India’s attractiveness as an investment destination. Myths, perceptions and the reality.

Sectoral analysis and case studies

ANZ CEO ForumIntercontinental Hotel New Delhi, India

David TwineDecember 2002

Introduction

As an element of investment due diligence and risk assessment, we sought to explore India’s attractiveness as an investment destination based on:

•actual government stances and actions (as opposed to rhetoric), and;

•case studies of foreign investors and how they have fared in India.

To examine the hypotheses …..

‘Success’ or ‘failure’ is determined by …

• the nature of policy evolution for the industry segment;• being an MNC or otherwise;• specific company’s operating style and/or strategies.

Approach

Examine how:

•Companies in different sectors have evolved;

•The sectoral categorisation reflects the policy evolution in India i.e. – where domestic and foreign participation has always been allowed– where domestic private participation was and/or is allowed– that were only open to government agencies.

Framework

Macro: Era and sector correlation. Assess its impact

Media and other

institutions’ roles.

Govt. and policy makers Specific political parties outlook and perspective

A Company’s Success or

failureNGO / other

bodies

Specially for resource sector

Market place acceptability:

Market share

Competitive scenario

Acceptance by society

Brand building / recognition

Case studies done in …

• FMCG• Automotive• Power • Gas• Refinery• An overview on India’s economic liberalisation and current thoughts

on disinvestment have been provided to qualify the analysis

Presentation Structure

• India’s economic liberalisation• Common concerns• Myths and perceptions• Sectoral analysis and case studies• Implications• Current thoughts on privatisation• India: environment for investment

India’s economic liberalisationHistorical perspective

• Pre 90’s, industrial development followed a socialist model. Key sectors (infrastructure, steel etc.) were nationalised, others were licensed;

• Private capital flows were discouraged by a tight regulatory regime, which restricted foreign ownership, technology transfers and portfolio investments in companies operating in India;

• Foreign capital flowing into India consisted of aid, commercial borrowings, government debt and bank deposits from Non Resident Indians.

India – the last decadeKey sectors opening up to foreign investment and privatisation

• 1991 saw the beginning of economic liberalisation in India

1991

1993

1996

2000

Key sectors opened to foreign and private investments

• Telecom

• Banking

• Automotive

• Insurance

• Durables

• Power and energy

Current scenario

• Restrictions for Foreign Direct Investment (FDI) have been removed from most industries, barring a select list of hazardous and environmentally sensitive industries

• Foreign exchange regulations have been simplified further

Common concerns (1)

Stringent FIPB approval process

• In the early years of liberalisation, the FIPB (Foreign Investment Promotion Board), under the Ministry of Commerce and Industry kept a strict vigil on investments;

• Any company wishing to set up operations in India had to go through long and tedious procedures to obtain a clearance;

• Today however a significant shift in mindset is seen; from ‘seeking a reason to holdback’ towards ‘finding reasons to approve’.

Common concerns (2)

• While the Board still has policies and guidelines governing investments in certain sectors, these are not as stringent as they were previously.

• Flexibilities are built into the system for:

– substantive investment and commitments – not for marginal investors;

– ‘genuine’ proposals, e.g. not for products with no intention to manufacture domestically.

Common concerns (3)

Press Note 18 (FIPB)

– This note disallows companies having a JV in India to qualify for automatic approval to set up a 100% subsidiary.

– Provisions exist that equally protect MNCs against their Indian counterparts ‘bullying’ them

Common concerns (4)

• Policies protect the Indian manufacturer• The reality however is …

– India is one of the original signatories to GATT and is committed to WTO agreements in full spirit

– QRs on almost all items have been removed

– FDI restrictions on most items have been removed as well

– However the government would stretch the commitments to protect India’s concerns as any other country would

Myths and perceptions

Harassment and corruption

• Bureaucratic interference does slow down and frustrate business operations

• Corruption and often harassment are de-motivating

Myths and perceptionsHarassment and corruption

But,

• a strong and pro-active judiciary has emerged in the recent past (note its role in relation to the Narmada Dam construction which is rife with controversies amongst NGOs and project leaders);

• Extremely strong Central Vigilance Commission (CVC – reporting directly to the President of India) is making a beginning to ‘clean up’ the system.

Summary of key issues

• Economic development in India initially driven by financial bankruptcy• Today however it is increasingly driven by:

– International commitments - WTO; IMF; etc.

– Pressures of foreign governments;

– Lobbying by industries

– by a small political establishment that seeks to do what is economically right and fiscally responsible.

• Foreign Policy is now being drafted along economic considerations - countries with economic clout will leverage access to markets

Where foreign investment has always been allowed

Case: FMCG

Sectoral Analysis

FMCG in India: Policy development (1)

• MNCs have been allowed to operate in India ever since its independence in 1947. Most international big players have had operations in India, e.g,

– Hindustan Levers had manufacturing facilities

– Colgate and Nestle had only trading activities

• In 1978 however the government reserved several product categories only for the small scale manufacturers

• Further, MNCs were asked to reduce equity stake to 40% or else to leave the country

FMCG in India: Policy development (2)

• Government’s perspective on this sector was - these products are luxury items and therefore do not warrant encouragement

• Later in the 80’s, governments policies of higher excise duties on toiletries and cosmetics made the environment difficult in this sector

FMCG in India:How it all opened up

• Local players who did not have technology and capital could not provide good quality products and remained ‘in-competitive’

• MNCs were better equipped to sustain higher costs and benefited from the controls. They were able to spread out to reach larger masses

• In the post 1991 era, duty rates have been slashed, there has been a progressive reduction in excise duties and licensing restrictions have been eased

FMCG in India:Today

• Foreign FMCG companies dominate most product categories

• Few national level Indian FMCG companies exist, mainly in niche segments

• There is a large and fragmented ‘unorganised’ sector, which, sheltered under government incentives competes with the organised sector on price and availability (but not quality)

FMCG in India:Indian organisations

• As a fragmented and unorganised industry it has been difficult for the industry to meet mass consumer needs;

• To cater to all consumer needs required investments and technology as well;

• Most Indian companies never had the capabilities to meet these expectations;

• The FMCG sector even otherwise has not been a priority for big industrial houses like Tata, Reliance etc.

FMCG in India: How the operating environment changed

• In 1978 due to the policy of protecting the small scale sector the environment turned hostile towards the then big players in the market. Many like Coca Cola did leave India

• However, there were others like Hindustan Levers who adapted to the changing environment and stayed on demonstrating a long term commitment

Case studies were carried out for the following companies (but are not included in this pack)

• Hindustan Lever• Coca Cola• KFC• McDonalds

FMCG sector in IndiaSummary

• Almost all leading players are MNCs.

• Indian companies exist in niche and regional segments only

• Indian consumers consider the overseas FMCG organisations as ‘Indian’ as the local companies

• Success for the companies has come from long term commitment towards the Indian market and adapting themselves to its diverse culture

Where foreign investment has been allowed post liberalisation in 1991

Case: Passenger Cars

Sectoral Analysis

Passenger Cars in IndiaHistorical perspective (1)

• Untill the 1940’s, passenger cars were only being imported into India

• In 1946 Premier Automobiles Limited (PAL) became the first manufacturer of cars in India by assembling Dodge DeSoto and Plymouth cars

• Later in 1949 another Indian company, Hindustan Motors (HM), started manufacturing cars

Passenger Cars in IndiaHistorical perspective (2)

• Until this time foreign companies operating in India were allowed to assemble cars

• In 1952, the government set up a tariff commission to develop an indigenous automobile industry

– Foreign companies which were assembling cars and did not have plans to manufacture in India were asked to shut down

– As a result General Motors, Ford and others left India

• The next three decades saw only two models on Indian roads -- Ambassador (from HM) and Padmini (from PAL)

Passenger Cars in IndiaPolicy controls

• These restrictive set of policies were mainly aimed at building an indigenous auto industry

• But further controls that were imposed related to production, distribution and even extended to fixation of prices of cars and dealer commissions. This started affecting the Indian manufacturers as well

Passenger Cars in IndiaChanging environment

• In early 1980’s Maruti Udyog Limited (MUL), a Government of India JV with Suzuki of Japan was set up

• This became the turning point in the Indian auto industry. Most controls were abolished during this era

• Though the govt. liberalised policies by announcing foreign collaborations for technology and finance, these policies mainly favoured MUL. Other Indian manufacturers like TELCO, PAL and HM were denied permissions by a strict FIPB.

Passenger Cars in IndiaPost liberalisation

• In 1993 the industry was de-licensed and gates were opened for foreign investors to set up operations in India;

• As a result Daewoo, Hyundai, Ford, Mitsubishi, General Motors,Honda, Fiat, Toyota have set up their manufacturing units;

• With the advent of technology and newer models that these companies brought in, Indian manufacturers faced stiff competition.

Passenger Cars in IndiaPost liberalisation (2)

• This has resulted in PAL having closed its operations and HM’s share in the market has continuously been on the decline

• The only Indian manufacturers now are TELCO and Mahindra.

• Overall the industry is dominated by MNCs.

Passenger Cars in IndiaMNC success India (1)

• All MNCs have invested heavily in India

• Companies like Daewoo and Ford have their manufacturing plants planned for exports from India as well

• For instance Ford has built a plant that conforms to ISO 14001 and has a capacity to produce 100,000 cars per annum

• Most MNCs are addressing the Indian consumers needs in terms and quality. They have altered their car designs and included variants to cater to their tastes.

Passenger Cars in IndiaMNC success in India (2)

• Today these companies have successfully convinced the Indian government to protect them from imports of used vehicles in India, even though such vehicles could be from their parent company

Case study was carried out for Ford company (but is not included in this pack)

Passenger Cars in IndiaSummary

• With only two private India operators and a Public sector undertaking, the sector remained closed for foreign investment for a long time

• Today however the Indian operators are no longer in existence and the industry is lead by foreign companies

• Certain policies did favour Maruti for a few years, but with dis-investment of public sector companies on the cards a level playing field is now clearly in place.

• The industry is more capable and competitive and the consumer is a major beneficiary.

Where foreign investment has been allowed post liberalisation in 1991

Case: Power and energy

Sectoral Analysis

Power sector in India (1)

• Until early 90’s power generation was undertaken exclusively by the public sector and select Indian organisations

• The door to Foreign Direct Investment was opened in 1992. Indian delegations travelled the globe to attract investors

• Nearly a decade after the sector was opened up, the progress is abysmal. Of about 50 projects sanctioned, including a tranche of so-called “fast track” projects, less than one fifth have been commissioned

Power sector in India (2)

• Many large players like Cogentrix have pulled out of the country completely and Enron (the most famous of all) is on the verge of pulling out

• Today there are hardly any success stories upon which to comment in this sector – either of a foreign company or Indian

• The Enron project has the ‘distinction’ of bringing out a number of lessons in the otherwise uncharted recesses of the Indian power sector

• A case study on Enron and PowerGen discusses the issues in this sector

Case studies were carried out for the following companies (but are not included in this pack)

• Enron• PowerGen

Power sector in IndiaSummary

• Only one major foreign power plant having been able to start operations in India affirms an environment that is extremely slow – so slow that several high profile companies have been sufficiently discouraged and de-motivated to exit

• In this sector neither enough Indian or foreign companies have been able to demonstrate material success

• Successful Indian and foreign ventures exist in the mini power generation segment.

That were only open to Government agencies

Case: Gas sector

Sectoral Analysis

Gas sector in India

• Indian consumption of natural gas has risen faster that any other fuel in the recent years. Use of Natural Gas in power generation and the Indian government’s encouragement to build gas-fired electric power plants has been the main reason

• Given that a large gap exists between the domestic gas supply and demand, India remains a large importer of gas. The imports are facilitated via ship or cross border pipelines.

Gas sector in IndiaOpening up of the sector

• Until the beginning of liberalisation in 1991, this sector was completely regulated

• Thereafter the sector was partially opened with permission granted to parallel marketers to sell LPG

• Given the overall reliance on imports, India is investing heavily in the infrastructure required to support the same, by building LNG import terminals and pipelines

Gas Sector in IndiaEnvironment today

• The FIPB has already approved almost a dozen prospective LNG import terminal projects;

• However, to keep the demand and supply situation under control, GoI believes that not all terminals should be built according to the approved schedule, as their combined capacity would exceed the projected demand

• GoI has thus frozen approvals for new terminals. (This unfortunately presupposes that all of the approved projects will materialise, and on schedule and at the approved capacity – this is not remotely probable or possible).

Gas sector in IndiaCurrent players (1)

• The largest state government projects have been established by Petronet – a JV between Oil and Natural Gas Commission (ONGC), Indian Oil Corporation (IOC), Gas Authority of India Limited (GAIL), National Thermal Power Corporation (NTPC) and Gaz de France

• Under this plan each of the state firms hold a 10% stake, the Gujarat state government would hold another 5% stake. The rest is offered to private investors.

Gas sector in IndiaCurrent players (2)

• Other projects include consortiums such as:– British Gas and NTPC– Siemens and CMS energy, Woodside petroleum and Unocal– Total Fina Elf with Tata electric and GAIL– Shell has received approval for an LNG import terminal at

Hazira, Gujarat– Reliance Industries also has plans of an LNG import terminal

at Jamnagar, Gujarat - near its oil refinery

Gas Sector in IndiaEnvironment today (1)

• But, the progress on most of these is slow, due to the government’s lack of experience in negotiating and entering agreements, e.g. Power Purchase Agreements, Financial Guarantees, Escrows

• Another problem with the current climate in LNG imports is the lack of a coherent regulatory structure

• India is currently working on a new legal framework for natural gas – the Gas Regulation Bill.

Gas Sector in IndiaEnvironment today (2)

• This bill seeks to set up a regulatory body for natural gas and to allow for exclusive distribution rights in some areas to guarantee a market for new gas projects

• Although the bill has been drafted it is yet to be discussed by the Indian parliament. It is a long way from becoming law.

Case Study: British Gas (1)

• BG International is one of the successful MNC’s operating in the gas sector in India. Currently it has a controlling stake in Gujarat Gas Company Limited (GGCL), is in partnership with the Mahanagar Gas JV and is developing an LNG import and regasification project at Pipavav.

• BG holds 65% of GGCL and 50% of Mahanagar Gas.

Case Study: British Gas (2)

• BG is aiming to cater to the vast demand and supply gap that exists in India, and likely to remain so. It has based its plans on a long term commitment.

• BG has been active and visible and has made bids for various projects including the trans-border Indo Bangladesh natural gas project. During 1998, when this plan was promoted (by Enron), BG took the initiative to lobby with Bangladesh as well for generating source gas.

Case Study: British Gas (3)

• But not everything has been smooth. BG faced initial restrictions by FIPB on its plans to invest in India. More recently FIPB has granted exemption to BG from seeking any approvals in the automatic approval sectors. BG was the first foreign holding company to have been granted this exemption;

• BG has also faced some resistance in relation to raising its stakes in various of its JVs – but mainly from its own JV partners not the government per se.

Sectors that were previously only open to Indian Government agencies

Case: Refinery

Sectoral Analysis

Refinery sector in IndiaReasons for deregulation

• In an initiative aimed at attracting FDI, India Hydrocarbon Vision 2025 (an advisory group overseen by the Prime Minister’s Office), has recommended 100% foreign equity participation in the sector

• The need for deregulation also stems from the following factors:

– Increase in demand of petroleum products

– Stagnation in crude oil production

– Difficulty in administration of APM

– Increase in the oil pool deficit

Refinery sector in IndiaEnvironment today (1)

• Opportunity in India’s downstream sector is restricted to sale of lubricants only

– Elf, Mobil, Total, British Petroleum etc. have already made their presence felt

• This sector otherwise has left bitter memories. Exxon, Saudi Aramco, Shell and Kuwait Petroleum have all tried, and have failed, to enter into JV agreements for construction of greenfield refineries in India

• Even amongst Indian organisations, only Reliance has been able to demonstrate any meaningful success.

Refinery sector in IndiaEnvironment today (2)

• These failures are blamed on inconsistent government policies regulating foreign investment in the sector

• Further, no foreign oil company is allowed to market oil products in India. This remains the purview of IOC and other state-owned refiners

• Until this sector is opened up, foreign oil company interest in the downstream sector will remain weak

• Also, red tape and vested interests remain a hurdle.

Refinery sector in IndiaSummary

• There is general agreement that prospects for Indian petrochemical industries are positive. However limitations of public policy restricts FDI making in roads in this sector;

• Environment, infrastructure, tariffs and taxes are the primary constraints above any other factors;

• GoI is otherwise planning to privatise its holdings. The process has already begun for the public sector undertaking IPCL.

The other sectors …Cellular services in India (1)

• Being a new service to the world, cellular telephony saw all major international players investing in - or at least courting - India

• Today most foreign operators are out of the market. Main reasons being:

– An over estimation of market size. e.g. France Telecom estimated high returns in the Gujarat Market but was never able to secure many subscriptions there

– Slowdown in the global industry. e.g. British Telecom which is marred with slow growth in its worldwide operations is in a delicate position in India as well.

The other sectors …Cellular services in India (2)

• Indian organisations neither had the capital or the technology to be in the market solely. JVs were necessary and Indian organisations became the front end of the alliances while foreign collaborators supported them;

• The liberalisation process appeared to be marred with controversies from the beginning:– Licenses were issued on a highest bidder basis, without checking on the

antecedents of the firm – led to default in license fees;– Controversy on critical issues such as limited mobility to basic operators -

opposed by cellular firms.

Cellular services in IndiaWay forward

• Mergers and acquisitions for consolidation is now the primary area of activity.

• Companies have realised the fault in the system of licensing and know that the only way out to achieve profitability is to have wider spread / scale and reach;

• This sector has been a classic learning curve for the Indian government on how to go about designing policies in ‘new’ economy sectors.

The other sectors …Mining Case study (various mining companies) (1)

• The nature of mining is such that a key challenge is to gain the confidence and advocacy of the local communities.

• Each of the mining companies reviewed has policies in place to engage the local communities and articulate what is planned and the benefits to the community.

The other sectors …Mining Case study (various mining companies) (2)

• Each company believes that there is no anti-MNC sentiment in the Union Government, though at times regional and State governments have demonstrated favour to local / Indian companies;

• Such sentiments however are believed to be dissipating as State governments increasingly appreciate that investment is good for growth and progress, and that foreign investment is often superior in terms of the State’s strategic interests and economic multiplier benefits.

The other sectors …Mining Case study (various mining companies) (3)

• The companies believe that putting the blame on ‘anti-MNC sentiment in India’ is an easy way (excuse) for companies to pull out and in turn a ‘believable’ reason to communicate to investors and stakeholders for companies who don’t have the will to be in India for the longer term.

• This is particularly unfortunate too because such cases also tend to attract higher profile press coverage – unjustifiably.

India - privatisation sentiment

• The Union Government is no longer embarrassed or apologetic about reforms – privatisation is being talked about freely;

• The Government has also begun to admit that reforms have been meaningful on poverty, unemployment and literacy – fears have remained as possible for the negative impact.

India privatisation: anti MNC?

• The activity of privatisation, is politically amongst the most sensitive. In general, the process has seen an ample demonstration of ‘may the best man win’;

• They attract attention from all quarters and must therefore be able to stand up to scrutiny.

Indian government privatisation: anti MNC?

• Two ‘disinvestments’ have been actioned in India - they have raised controversies and stiff opposition from various quarters (mainly political)

– sell off of the aluminum company Balco to Sterlite Industries (an Indian group)

– sell off of Modern foods to HLL (an MNC)

• Controversies and negative publicity were greater and extended for a much longer period for the Balco sale

• Therefore not about the origin of the buyer per se …..

Findings

• Sectors that have been opened up to private investment post liberalisation in 1991, and have required large investments for setting up operations such as power and refining, have no material successes even among the Indian operators;

• Others which were open to foreign investments earlier (FMCG) and those which have no Indian company with technology to compete (passenger cars) are dominated by MNCs.

Findings

• There is no common theme or link to suggest an anti MNC sentiment exists in any quarter;

• Successes have been a result of a company’s own strengths and “taking people along” – positive and productive community and stakeholder engagement;

• Government demonstrates ample flexibilities for foreign companies who show long term commitment to the market in part demonstrated by substantial investments.

Findings

• Anti-MNC / anti-foreigner sentiments have led to failures and penal treatment for those who have not respected local sentiments, culture, sensitivities and ideologies. e.g Enron

• Lack of demonstrable India-specific strategy/ products , e.g. KFC, Kelloggs.

Findings

• It is imperative to be perceived and operate as an Indian company (and with the highest international standards of governance and integrity) not a ‘non-adaptive’ global corporation

• Factors affecting this image include

– Nature of product and services

– Adaptability to local sentiments and tastes

– Operating styles i.e, Indian vs. expat managers, advertising campaigns etc.

A successful MNC is run like an Indian company within a framework of international standards of governance and ethical conduct

Issues that remain to be resolved

• Lack of transparency and accountabilities in the system• Bureaucratic hurdles• Corruption and harassment• Slow progress in infrastructure development

…. not an anti- MNC sentiment per se

The Opportunity …

• India is a long haul market – most successful foreign companies have come with a clear vision to adapt and stay for long periods

• Progress is slow … but positive.

India’s attractiveness as an investment destination - myths, perceptions and the reality.

Sectoral analysis and case studies

ANZ CEO ForumIntercontinental Hotel New Delhi, India

David TwineDecember 2002