International Herald Tribune
A closer look at India
Thursday, February 8, 2007

HONG KONG: I've been bullish on India for the past 17 years, but now I'm nervous. One does not need to be in the country to be deluged by "India rising" triumphalism. The BBC World Service is providing an endlessly repeated series on the subject. Morgan Stanley's star economist Stephen Roach has followed the crowd and returned from the subcontinent with "great enthusiasm" for the "magic of its entrepreneurial spirit." Fortune magazine advises us to look out for more multibillion-dollar acquisitions by globalizing Indian companies.

A resurgence of Indian pride is understandable after decades when India was ignored by the Western media and viewed with disdain by fast-growing East Asia. Such a boost to national self- confidence must be of long-term benefit and create a dynamic of rising expectations.

But there are too many signs of an overconfidence that looks more and more like hubris. If suddenly deflated it could undercut the basis on which Indian optimism is built — that India can compete in a globalizing world and one day equal China in economic weight.

The hype about ethnic Indian talent is a reminder that a decade ago much the same thing was being said of ethnic Chinese. Back then, the world was caught up in the "miracle" of Southeast Asian growth, fueled, it was said, by the business skills and networks of overseas Chinese. Success was attributed to the culture of Confucius, who believed in a hierarchical society directed by a wise elite. "Asian values" were equated with Confucian ones. The "global Chinese" story — while not a myth — was overblown and finally punctured by the Asian economic crisis.

There are other reasons to worry now about the India hype. It is all very well for Indians to express racial pride over the success of Mittal in gaining control of European Arcelor to become the world's biggest steelmaker. But why, it might be asked, has the Indian-born, London-dwelling Lakshmi Mittal invested so little in India itself? And where would India be if its markets were as open as those of Europe, an openness which enabled Mittal to buy Arcelor?

The Tata Group's acquisition of the Anglo-Dutch steel group Corus raises other concerns. Maybe there are synergies and Tata can acquire technology. But, again, one may ask why Tata, a 100- year-old family conglomerate, is investing so heavily outside India when India offers the greatest growth potential of any major steel market. Its current steel output of 44 million tons is one-tenth that of China.

Contrast the effort by Tata to buy into the international big league with that of Posco of South Korea. Its rise from nothing to become the world's third largest producer and a leader in steel technology was achieved through organic internal growth and investment in research — just as Japan's was a generation earlier. Although Posco was protected by the government, it was always under pressure to produce quality steel at prices that kept South Korea's shipbuilding and other steel-using industries competitive.

Indian overseas acquisitions have been possible not so much because the acquirers are especially rich or dominant in their industries, but because it has been so easy to borrow. Indian companies are the beneficiaries, for now, of the same global liquidity bubble that is producing multibillion-dollar private equity takeovers and has helped the Indian stock market rise fourfold since 2003.

Thus, Indian companies are investing more overseas than foreigners are investing in India. Of course some acquisitions are in fields where India does lead — software and generic pharmaceuticals. Some are driven by business logic. But others do more to swell Indian pride than boost the Indian economy.

At home, Indian investors have been helped by an unsustainable rate of growth in bank credit — 20 percent last year. The fact is that India remains a capital-short country. The growth of its gross domestic product has been stimulated by a rise in the investment rate from around 25 percent of GDP to 30 percent. But even more is needed to sustain growth, and even the present rate may prove hard to maintain when global conditions become tighter.

As it is, India's private-sector savings surplus has fallen sharply while the public-sector deficit remains very high. The serious deterioration now occurring in the current account will probably crimp India's growth, push interest rates back up and prick the stock bubble.

Enthusiasm about India's global role as a manufacturer, given its supply of labor and vast domestic market, is fine in theory, but it must be tempered by the reality of high tariffs and a huge manufacturing trade deficit. India is more dependent than ever on exports of services and raw materials, and on workers' remittances.

Long term, I remain bullish on India. But it is time for a reality check.