Investing in India – Opportunities and Challenges

1. Investing in India – Opportunities and Challenges

2. The India Opportunity

3. The transformation… Yesterday • Slow rate of growth • Bureaucratic • Protected and slow • Small consumer markets • Weak infrastructure Today • One of the world’s fastest growing economies • Reasonably proactive • Opening up of sectors for investment • Promising consumer markets • Infrastructure needs improvement India is the world’s largest democracy

4. India today… • Has world-class recognition in IT, bio-technology and space • Is the largest English speaking nation in the world • Has the world’s largest single-location forging facility • Has the second largest petrochemical facility in the world • Is the lowest cost steel producer in the world • Is the largest 2 wheeler manufacturer in the world • Is the second largest tractor manufacturer in the world • Is the fifth largest commercial vehicle manufacturer in the world • Is among six countries that launch satellites and does so even for Germany, Belgium, South Korea, Singapore and EU countries • Is one of the few countries that has built its own Supercomputer

5. Strong fundamentals Growth Oriented GDP (%) 1 Increasing share of services in GDP 2 With Services Sector gaining importance…. Indian economy in a resilient mode in terms of GDP growth… Source: Central Statistical Organisation Increasing International Trade 3 Strong Forex Reserves 4 …along with rising forex rate and reserves …and has an increasing share in international trade Source: Indiastat.com

6. 3 MILLION households 6 MILLION households 1 MILLION households 66 MILLION Households 75 MILLION Households 29 MILLION households 66 MILLION Households 78 MILLION Households 48 MILLION households 48 MILLION households 32 MILLION households 33 MILLION households 24 MILLION households 32 MILLION households 17 MILLION households … resulting in a transitioning Indian demography The Classes 1994-95 1999-00 2005-06 Rich (Above USD 4,600; INR.2,15,000) Consuming (USD 970 – 4,600; INR. 45,000-2,15000) Climbers USD 470- 970; INR.22,000 – 45,000) Aspirants (USD 470 - 347; INR.16,000 – 22,000) Destitutes (Less than USD 470; INR.16,000) Source: The Marketing Whitebook, 2003-04 by Business World

7. Four sectors underline the Indian growth story • Major hub for outsourcing IT-based business processes • Driven by cost effectiveness • India’s wealth of man power Information Technology • Rapid integration with global industry • Foreign manufacturers seek to cut costs • India has high engineering levels and established productions plants Auto-components Pharmaceuticals • Entering a paradigm shift with new product patent regime • Availability of highly skilled scientists Textiles • Removal of quotas will unleash significant potential • Advantages include availability of raw materials and low-cost production

8. Today India is well-positioned as an offshore processing destination Ireland Australia Singapore UK High India • Location Attractiveness • Time zone • Geopolitical factors • Infrastructure China Philippines Low Mexico Low High • People Strength • Skill availability • Language(s) • Cost advantage Note: Size of circle indicates resource availability Source: NASSCOM – McKinsey 2002

9. Scale Cost Time Quality & Productivity Scope India’s value proposition: Cost-effectiveness and high quality • 40% - 50% net cost savings on labour and skills intensive activities and processes • Additional benefits through low cost process improvement, consolidation and automation • Faster turnaround using time zone differences (US 10-12 hrs, Europe 4-6 hrs) • Ability to implement a 24X7 service model • Large, qualified and young workforce • Easy availability of skills • 14 million graduates, 1 million technical resources Companies enter for cost, but stay and expand for quality and enhanced competitiveness • Wide scope of functions - low to high value skills • Offshore opportunities span entire value chain across industries • 10% - 15% productivity improvements • Lower error rate, quicker turnaround • Greater quality visibility • Large proportion of SEI-CMM, COPC, ISO9001 certified service providers and 6-sigma practitioners

10. The India Challenge

11. Companies attracted to India must do more than merely transplant strategies… European Union GDP: USD 11,650 bn Area: 3,976,372 Population: 456,953,258 Languages: 20 Per Capita Income: USD 25,494 • India is approximately 82% the size of the EU • Its population is more than double that of the EU • Almost the same number of languages (India has several dialects as well) • India and the EU have large variations in demographics vis-à-vis paying capacity India GDP: USD 3,319 bn Area: 3,287,590 sq km Population: 1,080,264,388 Languages: 18 Per Capita Income: USD 3072 …given India’s regional diversities of continental magnitude and interstate variation

12. Challenges companies face in India Infrastructure and environment Market-related Regulatory / Governance • Complex business environment • Poor physical infrastructure (roads, ports, airports) • Weak rural infrastructure • Bureaucracy • High cost of and unreliable power • Low urban penetration levels • High cost of entry / exit • Under-developed consumer markets • Low penetration levels due to low urbanization • Widely varying consumer tastes across regions • High price / value sensitivity • Regulatory changes impacted by coalition politics • Restrictive labor laws, e.g. exit options • Laborious and time-consuming process to start a business • Slow legal process • Politicization of investment decisions

13. Navigating through tangles of bureaucracy in business and procedures Days taken to start business Level of complexity According to Transparency International’s ’04 Corruption Perception Index India’s score is 2.8 out of 10. India ranks 90 out of 145 on the Transparency International Corruption Perceptions. Coalition politics have impacted the pace of reforms

14. Restrictive labour policies can impact flexibility in business • Labour regulation is a disincentive to grow businesses, reduces flexibility in operations, and increases exit costs. • Business with over 100 workers have to secure the permission of state governments to close businesses or lay off workers • Difficult to redeploy workers in reorganisations without unanimous agreement of workers. • Downsizing strategies that include large-scale job cuts are difficult and achievable only with local government support • Most large manufacturing companies continue to be seriously overstaffed for want of a transparent “hire and fire” policy • Terms relating to labour conditions, attendance, flexibility, and days lost through disputes vary hugely from state to state. While it is difficult to fire workers in India… Source: Doing Business, The World Bank Rigidity of Employment Index • Relatively easier to hire • Flexibility to work longer hours • Lower cost of laying-off Note: Rigidity of Employment Index is an average of the following three indices – how difficult it is to hire a new worker, how rigid the regulations are on working hours, and how difficult it is to dismiss a redundant worker. Values are assigned between 0 and 100. Higher values represent more rigid regulations.

15. Infrastructure investment has not kept pace with the needs of the economy Low infrastructure development Low spend In the past 10 years, government has cut capital expenditure as a percentage of GDP5.6% (in F2004) from 9.3% In 2003, India’s infrastructure spending was just US$35 billion Immediate requirement A meaningful impact on overall growth will require consistent investment of at least US$60-80 bn p.a. Demographic trends can lift household savings and channel them into infrastructure projects Private investment (domestic and foreign)in infrastructure projects

16. The Indian success story has to be objectively viewed from another perspective as well… Weak results from Privatization • The Indian privatization process has been very slow • Total amount collected in last 14 years was just US$11.9 billion • Few companies have transitioned into private hands Fairly large size of assets Politicization • Estimate of market value of government companies (excluding infrastructure assets) ~ US$150–175 bn • Privatization has been mired with controversy of being anti-labour and non-transparent

17. Corporate Governance is gaining acceptance, albeit gradually….. Unwinding the Corporate Veil might be a challenge Non Arm’s Length Transactions with Related Parties/Group Companies Spirit behind Implementing Corporate Governance Measures may be Questionable Complex group structures – difficult to unwind, ‘hidden’ owners especially other factions of the family -especially true for promoter owned and managed companies Fiefdoms’ – decision making concentrated ‘Associated companies’ may need to be consolidated which may bring in more liabilities Minority interests may have a disproportionate amount of power Related party supplier / customer relationships on non-commercial terms No formal arrangements with related parties Funds deployment in non-core activities Sacrifice of shareholders’ interest for promoter gain Implementation ranges from academic/ cursory to robust, depending on management philosophy Reliability of internal and external audit report may be questionable Statutory audits by small time auditors run the risk of being an eye wash

18. Aggressive Tax Positions Continue to Find Favour…. Aggressive tax management (tax planning vs. tax avoidance) Tax litigation is common, Final resolution of issues time consuming This could result in cash outflows at the outset and inflows later if company successfully defends: impacts cash flows given lengthy legal process Continued availability of tax benefits/ incentives post transaction (needs careful analysis)

19. Need to pay attention to the operating environment and to cultural aspects In India ‘everything goes’

20. In conclusion… Reforms consistently moving in the same direction. Urgency to revamp infrastructure Faster implementation of reforms needed Sun-rise industries establishing themselves internationally. Redefinition of roles of public and private sectors. Indian manufacturing sector becoming globally competitive Investment opportunities driven by: Existence and growth of markets Availability of resources and global competitiveness …India today offers an early mover advantage Source: KPMG research