Commentary

Indian Investments Abroad up from 94th in 2000. Even among the

developing economies, Indian investments
are modest as the country does not figure
in the top 15 outward FDI countries.
What Explains the Boom? Of course, these are figures for 2005, and
Indian acquisitions abroad have exploded
in 2006 with big ticket items like the Tata-
The Tata-Corus and Videocon-Daewoo deals are the most recent Corus and Videocon-Daewoo deals. This
and largest of Indian investments and acquisitions abroad, but the is likely to make India leap in the rankings
trend has been in evidence since the early 2000s. There are for 2006.
domestic reasons and international factors propelling Indian After netting out investments between
outward flows; and industry specific factors have also contributed China and Hong Kong, the two countries
together would account for a substantial
to the trend. Success, however, is not guaranteed. share of capital outflow from the develop-
ing economies, that is, many times the
R NAGARAJ exception). Cumulative capital outflow value of investments from India. While
from India between 2000 and 2005 was much of China’s investments are in search

T
he year 2006 will probably end on
a unique note, with private capital
outflow from India exceeding
inflow of foreign direct investment (FDI).
According to Dealogic, a consultancy firm
tracing cross-border investments, in the
first nine months of 2006, investment
outflow from India was estimated to be
$7.2 billion, up from $4.2 last year
(Financial Times, October 3, 2006).
What started as a trickle in 2000 has
grown into a flood with Tata Steel cata-
pulting itself to become the world’s fifth
largest steel manufacturer by acquiring
the Anglo-Dutch company, Corus. This
has been closely followed by Videocon
Industries acquiring Daewoo’s electronics
manufacturing facility in South Korea
to become the self-proclaimed “Indian
Multinational”.
According to news reports, prior to the
Corus deal the Tata group alone had made
28 overseas acquisitions since 2000, in-
vesting $1.4 billion in eight major acqui-
sitions spread across the world in indus-
tries ranging from steel to beverages (Wall
Street Journal, October 7, 2006). The
recently released World Investment Report
2006 notes that India is not alone in
experiencing a boom in outward flow; this
is true of developing countries as a whole.
However, while most of the investments
from developing countries are into other
developing countries and in services, recent
Indian acquisitions have been, one,
mainly in the advanced economies and,
two, the acquisitions are now concentrated
in manufacturing (software being the
$8.1 billion.
Since 2001, Indian firms have made 30
to 60 overseas acquisitions per year, as per
the Centre for Monitoring the Indian
Economy’s (CMIE) information on inter-
national acquisitions and mergers. About
40 per cent of them are of less than $ 10
million each. Ten deals are of a value of
over $100 million each, while financial
information regarding 38 per cent of the
acquisitions is unavailable.
Software Focus
Software is the single largest industry of
acquisition, followed by pharmaceuticals
and the automotive industry. Over 40 per
cent of the acquisitions are made in the
US, followed by continental Europe, the
UK and Asia, in that order. Although
information technology (IT) and the in-
formation technology enabled services
industry (ITES) lead the number of acqui-
sitions from India, these are quantitatively
small in value. About 300 Indian firms are
reported to have set up representative
offices in London, and India currently
ranks third in FDI inflow in the UK. London
is apparently the first port of call; this is
natural given the long-standing business
and social connections, and access to
its financial market and commercial
expertise.
Though capital outflow from India
appears large, it is still modest by inter-
national standards. According to the
WIR 2006, FDI outflow from India ranked
only 88th in 2005 in world outward FDI,
of oil fields and industrial raw materials
to sustain its rapid growth, India’s invest-
ments, in contrast, are seeking markets for
their products in developed economies, in
the manufacturing sector and in mature
industries, like machinery, automotives,
textiles and pharmaceuticals.
What explains the boom in FDI from
India? There are domestic reasons and
international factors propelling outward
flows; and industry specific factors have
also contributed to the trend.
In the face of investment and trade
policy reforms, Indian industry under-
went a major restructuring in the 1990s –
lay offs and retrenchments, domestic
mergers and acquisitions, hike in
promoters’equity holdings to ward off
threats of hostile takeovers, and so on.
There was a surge by incumbent firms
in fixed investment to expand manu-
facturing capacity and distribution
networks to face external competition.
But with the sharp downturn after
1995-96, the industrial sector was
saddled with huge excess capacity. This
experience taught Indian business the
perils of excessive dependence on the
domestic market in an increasingly open
economy. The bigger and more successful
Indian companies also sought to establish
businesses abroad so that they would
not be dependent on the fortunes of a
single (i e, domestic) market. In this
gloomy scenario, the success of Indian
software firms demonstrated India’s
advantage of low cost skilled workforce
in exploring international market.

4716 Economic and Political Weekly November 18, 2006

 One of the decisions the government
took during the depressed investment
scenario (operative from the mid-1990s
until 2002-03) was to allow Indian firms
to invest abroad up to twice their domestic
net worth, enabling them to target acqui-
sitions in advanced countries where indus-
trial assets were available at a discount on
account of the global economic downturn
in the early 2000s. In principle, such
acquisitions allowed firms to combine
their low production costs at home with
low interest rates in international capital
markets to emerge as low-cost producers
accessing the world market. By acquiring
running businesses, they got ready access
to customers and markets, closely knit
supply chain networks and consumers’
brand loyalty. Such investments have
enabled Indian firms to produce labour-
intensive parts/subassemblies/processes
in India and use the factories and firms
in advanced countries to undertake
capital or technology-intensive invest-
ments in their business. The speed with
which Indian firms went overseas over
the past five years was also perhaps
driven by the desire to get a toehold in
a variety of markets divided into trading
blocs.
However, the foundation for overseas
expansion was laid a long time ago. It is
well worth remembering that given the
large size of the domestic market, India
had acquired international competitiveness
in many industries, mainly based on the
low cost of skilled workforce. It is worth
recalling the words of late Sanjaya Lall,
who in 1982, described TELCO (now Tata
Motors) as “…(the) first real automotive
multinational to emerge from the Third
World with its own trade and technology…”
(Sanjaya Lall, Developing Countries as
Exporters of Technology, Macmillan,
London, 1982: 41).
Positive Externalities
Now in the 2000s, in an increasingly
open world economy, large and efficient
firms in India would want to expand
overseas, to secure external markets, to
extend their intangible assets like brand
names into newer territories. For example,
Asian Paints, which has been setting up
plants or acquiring paint-making factories
and firms abroad for some time now, has
apparently emerged as the world 10th
largest producer operating in 24 countries.
This follows its acquisition of Berger
Economic and Political Weekly November 18, 2006
International in Singapore in 2003. Asian
Paints’ efficient manufacturing and
distribution systems seem to be the source
of its success. As the firm has developed
technology to produce paint intermediaries,
export of these goods add value to the
firm. Such overseas expansion could, in
principle, have a positive externality as
it augments domestic production capa-
bility, promotes backward and forward
linkages, and also increases employment
opportunities.
Coming to industry specific reasons, in
pharmaceuticals many firms have proven
their capability to produce generic drugs
at a fraction of world prices. This is clearly
the result of the Patents Act of 1970
(that promoted process patenting and
facilitated reverse engineering), and
import substituting industrialisation that
encouraged local technology and skill
development. Indian firms now perceive
an opportunity to produce a large number
of drugs that are going off patent.
Although it may be cheaper to produce
many of these drugs in India, by acquiring
firms abroad they get access to the pres-
cription drug markets, which are often
restricted to firms belonging to the country
or trading bloc like the EU. Getting access
to specialised R&D firms to speed up the
drug discovery process is another reason
for such investments.
In the case of the automotive spare parts
industry, some efficient domestic firms
have received international recognition for
quality (e g, Deming award for Sundaram
Fasteners) that gives them access to firms
like General Motors. As the automotive
industry has a tightly knit supply chain
across the world, Indian firms perceive
their growth prospects in becoming a part
of such supplier networks to original
equipment manufacturers (OEM). Bharat
Forge and Sundaram Fasteners are two
examples of such suppliers. Though most
Indian suppliers at the moment operate at
the low end of the spectrum, they expect
to move up the value chain to supply
complete sub-assemblies with the help of
their external acquisitions.
In telecom, the boom in the telecommuni-
cation industry in the second-half of the
1990s created huge capacity, but with the
collapse of the dot com bubble and the
implosion of firms like Tyco and
WorldCom a significant amount of surplus
capacity became available. As the prices
of these “unlit” fibre optic cable network
plummeted, large Indian telecom firms like
Tata VSNL and Reliance have competed
to get hold of the networks to augment long
distance telephony and data transfer
capacity to meet the growing requirement
of the IT and ITES industry.
In IT, after the late 1990s bust, many
firms have set up new offices and made
outright purchase of software firms abroad
to move up the value chain, building on
their strength of low cost and credibility
of their services. After the 2001 terrorist
attacks in the US Indian software companies
are apparently investing in “mirror sites”
or parallel locations in places like Singapore
to ensure uninterrupted services to their
clients in the west. Many of these acqui-
sitions in the US are mainly from non-
resident Indians, perhaps reflecting prior
business and social ties.
Risk Factors
The great Indian outward movement does
not, however, mean success is guaranteed.
While internationalisation of business
represents natural progression in an open
economy, it faces many risks and uncer-
tainties. Allowing large domestic enter-
prises to tap the international market for
funds to fuel the acquisitions exposes them
to the volatilities of the global financial
markets with attendant risks. Many of the
recent large acquisitions are predominantly
financed by debt finance (leveraged buy-
outs), raised from the global capital mar-
ket; success depends on augmenting cash
flow in international currency to service
the huge debt. In the event of an economic
downturn – which is not a question of if
but when – servicing such debts could pose
serious challenge for these firms. More-
over, the experience from developed
countries suggests that about one-third of
mergers and acquisitions fail to add value
to the firm and the shareholders. More
fundamentally, industrial organisation
literature suggests that it is still an open
issue about whether or not corporate
mergers improve efficiency and profit-
ability (F M Scherer, ‘A New Retrospective
on Mergers’, Review of Industrial
Organisation, Spring 2006).
What are the policy implications of
growing outward investment from India?
Given the scarcity of industrial resources
in relation to India’s size, there is perhaps
a need for strategic initiatives to encourage
public and private sector firms to seek
scarce natural resources, including energy,
to facilitate industrial development at home.
4717
Since the policy-makers in their preoc-
cupation with market-oriented reforms
during the last one and half decades, took
their eyes off energy security, there is now
an urgent need to refocus on India’s long-
term investments in exploration and deve-
lopment of mineral and energy resources,
just as China has done to invest in Australia
and more recently Africa. For this purpose,
it may be desirable to be open to forming
joint ventures with firms in developed
economies to acquire technology and design
capabilities.
More recently, with oil prices reaching
unprecedented levels over the past
two years, Indian policy-makers have
begun to emulate China and make frantic
effort to acquire oil and gas exploration
rights to ensure energy security. Public
sector firms like ONGC have also made
considerable investments to acquire oil
fields in countries like Sudan, Russia,
Vietnam and Kazakhstan to augment
supply of petroleum for domestic use.
Some Indian firms, public and private,
have also picked up stakes in mining
operations in Australia.
Access to long-term finance at reason-
able interest rates is imperative to enable
Indian firms to exploit external opportu-
nities. Development finance institutions
need to open special windows to promote
international business – just like China’s
policy banks systematically do so for their
domestic firms. Exim Bank of India has
a window for this purpose, but it appears
a feeble and nominal initiative to be of
much consequence. Given the sizeable
foreign exchange reserves of $160 billion,
India could probably consider setting up
an investment arm like the Temasek
Holdings of the Singapore government to
strategically invest globally to secure
resources for rapid industrialisation and
access to external markets.
The boom in the outward investments
is likely to increase external pressure on
India to quickly reduce tariffs and dis-
mantle the remaining restrictions on capi-
tal inflows. Calibrating these moves with-
out foregoing the interests of the vast
unincorporated sector enterprises and the
rural economy would remain a challenge
for policy-makers. EPW

Email: nagaraj@igidr.ac.in
[This is an abridged and updated version of the
author’s San-Ei Gen lecture delivered at the
University of Edinburgh Management School and
Economics in November 2005.]

4718 Economic and Political Weekly November 18, 2006