huge investments are lined up in the cement sector over the next few years. Incremental capacities commissioned during FY08 are expected to be absorbed by the incremental demand for cement.  This would keep capacity utilisation rates and prices high during FY08. However, by end of FY09, the incremental capacity addition is likely to disrupt the demand-supply equilibrium towards a surplus situation. Consequently, it is expected that there could be a marginal fall in capacity utilisation rate and cement prices in FY09. Some of the expectations of the cement industry from the government are reduction/abolition of import duty on coal and pet coke and permission for duty free import of tyre chips (shredded tyres) by end users for use as alternative fuel.

2008 would mark the entry of the Indian economy into the eighteenth year since the new economic policy and reforms were initiated. This may be symbolic in terms of the coming of age of the Indian economy, and will place on it the responsibility of consolidating its place in the world economy. As the economy matures, its concerns towards the realization of its growth potential must mature as well.

We expect that the dominant theme for 2008 will therefore be resource management, with particular focus on human resource. As the war for talent intensifies, well trained and capable human resource will become the defining component to achieving strategic successes, exploiting opportunities, and thus enabling growth. The unavailability of such resources could possibly become the bottleneck to growth, and could well be the differentiating factor between companies and nations alike.

As a related concept, productivity and efficiency gains through innovative management techniques coupled with the use of technology will emerge as key growth drivers. We expect that the forthcoming Budget will articulate specific initiatives for the education sector, as has also been the accent of the 11th Five Year Plan. 2008 could well emerge as the year of investing in the human resource development of India.