Bloomberg World Roundtable on India Budget Day 2013

IndusView Chairman Bundeep Singh Rangar invited on Bloomberg World Roundtable on India Budget Day 2013.

India’s Union Budget 2013

India’s Finance Minister will be assessed by international investors on policy changes to increase foreign inflows, clarify tax laws and expand the country’s tax base, in his presentation of the Union Budget shortly after the latest gross domestic product (GDP) data is released today.

India's current-account deficit (CAD) has worsened since 2008 due to slowing exports and expensive oil and gold imports. It recorded a current account deficit of $22.3 billion in the third quarter of 2012, or 5.3% of GDP, the worst in a decade. That compares with less than 1% of GDP in the first half of the last decade.

“The Finance Minister has to steer the country away from the danger of being the first BRIC country to lose investment grade status via a credit downgrade,” said Bundeep Singh Rangar, Chairman of London-based advisory firm IndusView. “He has a challenging task of revving a growth engine, that sputtered under his predecessor, with the fuel of more foreign capital and wider tax collections.”

             “India’s current tax base represents fewer than 35 million, or a dismal 3% of its population,” said Rangar. “That contrasts the size of its middle class estimated to be 250 million people that’s expected to reach 600 million by 2030.”

India’s CAD is being financed through stable capital flows, according to India’s Harvard-educated Finance Minister P. Chidambaram. In 2012, Foreign Institutional investments (FII) totaled $10 billion and the country attracted $27.3 billion worth of Foreign Direct investments (FDI). Both combined represent $37.3 billion, which isn’t enough to feed the growing CAD.

On the other hand, annual remittances into India that currently fuel the world’s largest remittance-corridor, surpassed $70 billion in 2012, as NRIs took advantage of a week rupee and high deposit interest rates at Indian banks.

“India’s secret weapon is its 25 million strong overseas diaspora who sent twice as much money into India in 2012 than FDI and FII combined and more than net earnings from exports of software, business, financial and communication services,” said Rangar. “$70 billion in annual remittances by Non-Resident Indians (NRIs) provides India with a distinct advantage over other BRIC economies.”

“Cutting subsidies and privatizing public sector companies will only go so far,” said Rangar. “The Budget should make it seamless for Non-Resident Indians (NRIs) to use their remittances to invest in Indian company securities, mutual funds and other investment products and foster an increase in annual remittances into India.”

“India needs to attract more inward investment and better collect tax to fund the $1 trillion requirement outlined by the Prime Minister to build the country’s infrastructure over the next five years,” said Rangar. “Better infrastructure is critical to increase India’s GDP as it will shear waste and inefficiencies in agricultural and industrial output.”

              To attract foreign investments, the government should best amend its controversial tax law and not impose tax with retrospective effect on overseas deals involving local assets. India has also said it may soon finalize the rules for a proposed clampdown on tax avoidance as it considers delaying implementation of a plan that also spooked foreign investors.

              India is currently aggressively pursuing tax claims against multinational firms and has targeted several companies for tax audits on transfer pricing.

              “The Indian tax man’s potential treatment of low cost intellectual capital work allocated by India to multinationals, as being a higher value service and therefore, taxable at higher rates, will give reason to multinationals to seek other jurisdictions where taxation is simpler and the cost advantages are as good, if not better than India,” said Rangar. “The tax man should focus its efforts to widen the tax base and therefore, increase revenue.”

             India, currently the world’s tenth-largest economy, is vying to be among the top five by 2022, according to the London-based Centre for Economics and Business Research (CEBR).

Is India Wooing the Wrong Dollar-surplus Segments?

India needs foreign exchange. The country's oil import bill was US$15.6 billion in January 2013. Total imports were US$45.6 billion and exports were a much lower US$25.6 billion, leaving a monthly trade deficit of US$20 billion. Projections for the full year (2012-2013) put the deficit at US$200 billion, up from US$185 billion last year. "This is unsustainable," says D.S. Rawat, secretary general of India's apex chamber of commerce, Assocham.

The government can't do much about the petro-goods import without crippling the economy. And leaders seem to be unable to do much about gold imports -- the second biggest item in the import basket. In calendar 2012, India imported more than US$40 billion in gold. Recent increases in import duty are not likely to help given the practically insatiable Indian demand for the yellow metal. According to the World Gold Council, India will import 965 tons of gold in 2013 compared to 864.2 tons in 2012.

There was a time when India lived on loans and aid; the 1991 crisis that ushered in economic reforms and liberalization saw foreign exchange reserves come down to US$1.2 billion in January of that year. (Reserves stand at around US$300 billion currently.) Today, India is among the fastest-growing economies in the world and can't rely on foreign largesse.

How will the government balance the books? Experts say a strong first step would be to create an atmosphere conducive to physical exports and invisibles like information technology (IT). But this takes time. So, as a short-term measure, they say, the nation must embark upon wooing the world.

Wooing Foreign Investors

Early this year, Indian Finance Minister P. Chidambaram was hard-selling the India story to foreign investors in Hong Kong, Singapore, Frankfurt and London. "FIIs [foreign institutional investors] are betting big on the India growth story," he said while in London. "FDI [foreign direct investment] inflows will also improve."

Chidambaram has ushered in a new wave of reforms and some of the anti-FDI moves of his predecessor -- and now president Pranab Mukherjee -- have been watered down. But multinationals including Vodafone, Nokia and Shell are currently immersed in tax disputes with the Indian government. So the jury is still out on whether the climate for foreign investment has changed that radically in India.

The numbers reveal that the India growth story cannot be ignored by companies facing stagnant markets at home. Even in a bad year -- GDP growth is expected to slip to 5% in 2012-2013 -- there are opportunities. "FIIs pumped in more than US$24 billion into Indian equities in 2012," notes Dhruva Raj Chatterji, senior research analyst at Morningstar India. This is the second highest FII inflow in any calendar year into the Indian stock markets. The highest FII inflow was US$29.35 billion in 2010. In 2011, there was actually an outflow of US$0.36 billion.

Given the calamitous 2011, the last year was obviously good news for the Indian markets. "The key takeaway is that India was an indirect beneficiary of global liquidity and sentiment in 2012, which led to large inflows into riskier asset classes like emerging market funds and exchange traded funds during the year," says Chatterji. FIIs have been blowing hot and cold with India. In 2007 and 2009, there were inflows of US$17.65 billion and US$17.47 billion. In 2008, there was an outflow of US$11.97 billion. "FII inflows have been volatile and fickle over the years," adds Chatterji.

Chidambaram is aware of that. His real target during the overseas visits was FDI money. If companies are investing in plants and machinery, it is not so easy to pull out if things go wrong. FDI, by its very nature, is there for the long haul.

And FDI is the real worry, experts say. In November 2012, FDI inflows into India declined to a two-year low of US$1.05 billion. In the equivalent month of 2011, it had been US$2.53 billion. Aggregates also show no clear trend. Total inflows were US$36.50 billion in 2011-2012 against US$19.42 billion in 2010-2011 and US$25.83 billion in 2009-2010. "FDI and FII inflows are very unstable as they are highly dependent on investor sentiment, capital market performance, the country's growth, political stability and the value of the currency, among other factors," notes Bundeep Singh Rangar, chairman and founder of IndusView, which advises multinational companies on business opportunities in India.

India Tops in Remittances, But...

Yet even as Chidambaram was talking to potential investors in foreign cities, Prime Minister Manmohan Singh and President Mukherjee were playing host to a much larger party at Kochi, in the southern Indian state of Kerala. This was the 13th meeting of the Pravasi Bharatiya Divas (PBD).

Translated as non-resident Indian (NRI) day, the PBD takes place every year in January. It is a recently-discovered opportunity to celebrate -- but it wasn't exactly a resounding success, observers say. NRIs come in too many hues to have much in common. There are Indians who have been abroad for centuries (and are classified as people of Indian origin -- or PIOs). Others may have gone to the Gulf as migrant labor only a few months ago. The green card holder from the U.S. likely can't even talk in the same language as the mason from Madurai: India has 21 official languages and several thousand dialects.

Yet Finance Minister Chidambaram could probably have made a better pitch in this case, experts say. FIIs are whimsical -- fund managers tend to rush in and out to wherever in the world they see the chance of making profits. FDI, however, always wants its pound of flesh: if a company is putting one billion dollars into a soda factory, it will make sure local competitors do not receive undue favors from the government. NRI money doesn't come with such strings attached. "Remittances to India are expected to cross US$70 billion in 2012," notes Rangar. "They have been more stable and consistent and have been growing steadily."

According to the World Bank's Migration and Development Brief, officially recorded remittances to developing countries are expected to reach US$406 billion in 2012, up by 6.5% from US$381 billion in 2011. The next year will see a further jump of 8%. "The size of remittance flows to developing countries is now more than three times that of official development assistance," the brief continues. The World Bank reports that India is the top recipient followed by China (US$66 billion), the Philippines (US$24 billion), Mexico (US$24 billion) and Nigeria (US$21 billion).

FDI and FII money will together account for some US$40 billion at best this year against remittances of US$70 billion. So shouldn't there have been a grander reception at Kochi, much more hoopla, and investment advisors with a cadre of options for such money? But Chidambaram wasn't there, and Y.A. Rahim, president of the Indian Association of Sharjah, says he won't be there next year. "It was a waste of time," he notes.

"There are three clear segments of NRIs," adds Ashvin Parekh, partner-national leader of global financial services at accounting and consulting firm Ernst & Young. "First, those who work in environments where they will never get a resident visa, like in West Asia or in difficult environments like Kazakhstan. They have no option but to send their money back to India. Second are people who may migrate, but are in specific jobs or roles like the area of technology. These people typically have short-term job and income opportunities. This segment also doesn't have too much of a choice. The third segment comprises individuals who run their own businesses. Many of them first moved to Africa and then they and their families moved to the U.K., Canada, the U.S.... They possess substantial wealth and, importantly, have the option of not sending it back to India."

A Neglected Segment

According to Parekh, "The Indian government has conveniently ignored the first two segments because they don't have a choice. But it also has not focused on the third segment because of sheer lack of any thinking or planning. We are so engrossed in micro-politics that there is no proper plan or approach toward attracting any kind of foreign inflows. If there was any thinking, I am very sure we would have had proper instruments for all the three segments of NRIs."

"I've been saying for the past decade that this is an area that needs focus," adds Jayati Ghosh, professor of economics at the Jawaharlal Nehru University in New Delhi. "Most of the remittances in the past, especially in the 1990s, came from workers in the Gulf and West Asia. Since the 2000s, 50% has come from the U.S. When they come back, they get the money back in the form of a remittance. So at present there are two slightly different things at play.

He notes that one argument for why the government has ignored the Gulf money is a class factor. "These are workers of lesser skills," Ghosh notes. "They are semi-skilled and unskilled workers, including women who go as domestic maids and nurses. The government is really not bothered. Because these countries allow only limited tenure, remittances continue to be stable."

It's not all about altruism for the NRIs who have a choice: "Here's the underlying reason: The average key lending rates of central banks in the U.S., the U.K. and the European Union were 0.61% in 2012, the same in 2011 and 0.58% in 2010," Rangar says. "In comparison, the Reserve Bank of India offered 8% in 2012, 8.25% in 2011 and 6.25% in 2010. This means that the arbitrage in interest rates kept increasing over the years. It went up from 4.36% in 2008, to 5.67% in 2010 and topped 7.39% in 2012."

To be fair to the government, however, it is much easier to tap someone like London-based L.N. Mittal, who is 21^st on the Forbes global billionaires list, than to separately reach 1,000 cooks. The cooks, carpenters and casual workers were there in Kochi. They were largely people on holiday attending the PBD to find some entertainment. (According to official figures, the Indian diaspora across the world is around 25 million with 1.8 million in Saudi Arabia alone.)

Need for Innovative Thinking

But when dealing with the masses, there are other ways to make people more welcome and investment more attractive, experts note. Parekh suggests changes in the tax environment. "We can look at having tax avoidance treaties with those countries that have a large population of NRIs," he says. "What could scare all three segments is this talk of taxing the rich and inheritance tax." (Chidambaram has started a discussion on the introduction of estate duty, which was removed some two decades ago.)

Ghosh adds that payment mechanisms should be improved. "In Kenya and other countries, they are experimenting with mobile telephony as a way of transferring money," she says. "We should definitely improve the technology and reduce the red tape for the people at home to collect the money. We should also think of innovative ways of channeling these remittances toward infrastructure and similar activities that would benefit the local communities rather than simply consumption."

For Rangar, it's about leadership going back on the road. "There is no one online distribution platform to sell investment products, such as an India sovereign bond, to NRIs," he notes. "That means that road-shows are required with select NRI audiences, which are time-consuming and require political will and execution. But it would certainly produce more results and stickiness than trying to attract skeptical foreign investors whose capital can be fleeting in times when foreign funds are most needed."

India Union Budget 2013 - IndusView on BBC Radio 5

Global Investors Expectations Ahead of New Union Budget Announcement

UK Prime Minister David Cameron urges India to Open up to British business

IndusView, Friday 22 February 2013 (London): UK Prime Minister David Cameron concluded his trip to India this week to meet his Indian counterpart, Manmohan Singh, as well as the Indian president, Pranab Mukherjee, asking them to open its trade doors wider to British business.

Mr. Cameron’s trip, his second visit to India as prime minister, comes days after a similar trade mission by President François Hollande of France, underlining how Europe’s debt-stricken states were competing to tap into India, which has one of the world’s fastest-growing economies.

“Cameron recognizes that India’s got what the British and Europeans want…perhaps even need,” said Bundeep Singh Rangar, Chairman of London-based advisory firm IndusView. “An economy that’s doubled in the past six years, which will double again in the next six years to approach $5 trillion. It’s also underpinned by a demographic advantage. A majority of Indians are still under 40 years of age with increasing discretionary spending.”

At a time when the British government is struggling to get its economy growing, officials see India as a key strategic partner. Mr. Cameron said it himself: he wants the relationship between Britain and India to be “one of the great partnerships of the 21st century“. India and the UK have vibrant economic ties and the two-way trade rose to about £10.58 billion ($16.16 billion) in 2011-12 from £8.22 billion ($12.56 billion) in 2010-11. Mr. Cameron said the countries were "on track" to double overall trade to £23 billion ($35.14 billion) by 2015.

Mr. Cameron said the two countries enjoy a “special relationship,” a term usually reserved for Britain’s ties with the United States, but it is a relationship undergoing profound change. The Indian economy is forecast to overtake Britain’s in size in the decades ahead and to become the world's 5th largest economy by 2020. In a nod to how the relationship is evolving, Britain will stop giving India aid after 2015.

Investors have been clamoring for years for India to open up to more foreign investment, and Mr. Cameron complained Monday that India still had outdated rules and regulations – The government should take more steps to improve the ranking of India from 173rd position by simplifying processes for making it easier for entrepreneurs to start a business.

Another of the trip's aims is to address controversy over the recent toughening of UK visa rules. Mr. Cameron said there was no limit on the number of Indian students that could come to British universities, as long as they had an English language qualification and a place to study. The UK is a popular destination for Indian students, second only to the USA. According to the UK Border Agency, the number of student visas issued from India dropped to 32,000 in 2011 from 41,000 in 2010.

The prime minister also spoke of making Britain's visa system simpler for Indian businesses, by introducing a same-day visa service.

The Indian Prime Minister, Manmohan Singh, expressed his concerns about the AgustaWestland deal since there have been allegations of bribery, which are being investigated by the Italian authorities. AgustaWestland signed a contract to supply 12 AW101 helicopters to the Indian air force in 2010 and employs more than 3,000 people in Somerset, UK. In response, says Britain will cooperate fully in the investigations.

During their talks Mr. Cameron and Mr. Singh also agreed more co-operation between Britain and India in combating cyber attacks, including police training exchanges and research into online security.

The Prime minister visited site of 1919 Amritsar massacre in India, where hundreds of Indian civilians were shot dead by British forces. Past prime ministers have expressed their regret, but Mr. Cameron is the first to pay his respects at the site in person.

Mr. Cameron’s delegation, which includes representatives of more than 100 companies, is the biggest taken abroad by a British Prime Minister. It includes four ministers, nine members of Parliament and companies including BAE Systems, BP, De La Rue, Diageo, the British unit of EADS, HSBC, JCB, Lloyd’s, the London Stock Exchange, London Underground, Rolls Royce and Standard Chartered.

Foreign M&A investors shun India as uncertainty reigns

Doing Business in emerging markets often requires as strong a stomach as eating at a roadside food stall, but investors last year were particularly wary of India, according to a report on inbound mergers and acquisitions by law firm Freshfields Bruckhaus Deringer LLP. The report shows that while China, Mexico, Russia and Brazil all experienced increased activity last year, India suffered a slump.

The value of foreign M&A investments targeting the top 24 growth markets grew 5% last year to $162.4 billion, rebounding from a 25% decline in 2011, even as global M&A value dropped almost 5%.

In India, however, which had a relatively strong 2011, deal value fell by 42% to $10.4 billion, said the report, which used Thomson Reuters data; although the number of transactions was almost unchanged (292 deals in 2012, versus 281 deals in 2011), the average size was far smaller.

Uncertainty over taxation (especially in the wake of the Indian government's decision -- since put on hold -- to impose a tax retrospectively on Vodafone Group plc's $11 billion acquisition of Hutchison Essar Telecom Ltd. in 2007) and the implementation of new antitrust rules contributed to the nervousness. Meanwhile, a depreciation of the Indian rupee, which undermines profitability for dollar-denominated funds, reflects a more general slowdown in Indian growth. Add that to concerns about large-scale corruption, exemplified last year by the furor over the allocation of second-generation mobile licenses and coal production licenses to allegedly favored companies, and investors have grounds for caution.

"I think there are a handful of factors you can look to, to explain a loss of confidence for people investing," said New York-based Freshfields partner Matthew Jacobson. "It's not necessarily in the underlying economics, but in the stability and predictability of what the rules will be."

PricewaterhouseCoopers International Ltd.'s Sanjeev Krishan, transaction services director at the firm's Indian affiliate, agreed. "For four or five months last year there was hardly any investment by private equity funds," he said. "There was so much regulatory uncertainty and it really spooked the investor community. Minds were not focused on making fresh investments, but on the tax implications if they did make them."

Krishan said not only inbound financial investment but also deals by strategic investors, with the possible exception of Japanese corporates, had dried up. While there were a number of very small deals, many of them venture investments worth less than $10 million, large transactions were elusive. With high prices and many previous infrastructure investments struggling with debt, and with the coal-sector scandal still reverberating, he added that people "did not want to touch infrastructure with a bargepole."

The statistics bear him out. According to IndusView Advisers Ltd. CEO Bundeep Singh Rangar, who advises multinational companies on opportunities in the Indian market, the number of deals in the Indian energy sector, for instance, has dropped dramatically. Deals in the sector fell from $837 million in the third quarter of 2011 to just $41 million a year later.

"The big-ticket deals will come from guys who want to buy a big mobile operator or a big energy company, which are expensive deals," Rangar explained. "But their boards are going to be cautious, and say we don't have clarity on the taxation and let's be sure we're buying into an economy that's continuing to grow."

He said financial investors were also worried about potential exits, because a depreciating currency could turn a rupees profit into a loss in dollars.

Yet valuations have not fallen in line with investors' expectations, Rangar said. "Indian entrepreneurs just need a bit of a reality check."

Transactions in some sectors have continued. In the IT sector, especially with the growth of broadband delivery, transaction values more than doubled from $503 million in the third quarter of 2011 to $1.3 billion a year later.

Waajid Siddiqui of Hogan Lovells LLP suggested that the proliferation of smaller deals might also be a natural development as the market matures, with both Indian and foreign investors shifting their focus from energy and real estate deals in favor of media and financial services, for example.

"These may not be the intuitive sectors for big transactions," he said.

A number of big private equity firms have been long-term investors in India, although none of those approached for this article -- 3i Group plc, Blackstone Group LP and Warburg Pincus LLC -- would comment. Last summer 3i CEO Simon Borrows said the firm was "cool on India" and likely to remain so "until there's greater certainty around the politics and the economy."

Warburg Pincus' website shows the firm made at least three investments in the country last year, two in retail and small business loans and one in classified advertising.

Taxation issues, and the long drawn-out battle to open the national market to large foreign retailers, have both been entangled in the country's perma-deadlocked coalition politics. However, Indian finance minister Palaniappan Chidambaram has indicated he will postpone the introduction of a wide range of general tax avoidance rules and may consider exempting some foreign investors entirely.

Chidambaram has also attempted to sort out the Vodafone mess, which has direct implications for billions of dollars worth of similar deals between two offshore shareholders, often structured through vehicles in Mauritius. Reports have made conflicting predictions, with some expecting him to propose exempting -- or "grandfathering" -- existing deals and to subject only future transactions to the new tax laws, but others suggest the government could reach a deal with Vodafone to waive the interest and late-payment penalties portion of its $2.6 billion tax bill and accept a reduced amount for the initial sum.

Meanwhile, antitrust legislation, which spooked investors because of the likely delays in completing deals, has turned out to be less of a worry than initially feared.

"It is not clear that the introduction of mandatory merger control with effect from June 2011 has affected the appetite to do deals or deals of a particular size," said King & Spalding International LLP lawyer Suzanne Rab, author of "Indian Competition Law: an International Perspective".

"Fears that the requirement to suspend implementation of transactions for up to 210 days until the regulator made a decision on a proposed deal do not seem to have been borne out. In practice, the Competition Commission of India has decided on a merger case well within that long stop time frame."

In fact, the government has also proposed shaving about a month off the merger process, by reducing the waiting period for deemed approval from 210 to 180 days, but Rab pointed out that the government may still spring surprises on mergers in certain sectors by changing the tests and thresholds for whether a deal should be subject to automatic antitrust scrutiny.

"Banking, pharma and regulated utilities have been mooted as particular sectors where modified thresholds might be adopted," Rab added.

As the government tries to remove at least some of the uncertainties, with what Freshfields' Jacobson calls "some of the right body language," optimism among dealmakers is beginning to return.

To spur growth, the Bank of India cut its key interest rate on Jan. 29 from 8% to 7.75% after adjusting its 2012-'13 financial year GDP growth forecast down slightly to 5.5% and predicting the next financial year will see growth of 6.5%; it has also emulated China by reducing the amount of cash Indian banks must set aside as reserves.

"India always likes to compare itself with China when it comes to economic growth," said IndusView's Rangar. "China's engine seems to be restarting a little bit, so India will be keen to follow."

Caution remains the watchword, however, not least because of India's perennial political uncertainty. Will the individual states implement the federal government's decision to open the market to foreign retail chains? Will the upper house of parliament agree to reforms pushed through the lower house? And will investors be able to rely on any decisions by the current government with elections due in a year's time?

PwC's Krishan warned: "It will take time before we recover. I'm not sure we've done enough to incite strategic investors to come back."

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Reserve Bank of India Cuts Rates To Boost Growth, Emulating China

Borrowing a leaf or two from Chinese policy makers to spur economic growth, the Reserve Bank of India (RBI) decided to reduce its key interest rate to 7.75% from 8% for the first time in nine months as well as reduce the amount of cash Indian banks must set aside as reserves.

India’s central bank reduced the cash reserve ratio (CRR), or the money commercial banks have to retain in the form of liquid assets in proportion to their deposits, from 4.25% to 4%. The move is expected to provide $3.35 billion of extra cash for them to lend. Last November, China cut the amount of cash that banks must set aside as reserves for the first time since 2008. Its key interest rate was dropped more than 50 basis points last year to 6% from 2011. Its GDP forecast is now at 8.1% for 2013 compared with 7.7% in 2012.

The RBI lowered the growth projection for the current fiscal to 5.5% from 5.6% projected earlier. It has also cut the growth forecast for the next financial year to 6.5% from 6.6%. The International Monetary Fund (IMF) lowered its projections for India’s economic growth to 4.5% for the 2012 calendar year from its earlier estimate of 4.9%. The RBI’s last cut on April 17, 2012 by 50 basis points, in an effort to boost growth, has yet to show results.

“Spurring growth in is back on the central bank’s agenda that had been obsessed with fighting inflation and controlling prices for the past two years,” said Bundeep Singh Rangar, Chairman of London-based advisory firm IndusView. “The rate cut and other reforms should act as turnaround catalysts as India hopes to emulate China whose growth is back on track as a result of its central bank’s policies.”

The RBI said that it has limited room for easing monetary policy to support growth as it is worried about the wide fiscal and current account gaps, on top of a likelihood that inflation may not ease significantly next fiscal year.

Inflation based on wholesale prices declined marginally to 7.18% in December even though rates of food items like rice, wheat, pulses and potato showed a rise. It is still, however, above the RBI's 5%-6% target. India’s inflation rate last month compares with 6.5% in Brazil, 6.1% in Russia and China’s 4.1%.

The Wholesale Price Index (WPI) was 7.24% in November and 7.32% in October. Industrial output growth rate had contracted by 0.1% in November, from a robust 8.3% in October.

“The rate cut was much needed as the economic growth is moderating and the industrial production is decelerating,” said Rangar. Government data released January 11 showed that India’s industrial production contracted 0.1% from a year earlier in November, the sixth time it has shrunk in nine months.

Notwithstanding the challenges on macroeconomic front, Indian business owners’ confidence witnessed an improvement for the second consecutive quarter, owing to the government's reforms push and easing inflation, says research firm Dun & Bradstreet.

For the first quarter of this calendar year, the Dun & Bradstreet Composite Business Optimism Index stood at 146.8, registering an increase of 4.3% compared to 140.8 in the fourth quarter of last year. On a year-on-year basis, however, the optimism for the coming three months still represent a decline of 6% compared to corresponding quarter last year.

The government has recently taken a number of reform initiatives such as opening the multi-brand retail and aviation sectors to foreign direct investment (FDI), hiking diesel prices and capping the number of subsidized liquefied petroleum gas (LPG) cylinders. It also decided to raise the FDI cap in insurance to 49% from 26%.

On The Turn - The Economist

IF TATA CONSULTANCY SERVICES (TCS), an Indian outsourcing firm, wanted to impress its customers with its dedication, it could do no better than take them to its engineering-services division in Bangalore’s Electronics City. In one room sit rows of young men working on computer simulations of crashing and accelerating cars. Next door is a laboratory full of engines and parts from TCS’s client, a big Detroit carmaker. It is festooned with garlands of bright orange marigolds to celebrate Dussehra, a Hindu festival. Next to one car engine is a shrine to Durga, a many-armed goddess. Celebrating everyday tools is part of the festival. "We worship the car engines,” explains one of TCS’s engineers. He sends photographs of the ceremony back to Detroit each year. The American car bosses, he says, are a little surprised but delighted to see their engines being prayed to.

However, they like to keep quiet about the work that gets done in India. TCS is not allowed to name its customer (clue: Bruce Springsteen, Prince and Don McLean have all written songs about its cars). Ten years ago TCS, part of the Tata Group, which includes Tata Motors and Tata Steel, did only very basic work for the car firm. Now it tests thousands of engine components, using computer models, and suggests improvements for their design.

For the offshoring of manufacturing China is by far the most important destination, but in services most of the work has gone to India. Of the ten leading cities for offshoring, according to "The Handbook of Global Outsourcing and Offshoring”, six are Indian. In 2008 India claimed 65% of all offshored IT work and 43% of offshored business-process work. Brazil, Russia and China are also important, and by 2011 as many as 125 offshore locations were offering IT and BPO services, but no other offshoring destination has come close to India, with its huge supply of IT and engineering graduates and its English-language skills.

Indian ingenuity

The painstaking work of Indian programmers has gone into innumerable Western products, from cars to Disney cartoons to Microsoft’s Windows range of software. In 2004 Indian engineers in Mumbai created a virtual Oscar figure for that year’s Academy Awards which melted away like the liquid metal machine in "Terminator 2: Judgment Day”. Nielsen, a ratings firm on which America’s media industry depends, in turn relies heavily on TCS for its data.

The killer application for the Indian "bodyshops”, as they were originally known, was providing labour to perform simple IT tasks at a very low cost. One of their first tasks was to check that the so-called millennium bug would not cause chaos in millions of computer systems at the end of 1999. Indian firms also saw rapid growth in business-process outsourcing (BPO), defined as the export of routine work such as customer care or insurance-claims processing, though IT services still have much the biggest share. Now, as demonstrated by TCS and the car giant, India’s outsourcing vendors are taking on far more difficult tasks for multinationals in many fields, such as testing new products, design and complex analysis.

The panic about Western jobs arose because whereas the traditional Western outsourcing providers, such as HP or Logica, used to employ mainly locals, the young Indian companies took the work offshore. The big Western firms themselves then rushed to hire in India; IBM is now India’s second-largest private-sector employer, just after TCS. Companies can choose to offshore IT and back-office services either directly to a firm headquartered in India or "under the covers” via a Western firm with a big offshore presence, explains one consultant.

Hackett, a Florida-based firm that advises companies on outsourcing, estimates that over the period from 2002 to 2016 offshoring is likely to claim a total of 2.1m business-services jobs (including IT, human resources, procurement and finance) at big American and European companies. Still more jobs will have been lost in business processes, including call centres and claims processing. Hackett says that about 150,000 business-services jobs a year are still being shifted from Europe and America; the offshoring of services remains in full swing. But the firm also predicts that the migration of services to India and to other offshore locations such as China and Brazil will slow down after 2014 and stop entirely by 2022.

The main reason for this startling prediction is that most of the easily offshorable jobs have already gone. Pralay Das, an equity analyst with Elara Capital in Mumbai, estimates that American and European banks and financial-services firms have already offshored about 80% of what they can reasonably send to India and other offshore locations.

A second reason is that a lot of the jobs that might have been offshored by Western firms in the coming years have already been wiped out by productivity improvements. New jobs in Western economies tend to be of a more demanding, higher-level kind and are less likely to be sent abroad.

All this has sent the Indian IT and BPO industry into a funk. There are fears that it will either stop growing or be forced to accept much lower profit margins as demand for its services falls. It is clear that for Indian IT vendors, demand for traditional outsourcing, meaning routine software and application development and maintenance, is already levelling off, says Pankaj Kapoor, an equity analyst at Standard Chartered Bank in Mumbai. The work used to roll in at you, explains an executive at one large Indian vendor; now you have to go out and search for it.

It is not only that the offshoring of jobs is reaching saturation point, but also that Western companies, after a decade of experience, are changing their attitude to the practice. KPMG, a global consulting firm, even announced "The Death of Outsourcing” in a research paper last year. After all, offshoring important tasks to an outside provider is quite a risky thing to do and carries significant hidden costs. Companies in services as well as manufacturing are now far more aware of the pitfalls. Until recently the most important reason for companies to send large chunks of important business functions abroad was to drive down costs. A decade ago wages in emerging markets were a tenth of their level in the rich world, an opportunity too good to miss. During the recession of 2008-09, says Cliff Justice, KPMG’s leading expert on outsourcing and offshoring, the race offshore accelerated, and more higher-value and complex work was sent overseas too.

But now many companies are finding that they lost their connection with important business functions, says Mr Justice. At the same time the cost advantage that drew firms offshore in the first place is disappearing. Salaries for software engineers are going up rapidly and inflation is high. For IBM, says Bundeep Rangar, chief executive of IndusView, an advisory firm, the total cost of its employees in India used to be about 80% less than in America; now the gap is 30-40% and narrowing fast.

The industry also continues to have a huge labour turnover (see chart 3), which can mean quality problems. That is chiefly because the vast majority of the work being offshored is repetitive and dull, and often well below the qualification levels of the people doing it. Increasingly, local industries such as retail, insurance and banking are offering more interesting jobs with better career prospects than much of what is on offer in IT and business-process outsourcing.

To be sure, much of the work that has gone to India in recent years is more demanding, but in that part of the market the cost of labour has soared. Good analysts and product developers in India and China are few and far between, so pay for such jobs has been rising by up to 30% a year. According to Mr Justice, pay for workers with such skills in India and China can be even higher than in America or Europe, with all the disadvantages of being several time zones away from head office.

Reasons why not

When outsourcing abroad was still relatively new in the 1990s, the idea was that outside partners would be better than insiders at IT and back-office work because they were specialists. And even if they were no better at it, at least they were a lot cheaper. This line of thinking is known inside the industry as "your mess for less”. It has now become clear that outside firms usually cannot do boring back-office work any better and often do it worse. Many offshore outsourcing relationships have proved disappointing and some have ended in lawsuits.

Some chief executives found that outsourcing relationships turned sour after a few years. The boss of one global European engineering firm points out that outsourcing partners are mainly concerned with their own profits. "They give you a good deal for two to three years and then they suck your blood,” he says. A firm that outsources a lot of IT also risks losing its expertise in a key area and can get trapped in legacy systems, he adds.

Some American firms that have outsourced a lot to India and elsewhere are building "shadow capability” in services in their home countries, says KPMG’s Mr Justice. Using unofficial budgets, he says, some chief information officers are hiring people back home to do the same kind of work that their offshore teams do, just to have them next door. Only a small number of firms have gone to such extremes, yet the fact that it happens at all indicates the value that firms place on proximity, says Mr Justice. And some of the biggest original pioneers of outsourcing, including General Electric and General Motors, have already taken the plunge and brought their IT work home.

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