The recent statement from Leif Lybecker Eskesen, HSBC’s chief economist for India, describing the country as "a gasping elephant" would have been unthinkable a few years ago, as would have been the comment from Jim O'Neill, former chief economist at Goldman Sachs and the man who coined the famous "BRIC" moniker - that India was the "biggest disappointment" of the BRIC nations. An interplanetary traveler visiting Earth in the 2009, shortly after India had weathered the global financial crisis with a sense of relative calm, and then returning sometime in the first half of 2012 would be encountering a completely different country, particularly if the newspaper headlines were to be believed.
Much of the negativity, however, has been justified. India's GDP grew a mere 5.3 percent in the quarter compared to a year earlier, its slowest quarterly pace since early 2003 and below economists' forecasts of 6.1 percent. For those used to the 8 percent the country had registered in recent years, it certainly felt like the growth party was over. This was the hangover setting in. As of the time of writing, the rupee had breached the mark of 56 to the dollar, and did not look like it was headed the right way anytime soon. India’s trade deficit in April amounted to $13.48 billion, with oil imports which account for the single largest chunk of India’s import bill, standing at $13.9 billion. When you combine all these with stifling red tape, a lumbering bureaucracy, and some distinctly investor-unfriendly moves by the Congress-led coalition government of Manmohan Singh, the picture begins to look grim indeed.
The government has attributed much of the slowdown to the falling growth seen elsewhere around the globe. But India’s current situation owes much to problems at home, and has been on the horizon for a while now. "There is no point blaming the Greeks or the Spaniards for India's economic woes. Nor are the usual suspects, the rain gods, at fault this time," noted the Economic Times, possibly the most influential business newspaper in India. "Growth slowdown is essentially homemade." New Delhi has been spending massively on welfare programmes, which, while politically popular, have widened the budget deficit and exacerbated inflation. Oil imports (as stated above) have widened the trade deficit, weakening the rupee and pushing up the cost of imported goods. To rein in inflation, the Reserve Bank of India doubled benchmark interest rates over a period of two years – from 4.25 percent in January 2010 to 8.5 percent in January 2012 – and this has led to a drop in the pace of investments in the infrastructure and manufacturing sectors. In April, Standard & Poor's downgraded India’s rating from stable to negative, citing “lower GDP growth prospects and the risk that its external liquidity and fiscal flexibility may erode.” Clearly, the alarm bells have begun ringing.
Much of the blame is laid at the feet of the current government. “Certainly six months back, if not earlier, there was realisation that the eurozone crisis and (the) weakening of the Indian economy (deficit and inflation included) would have an impact on India,” says Jyoti Sagar, founder partner at J. Sagar Associates. “However, since November 2011, the acts of commission and omission in governance, or the lack of it, have clearly and disproportionately impacted India.” The Indian authorities have been accused of paying scant respect to Indian firms, while displaying a condescending attitude towards investors. Additionally, it has made no moves toward reforms of any variety as corruption and red tape have run unchecked. Examples like the scandal surrounding the sale of 2G licences and the Vodafone case, which has led to a Finance Bill containing extraordinary retrospective provisions that go back 50 years, have not helped either. “From purely a lawyer’s perspective, the casualty has been the belief that we are a country governed by the rule of law,” says Sagar.
LEGAL WORK IMPACTED
According to Sagar, the gloom pervading the Indian economy has led to market sentiment being definitely bearish, especially when compared to the bullish waves of the recent past. Another outcome has been a fall in foreign investments, both financial as well as strategic. “This is characterised by lower (and perhaps more realistic) valuations in the M&A and private equity space, as contrasted by the more bloated valuations one would witness up until four or five years ago,” he says. “While mid market M&A activity is still prevalent, it is the transactions having a larger ticket size which are only few and far between and less forthcoming.” Sagar adds that there has not been any significant capital markets activity.
Rabindra Jhunjhunwala, partner at Khaitan & Co, agrees with regard to the capital markets work. “With the economy being what it is, there has definitely been a dent,” he says. “Investor confidence is low, which has resulted in IPOs being stalled, and hence the volume has dropped significantly, even though clients are still interested in listings.” According to Ashwin Ramanathan, partner at AZB & Partners, part of the reason for the slowdown in capital markets work is that IPO promoters have very little incentive to go through with them. “Companies are currently waiting for markets to turn,” he says.
Jhunjhunwala adds that a lot of the firm’s capital markets lawyers are now helping out on the M&A side, which seems to be awash with work. “There is so much buying happening, and it is pretty much across all sectors,” he says. “We honestly do not know how to handle all this work.” Arun Balasubramanian, a Singapore-based partner with Linklaters’ India practice, notes that his firm has seen a fall in plain vanilla transactions, and an increase in more complex structured deals like IL&FS Transportation Networks Ltd (ITNL), which through its Singaporebased subsidiary, became the first Indian company to raise money by issuing yuan-denominated bonds in a standalone offering. He adds that an interesting trend has been the continued appetite of Indian companies to acquire assets overseas, despite the prevailing global economic conditions, and cites auto parts maker Motherson Sumi’s acquisitions in Europe. “Also, there is a great deal of potential for M&A activity in the technology and healthcare sectors,” he adds.
Ramanathan also says that in a way, the larger law firms are hedged against market turbulence since they can provide a wider range of services. “As the capital markets work reduces, our litigation side is positively booming,” he says. “What is different now from other financial crises is that clients have much less patience when it comes to initiating litigation. They are willing to pull the trigger much earlier.” Sagar says that his firm is seeing continuing activity in the dispute resolution sphere, apart from the regulatory and infrastructure space, “given the uncertainty in the regulatory climate and contractual defaults”.
RETAIL TO THE RESCUE?
Lawyers agree that one of the brightest spots in India’s road to recovery is the introduction of foreign direct investment into the country’s massive retail sector [See box on P. 34] - something the government has been unable to carry out in full in the face of fierce opposition from across the political spectrum and from traders' unions. The annual sales of the sector amount to an estimated $450 billion, with nearly 90 percent of the market being controlled by tiny family-run shops. The country recently allowed 100 percent FDI in single-brand retail subject to certain sourcing restrictions, but no ownership in multibrand retail. “The opening up of the insurance and retail sector to foreign investors will certainly augur well for the industry and investor sentiment alike,” says Sagar.
Jhunjhunwala agrees. “Liberalisation is key, and I expect it to happen in a number of sectors, including retail and insurance,” he says. “These are hard decisions that the government has to take.” He adds that just a “few small things” in the near future would be enough to turn around India’s fortunes. “We need clarity on the telecom issue, and we need clarity on the issue of tax,” he says. “(And) all these will happen; I am positive.” Another positive for him is the fact that many countries around the world are experiencing slowdowns as well. “The West is presently having a hard time too,” he says. “This is clearly a time of opportunity.”
According to Balasubramanian at Linklaters, one trend he is seeing is more foreign investors entering into JVs with Indian counterparts instead of going for outright acquisitions. “This tends to benefit both parties,” he says. “The Indian partner gets the knowledge and the knowhow, while the foreign partner gains exposure to the Indian market.” He expects to see liberalisation in sectors like retail, and hopes for greater clarity on ongoing tax issues such as Vodafone’s and “sensible regulations” in areas like transportation and aviation. “However, you need to keep in mind that this is a sentiment-driven market,” says Balasubramanian. “That needs to change.”
For Ramanathan at AZB, one of the biggest pluses about the current situations is that assets have become cheaper. “Currently, as capital is hard to come by and debt is very expensive, valuations have become more realistic,” he says. “These present great opportunities for investors.” From a law firm’s perspective, he says that one of the strongest areas of growth has turned out to be the competition law practice, apart from the spike in litigation. However, he cautions that much will need to happen for India to come out of the woods. “All the problems that are being discussed need to be resolved,” he says. “A lot needs to be done. Investors are not convinced that this is the best time.”
THE BRAND REMAINS STRONG
It is worth noting that despite all the headlines, not all the news coming out of India has been depressing. In March, India attracted FDI of $ 8.1 billion, the highest monthly inflow ever recorded, even though much of it was due to the $ 7.2 billion Reliance Industries- British Petroleum (BP) deal announced in February 2011, which saw BP picking up a 30 percent stake in Reliance Industries' 21 oilfields. According to Sagar, despite its recent troubles, the fundamentals of India “as of now are still sound, be it the demography and be it also democracy. Both (of) these are long term positives. Foreign investors should see that side of the coin too. Bold and positive moves by the government would provide the credibility and the spark that we need urgently to put to work our inherent strengths as a country.”
Jhunjhunwala at Khaitan concurs, but says that while the last few months might not have heralded the end of the road for “India Shining,” it has clearly had an impact on the way the India brand in perceived among investors, particularly in the aftermath of the Vodafone tax case. “The announcement of the retroactive General Anti Avoidance Rule (GAAR), slated to come into force in 2013, had a lot of people asking: ‘What exactly did the Finance Minister have in mind?’,” he says. “Is this the way things happen in a democracy, in a country governed by the rule of law?”
Nevertheless, he sees some positive trends in the next year or so. One is the growing number of outbound transactions, as cashrich Indian companies take advantage of cheap assets overseas, particularly in natural resources. Another trend is that of PE funds selling to other PE funds. “Since exits are currently difficult as IPOs have stalled and funds that have raised money looking for assets to purchase, I see a lot of acquisitions of PE assets by other PE funds,” he says. Jhunjhunwala also sees competition law as a growing practice area for firms as awareness increases, and M&As continuing to be their biggest revenue generator. Another promising area, he notes, is infrastructure, where India has penciled in an investment of about $1 trillion. The country plans to award 9,500 kms of road projects, and commission three new airports in the fiscal year to March end in 2013.
Balasubramanian sees a lot of opportunities emerging from the so-called “South-South trade.” “I expect to see a lot of economic activity between India and Africa, Australia and Southeast Asia, and maybe Brazil, focused at least on the near term on resources,” he says. “This should give rise to interesting transactional opportunities.” Additionally, the larger companies with access to capital will continue to look at attractive assets overseas, he says, citing the attempt by Tatas to acquire Cable & Wireless as an example.
Sagar, however, has words of caution. “We have to avoid the temptation (and the arrogance) that we will be an attractive investment destination irrespective of what we do or do not do,” he says. “Unfortunately, the world increasingly sees us in negative light. The perception is that we have red tape and not a red carpet for foreign investment. Add to that, we are not considered a business-friendly country… Now the recent threat that India’s rating could be pegged below investment grade does not really help.”
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