Impact of Roubini’s Perfect Storm Predictions on India

Indian economy is not doing well. It grew at just 5.5 percent in the June quarter. The slow growth continues from last quarter, and the rapid economic growth of the last decade can no longer be taken for granted. The political paralysis, frequent corruption and scam charges, and inability to pursue  reforms has all led to this sorry state of affairs. This week with much fanfare reform guidelines for foreign direct investment in retail and aviation were released. Let us see whether they make a difference in the long run.

The area of concern is that economist Nouriel Roubini dubbed ‘Dr Doom” for predicting 2008 financial crises, recently predicted a global perfect storm in 2013. He highlighted five factors that will derail the global economy.

If India’s internal problems continue and Roubini’s predictions become real, the dream of India becoming a super power by 2020, may just remain wishful thinking.  As there are divergent views on India’s growth story, let us take a look on the impact of these factors on Indian economy and growth.

1) Worsening debt crises in Europe

The European crises is more than a spanner in the wheels, it has the capacity to bring the global economy to its knees. With Greece, Ireland and Spain in doldrums and economist predicting a breakdown of Eurozone in near future, things couldn’t be worse. London and other euro cities are home to the biggest financial institutions and extensively interconnected with the rest of the world. The combined economies of Eurozone is the second largest in the world, hence anything going wrong here will impact the rest of the world.

A recently released FICCI report states that – “Indian companies doing business or which have invested in Europe have been adversely impacted. About 75% respondents said they have reported decline in their business prospects and also a loss of over 20% in business generation from the European region.” If a full-blown breakdown occurs, then Indian economy will definitely suffer. Though, a lot has been said about European institutions working together to bring financial stability and governments having the political will to take corrective measures, it seems doubtful. Good economies, Germany for one, may back out as its citizens may not wish to carry the burden of other countries.  Hence, Indian companies are spreading their business in Africa and Middle-East to counter the downturn of Europe.

2) Tax increases and spending cuts in US that may push the country in recession

Barack Obama inherited an economy in crises. Though the financial crises is over, the economy will take a few years to recover. Last six months economic indicators show progress . The annualized growth rate is ranging between 1-2% in 2012, a major improvement from -7% in 2009. The unemployment rate is around 8%, and property prices have risen in the last six months after 5 years.

As neither Barack Obama nor Mitt Romney has a magic wand, the possibility of US going in recession is high, specially as it is highly linked and dependent on Europe. For India, a US recession is firstly bad news for the outsourcing industry. Obama and Romney, both in their election campaigns have targeted Indian outsourcing business as the source of all problems prevailing in US job market.

Though Indian software industry exports were US $ 101 billion in revenues in the year ended March 2012, NASSCOM has stated difficulty in predicting Indian software exports for more than two quarters in uncertain conditions. India exported  merchandise goods to US for $57.8 billion in 2011 and is growing. Since majority contributions are of textiles, stones etc., the impact of recession  isn’t significant.

In respect to FDI’s, receives investments through Mauritius, Singapore etc and “According to the latest data released by the Department of Industrial Policy and Promotion (DIPP), India received foreign direct investment (FDI) worth US$ 1.33 billion in May 2012 while cumulative inflows for April-May 2012-13 stood at US$ 3.18 billion”. Hence, the impact of US recession on Indian FDI will not be significant.

India in all likelihood can survive a US recession without much impact on a stand alone basis. With Europe also spinning out of control, the scenario changes.

3) A hard landing for China’s economy

Chinese economy over the last two decades flourished with high investment in infrastructure projects and low manufacturing costs. It imported capital goods, though not consumer goods, and domestic consumption didn’t increase much. Now growth forecasts are in single digits, and focus has to shift internally due to the Eurozone crises and US recession.

As Satyajit Das mentioned in a recent blog post, the world is divided into two groups with respect to China – Sino-philia and Sino-phobia. Some pro-China model believers think China is set to become a super power. On the other hand Sino-phobic believe China is out to control the world. Hence, the perpetual predictions of China succeeding and failing. However, Das has pointed out rightly in the following words –

Nothing illustrates this better than Chinese income levels. Despite its status as the world’s second largest economy, China ranks 98 out of 181 nations in the World Bank’s ranking of GDP per capita. Based on forecasts, wealth per capita in 2016 will be only equivalent to US$13,700 against $57,300 for the US and US$48,000 for Germany. This does not take into account the massive income inequalities in China, where a large portion of the population lives on less than US$1.25 a day.

China and India suffer from the same problems of huge income disparity, over-population and poverty. The corruption in the government further distorts the situation. If Chinese economy slows down, the disparities will continue and China will have to focus internally. It does give an opportunity for India to takeover but it depends on India straightening out its internal act.

4) Further slowing down of emerging markets

The BRICS – Brazil, Russia, India, China and lately South Africa – in the last decade showed tremendous growth. They were the torch bearers of developing world. However, now it is envisaged that BRICS will be growing in single figures. With it competition from other emerging markets is heightening – Indonesia, Philippines  Vietnam etc. . On both sides India is in trouble.

Firstly, with the slower growth in emerging countries, India will lose its advantageous position. As business heads start looking at other countries for investment, the FDI will slow down. Moroever, the emerging markets provide a good cost arbitrage. For example, Philippines have taken over the call center market specially that of US, as the cultures are similar and it is cheaper than India.

As each emerging country comes up with its own unique selling proposition, the Indian industries will be impacted unless they position themselves differently. As in the BPO business, India is now attempting to position itself as knowledge managers.

Emerging markets will increase competition for India, hence gazing at the crystal ball is not going to help. India will have to tackle its poor reputation on governance, public finances, scams and democratic setup.

 5) A military confrontation with Iran.

Political pundits predict that Israel to maintain its supremacy in Middle East will bomb Iran soon. Another view is that Iran will misuse its nuclear power to foster radical Islamic activities. Iran is rapidly building stronger ties with Russia, China and Latin America. In this situation, the target is US and Europe. The crucial question is, what does a war or attack by Iran means to India.

Besides ancient cultural ties, presently Iran is the major supplier of oil to India.  India has invested in the Oil & Gas industry in Iran to ensure its export. India imports 80% of crude oil to meet its energy needs from around 30 countries. Iran caters to 11% of the total requirement.

Hence, from cultural, political and trade perspective, India is not in Iran’s first list of country targets. However, if war does break out,  India is located between Pakistan and China. China would support Iran. On the other hand, Pakistan will face the tough choice of supporting the Islamic group or US. India is far to near the epicenter of the problem to avoid the war, as it has tense relationships with both its neighbors – Pakistan and China. On the whole, India loses out if there is a war in the Middle East. Tensions in Middle East will spell trouble for Indian companies having high energy consumption as crude oil price may increase.

Closing thoughts

Risk managers need to re-evaluate country risk of India and the rest of the countries they are doing business with. Credit rating agencies are threatening to further downgrade India’s rating. With the political risks of various countries changing, some impact on import-export, supply chain, customer relationships and investor participation can be expected. Even in the recent risk reports respondents have rated geo-political risks among the highest. This is a good time to take a close look at the risk scorecard to assess changes in strategic, financial and operational risks. Strategies should be developed for the country risks identified during the country risk assessment.

References:

  1. A Global Perfect Storm – By Nouriel Roubini 
  2. Roubini sticks to 2013 ‘perfect storm’ prediction
  3. 7 economic indicators that could decide the election By Market Watch
  4. Foreign Direct Investment
  5. Indian companies facing losses in Europe: Ficci
  6. BRIC Countries Hit A Wall – Forbes India

Managing Political Risks

Last Friday, results of five state elections were declared. In two of these states, West Bengal and Tamil Naidu the political landscape will change tremendously. Mamata Banerjee’s Trinamool Congress won West Bengal elections and  Jayalalithaa’s AIADMK won Tamil Naidu. Besides, both the states favoring parties led by woman, the victories are significant. Mamata Banerjee ousted the Left party CPI(M) after 34 years and Jayalalitha knocked off the 2G telecom scam tainted DMK party. West Bengal voted for progress and Tamil Naidu against corruption.

The election results coverage got me thinking. In a large country like India political risks change state wise and these risks not only impact multinational companies but Indian organizations also. For example, Tata Nano project in Singur faced the political backlash when farmers protested against forceful takeover of 400 acres of agricultural land for the project by West Bengal government. Trinamool party supported the farmers, played hardball and Ratan Tata took a decision to shift the project from West Bengal to Gujarat. One states loss was another states gain. West Bengal now is a financial mess. CPI(M) has left the state with Rs 2 lakh crore debt. To succeed as chief minister,  Mamata Banerjee has to woo back industrialists and multinational investments to West Bengal. Will the corporate world play ball and take the risk of setting up business in West Bengal. Politicians are fickle, they change stance seeing the direction of the wind, can they be relied upon?

When political changes can severely affect business, a questions that begs an answer is – how do organizations manage political risks?

In my view, political risks fall under the category of external strategic risks and organizations generally do some analysis about them at the time of investment. Insurers treat political risks as part of risk mitigation, by analyzing the countrywide risks and insuring the organization from negative impact. In my view, this strategy does not explore the golden opportunities accessible by leveraging political risks. Political risks if managed proactively can add tremendous business value. So let us discuss the various aspects of political risks.

The research paper “Political Risk Management: A Strategic Perspective” written by Witold J. Henisz and Bennet A. Zelner describes political risks faced by organizations as – “Individual firms confront different sources of policy uncertainty and political influence depending on factors such as their size, nationality, familiarity with the local environment, partner status, technological leadership and network of global stakeholders”.  I like the definition at it encompasses all aspects of political risks.

1.    Boundaries of Ethical Lobbying

Governments and business generally are hand-in-glove but their relationship can change from trust worthy partners to arch enemies quite fast. For example, in the 2G-telecom scam case, DMK party person A. Raja favored Reliance, Tata and other telecom companies by waiving rules for allocating bandwidth. Niira Radia tapes disclosed that there was a lot of lobbying from corporate sector for appointment of A. Raja as telecom minister. However, with the CAG report mentioning fraudulent activities, things have gone sour. Telecom heads are being grilled by CBI and some are presently behind bars. This is a case were political relationships were used in an unethical manner to add business value. Hence, one of the major questions for managing political risks is – where is the thin line between ethical and unethical behavior and how does one stay within ethical boundaries to manage political risks?

This case clearly illustrates that participating in corruption, bribes and crony capitalism does not add business value to an organization. Political risks need to be managed while respecting ethical norms and legal laws. Flouting laws and government regulations because some businesspersons believe they are good buddies with the politicians doesn’t help their case in the long run.

2.    Fluctuating relationships

Business lobbies with government and political parties to get favorable policies and benefits. In India the various industry forums – NASSCOM, FICCI, CII etc. provide a good base to organizations to have a bargaining power with government. However, the government may not listen to their requests or change its opinion at any time. For example, last year SKS Microfinance change in CEO got the focus on Micro Finance Institutions (MFI). The laws were immediately changed to protect the farmers in Andra Pradesh. Cases of farmer suicide had increased as a few MFIs were doing collections  by threatening farmers and their families.

A few companies mis-management has resulted in the whole industry paying a heavy price. Within six months, the whole industry cash flows were impacted. An industry, which was considered a cash cow, is struggling to maintain liquidity. Again, a situation where the start of the relationship was good as government needed micro finance companies in rural areas. However, because of their exploitative procedures the industry has painted itself in a corner. The industry as a whole lost its bargaining power.

Lesson here is that relationships need to be managed on a continuous basis. A sense of entitlement and privilege of organizations can damage the long-term relationships with government bodies. Organizations need to master the art of tight rope walking to add business value. It is never plain sailing with government, so don’t let your guard down.

3.    Foreign investments and relationships with multinationals

Everyone wants their place under the sun, and multinationals more so. They want a slice of the emerging markets from strategic growth perspective. But, the fear is always there that they are biting more than they chew. In India, states chief ministers clamor to get multinationals to invest in their states. The offer sops in the form of cheaper land, tax-breaks, easy licensing schemes etc. The courting period of state government and multinationals is sweet, it is hard to believe that things can go wrong. However, state governments being infidel lovers, loose interest after the investments are made in their state by the multinationals.

The corruption factor also has to be dealt with. It is not unheard that politicians to grant licenses recommend local partners (including their relatives), demand equity and other perks. Secondly, after the technology is transferred to the country especially in manufacturing sector, the multinationals loose bargaining power. The challenges for multinationals are to ensure that state governments deliver on the promises, continue with policies, which are favorable for foreign investments and allow free market economy to work. To do so the multinationals can use their respective embassy business relationship managers, local industry lobbies, their own country’s business lobbies and government. Lastly, multinationals should sign watertight agreements with government bodies so that the organization is not shortchanged.

Closing thoughts

Managing political risks is equivalent to walking on a landmine. Anything can erupt without much notice. It is a tough task to prepare after considering the political, economic and social uncertainties in the environment. Lessons can be learnt from some odd cases.

 

References

Political Risk Management: A Strategic Perspective Witold J. Henisz and Bennet A. Zelner

Political Risk Predictions for 2011

Just being in the second week of the New Year, I am  continuing with the last Sunday’s post on trends. This week I thought it might be a good idea to understand the world and country risks. Do the political pundits see a better world in 2011 or are they expecting something worse?

Below are three posts giving different viewpoints on political and economic risks. The first one is from Foreclosure Blues titled “The Year of Catch 22”. It is long post and gives a rather dismal view of US political and economic situation. The second post “The Global Economy in 2011: A Rocky Ride or Smoother Sailing Ahead?” is from Knowledge Wharton. It is an excellent post covering economic risks of all major countries and regions. I have put the India section in this post.  The third post “The G-20 is 2011’s Biggest Political Risk” authored by Ian Bremmer and David Gordon is from Harvard Business Review. It discusses that though the world is expecting G-20 forum to resolve global situation, not much good will come out of it.

Click on the headings to read the full posts. Though they are rather long, I would recommend a read to understand the world economic and political risks. It is excellent information to assess country risks and their impact on the organization.

1.    2011 – The Year Of Catch 22 (via Foreclosure Blues)

As I began to think about what might happen in 2011, the classic Joseph Heller novel Catch 22 kept entering my mind. Am I sane for thinking such a thing, or am I so insane that asking this question proves that I’m too rational to even think such a thing?  In the novel, the “Catch 22″ is that “anyone who wants to get out of combat duty isn’t really crazy”. Hence, pilots who request a fitness evaluation are sane, and therefore must fly in combat. At the same time, if an evaluation is not requested by the pilot, he will never receive one (i.e. they can never be found “insane”), meaning he must also fly in combat. Therefore, Catch-22 ensures that no pilot can ever be grounded for being insane – even if he were. The absurdity is captured in this passage:

There was only one catch and that was Catch-22, which specified that a concern for one’s own safety in the face of dangers that were real and immediate was the process of a rational mind. Orr was crazy and could be grounded. All he had to do was ask; and as soon as he did, he would no longer be crazy and would have to fly more missions. Orr would be crazy to fly more missions and sane if he didn’t, but if he was sane, he had to fly them. If he flew them, he was crazy and didn’t have to; but if he didn’t want to, he was sane and had to. Yossarian was moved very deeply by the absolute simplicity of this clause of Catch-22 and let out a respectful whistle. “That’s some catch, that Catch-22,” he observed. “It’s the best there is,” Doc Daneeka agreed. – Catch 22 – Joseph Heller

The United States and its leaders are stuck in their own Catch 22. They need the economy to improve in order to generate jobs, but the economy can only improve if people have jobs. They need the economy to recover in order to improve our deficit situation, but if the economy really recovers long term interest rates will increase, further depressing the housing market and increasing the interest expense burden for the US, therefore increasing the deficit. A recovering economy would result in more production and consumption, which would result in more oil consumption driving the price above $100 per barrel, therefore depressing the economy. Americans must save for their retirements as 10,000 Baby Boomers turn 65 every day, but if the savings rate goes back to 10%, the economy will collapse due to lack of consumption. Consumer expenditures account for 71% of GDP and need to revert back to 65% for the US to have a balanced sustainable economy, but a reduction in consumer spending will push the US back into recession, reducing tax revenues and increasing deficits. You can see why Catch 22 is the theme for 2011.

2.     The Global Economy in 2011: A Rocky Ride or Smoother Sailing Ahead? (via Knowledge@Wharton)

India: Muscling Ahead

In India, December 2010 saw corruption charges rise to a crescendo and a whole session of Parliament was lost as opposition parties, demanding deeper investigation into the scams, refused to let it function. None of the political parties wants a fresh election, so this government will continue. But its trajectory has obviously been affected. “The political climate is uppermost in the investor’s mind,” says Vallabh Bhansali, chairman of Enam Securities, a capital market services firm. “If there are policy logjams, they could create confusion.”

But the economy is expected to muscle ahead regardless. Estimates of GDP growth vary from 9.7% (the IMF prediction for 2011) to 7.7% (the Credit Suisse prediction for fiscal 2011-12). Credit Suisse is a rare pessimist; almost everybody else has upped their forecasts. The government projection is 8.75%, with a possible 0.35% addition. “India is on a mission to get its annual GDP growth to 10%,” according to Bundeep Singh Rangar, chairman of IndusView, an advisor to MNCs seeking opportunities in India. “A good monsoon [season] and a strong global recovery could make 2011 the year that India achieves that goal.”

The Bombay Stock Exchange sensitive index (Sensex) should keep pace with GDP. “By the end of 2011, the Sensex is likely to be between 24,000 and 25,000,” says Rajinder Sabherwal, who manages a macro fund called Magister Ludi Global. The New York-based Sabherwal, however, doesn’t think India will be a top performer in the markets. “India is a defensive holding for us. It sells at a premium. To some extent [that is] justified, but [it] is vulnerable to inflation and rising oil prices. In emerging markets, we prefer Turkey, Russia, Thailand, Korea and Poland.” Sunil Bhandare, advisor (economic and government policy) at the Tata Strategic Management Group, sees a 12% to 16% growth in the Sensex over current levels (around 20,000 at the end of December).

One big worry is inflation. Dharmakirti Joshi, chief economist at credit rating agency Crisil, says inflation will be the biggest challenge in 2011. His other concern is the impact of rising capital inflows on the rupee. Naresh Takkar, managing director and CEO of credit rating agency ICRA, also lists inflation as a top concern, especially in commodity prices. He sees improving international economic sentiment as a “double-edged sword” for India. “Sectors that are dependent on international demand will benefit, but commodity prices will see a further upturn,” he says.

If inflation climbs, the Reserve Bank will have to hike interest rates. This could result in “some moderation” in the growth rates of investment and private consumption, according to Joshi. Bhansali also sees “a bit of a cyclical downturn in growth, but it may be only a few quarters or a few months.”

It’s on the reforms front — inextricably linked to politics — where there is the greatest amount of uncertainty. Much could happen. Joshi pins big hopes on the proposed new goods and services tax, which he describes as a “game changer.” A slow approach would be just right for new banking licenses, suggests Rajesh Chakrabarti, finance professor at the Indian School of Business. “The dominant view is that caution and safety are key, and no rush towards greater liberalization is warranted.” He also expects the recent corruption scandals to create a bigger role for the government, “as the false assurance of the cleanliness of the private sector is now gone.”

“There are far too many policy reforms that are pending, but unfortunately, the parliamentary system has been bogged down by controversies, scams and corruption. No substantive reforms could move forward during 2010,” says Bhandare. “Our political parties must realize the adverse consequences of their actions.”

 3.    The G-20 is 2011’s Biggest Political Risk (via Harvard Business Review)

Among the acute political risks facing the world this year, the nuclear threats from Iran and North Korea are serious, no doubt, but the behavior of the 20 major economic powers scare us more: these countries can no longer agree on how the global economy should function.

“Oh, come on,” you might say. “When did the world’s leaders ever agree on anything?”

But, there used to be a pretty good understanding among the dominant economies on matters such as currencies, capital flows, and economic globalization, and the major players were willing to put their heads together to solve crises.

No more. The major economic powers are pushing their own agendas and using the key institutions that should be providing global governance as arenas for confrontation instead of collaboration.

This enormous change ushers in an era of growing political risk. It doesn’t have an official name yet, but we propose calling it the “G-Zero,” as in zero collaboration. It is the first item on the Eurasia Group’s Top Risks for 2011.

Before the global downturn, the G-7, and then the G-8 (including Russia), coordinated governance on key economic issues. The G-8 was superseded by the G-20 during the financial crisis, and at first the members cooperated well to prevent a global economic collapse. But the initial collaboration was misleading — it turned out to be merely a reaction to panic.

The first serious cracks in the group started showing in Copenhagen a year ago, following a climate summit marked by such disunity that the outcome was worse than if no meeting had taken place. Then, last fall, both the International Monetary Fund meeting in Washington and the G-20 meeting in Seoul ended with warnings of looming conflict. “We’re in the midst of an international currency war,” Guido Mantega, Brazil’s Finance Minister, said last September.

Well, this information does not give much comfort. The message is that do not view the world through rose-tinted glasses in 2011. It is a rough ride ahead and we have to be prepared. So let us keep a realistic view and still hope for the best.