Tuesday, January 29, 2013

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%.

Thursday, January 24, 2013

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.