All entries for Wednesday 17 August 2005

August 17, 2005

India, China…Tortoise, Hare?

Asia Times, 18.08.2005

Consider, for a moment, a few haphazardly scattered jigsaw pieces of the India-China puzzle. First, a report on August 15 suggested that the Oil & Natural Gas Corporation (ONGC), India's flagship public sector company for overseas acquisition of energy assets, had submitted a US$3.2 billion bid for Petrokazakhstan. Second, the total number of overseas acquisitions made by Indian companies amounted to 42 in the first half of 2005, compared to 60 in the entire year of 2004. The value of the deals was recorded at $948 million.

On the Chinese side, a recent edition of The Economist contained a cover story on 'How China runs the world economy', examining the impact of soaring Chinese demand on global commodity prices and Beijing's recent revaluation of the yuan. But there was also a reality check – reports came of the failure of CNOOC's $18.5 billion takeover attempt of Unocal.

The idea that Chinese companies will buy the world has both aggravated xenophobia in the West, and been a pipedream for the cadres in Beijing. Several failed acquisition attempts in recent months come to mind: Haier's exit from the Maytag deal when Whirlpool entered the fray; China Mobile's loss to a UAE-based company in its takeover bid for Pakistan Telecom; or Minmetal's $7 billion attempt to buy Noranda fizzling out as a "damp squib". Among other debacles to hit China Inc, the lockout at the white goods maker Kelon, after the arrest of its top management for financial irregularities, instantaneously comes to mind.

The $1.75 billion purchase of IBM's PC division by Lenovo earlier this year generated much kerfuffle as well. However, this was more a sign of Lenovo's shrinking profit margins back home than the result of a distinct corporate vision. It could be argued that the move could spell trouble for the Chinese PC maker, as competitors such as Dell and HP were squeezing IBM, which is why it moved almost entirely into consulting by selling its underperforming PC arm. Moreover, Gartner predicts a 2–4% fall in global PC sales in the years to come, which means that Lenovo could be fighting for space within a declining market. Lenovo shares have fallen by 23% since the takeover.

Scholars such as Yasheng Huang (MIT) and Tarun Khanna (Harvard) have long argued about the better long-term prospects of India's economy, which is based on its strong domestic companies, vs China's primarily FDI-based growth. It could indeed be argued, using the aforementioned examples, that China's own companies are on weak legs. Although the country ranks above India on the global FDI confidence index, its stock markets fell by 15% in 2004, making it one of the poorest performers in the world. It fared the worst among all countries tracked by The Economist for two years running in 2004. On the other side of the spectrum, the Indian market grew by 20% over the same period. The Bombay Stock Exchange is at record highs of around 7,800 these days, despite $67 a barrel crude prices and the recent flood in Mumbai.

Shanghai Stock Exchange CEO Fang Xinghai put it aptly, "Why do you want to visit the trading floor? There is nothing to see." The fundamental cause of the fiasco in China's equity markets (the bear market on Chinese bourses is now four years old) has been the mismanagement, manipulation and constant intervention of political circles in the market's operations, which has effectively prevented firms from listing by merit and with freedom. As a result, confidence among investors has been terminally shaken. In February, authorities at Baosteel were forced to delay its initial public offering (IPO) worth $3.2 billion. Compare that with the recent announcement of listing by Sasken Communications, a Bangalore-based firm, whose IPO was oversubscribed by more than a dozen times.

It is common knowledge that business enterprises in China have a much better atmosphere to flourish than in India. But apart from the issues of good governance – better roads, an uninterrupted power supply, a low tax regime and flexible labor regulations – this business-friendly atmosphere also has certain dubious characteristics. These include an undervalued currency facilitating exports; cheap and unlimited credit for "blessed" firms; no default on non-payments for the same (as shown by the country's still huge nonperforming asset burden); low-priced land; subsidies; unpaid supplier bills waived and, ironically, (in light of the country's view of itself as "the worker's state") quite an oppressive labor regime.

India presents an interesting contrast – the physical infrastructure is creaky at best, the labor regime is inflexible, corporate taxes are still too high by ASEAN standards, and a demented preference policy for small firms still continues. But Indian companies are faring well in spite of these obstacles. Why? There are two primary reasons. First, democratic India retains an element of the rule of law, whereby conditions are the same for all firms, resulting in a reasonably competitive environment. Second, the government has wisely refrained from intervening in "new sectors" such as information technology, business process outsourcing and to a lesser degree, pharmaceuticals. Relaxation of overt regulations has been continuous, albeit slow.

To be sure, plentiful problems remain in both systems, and whereas "firms are often kept from bankruptcy by officialdom" in China, firms are deterred from taking risks in India, as the bankruptcy process takes nearly a decade. An even greater problem comes when we compare the two, since the successful firms in India and China almost never operate in the same sectors. But a few portrayals ought to deliver the point.

Take Huawei Technologies as an example. Here we have one of China's burgeoning telecom equipment companies, which recently announced a $100 million investment in a research and development center in Bangalore. Although its sales have zoomed to $3.8 billion in 2004 from $1.9 billion in 2000, its operating profit margins declined from 24% to 18% over the same period. Similarly, while sales of China National Petroleum Corporation for the first half of 2004 (the last time period for which information is available on the company website) increased by 4.7 billion yuan (US$580 million) compared to the first half of 2003, operating profits declined from 24.5% to 23.7% over a period when global crude prices have been soaring steadily. The corresponding figure for ONGC rose from 20% at the end of the financial year in March 2004 to 23% in March 2005. This was in spite of the damage to ONGC's numbers from numerous excise duties and taxes extracted by the Indian government, and the company's insistence on not passing on the increased cost of crude to consumers. As for the top IT companies in India like TCS, Infosys and Wipro, they operate at margins well in excess of 30–35%.

It is not for us to judge yet whether the tortoise has finally overtaken the hare. Both countries have different socioeconomic models, and just how different they are is becoming more conspicuous – the pieces of the puzzle are coming together. China continues to attract $60 billion of FDI each year, has soaring exports and an economy that grows in excess of 9% a year. But most of what is "Made in China" is in fact made by multinationals originating in foreign countries. Chinese companies are still finding their feet, despite the heavy backing they receive.

India receives about $7 billion in FDI, has a small but growing foreign trade ratio to GDP and grows at around 7% a year. Yet its companies, somewhat strangled by slow-moving politics back home, are prospering. Is it because their entrepreneurship has been nurtured by India's free credentials, instead of being "guided"? Hypothetically, if governance improves with time in India and the government in Beijing is not able to sustain its social and economic engineering indefinitely (both the most likely scenarios out of all the possibilities), where will the fate of India Inc and China Inc ultimately lie?

We return again to the story of the tortoise and the hare – and we all remember how that one ends, don't we?


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