WHERE TO PUT YOUR MONEY: OVERVIEW
The Far Eastern Economic Review by Henny Sender/BOMBAY July 20,2000

AFTER MORE THAN a decade working outside India, Piyush Gupta returned to his homeland two months ago, exchanging the security and prestige of an international assignment with the Citibank unit of Citigroup for the uncertainties and turbulence of a local dotcom.

His return says much about how India is changing and more importantly about how the world is changing in a way that benefits India. "Indian companies couldn't make it in the industrial age," says Gupta, CEO of go4i.com. "But the knowledge economy plays to India's strength. India is evolving up the value-added chain in the New Economy."

There have always been two Indias, or at least two types of Indians. There are those who live by their muscle, a group that has always encompassed the vast majority of India's 1 billion-plus population. And there are those who are fortunate enough to make their way on the basis of their intellectual power. For the second group, that generally has meant taking advantage of opportunities outside India. Today, Indians hold top posts at some of the most formidable organizations in the world institutions such as Citibank itself and Lucent Technologies' awesome Bell Labs.

But now, for the first time, the brains of India are returning and powering New Economy companies back home. They are also transforming other parts of the economy, taking traditional, low value-added companies such as copycat pharmaceutical firms and pushing them up the value-added curve. As this new sliver of globalized India grows, the increasing income of these professionals and the people they employ is giving rise to a surge in domestic demand for everything from Honda cars to Pepsi soft drinks.

Indians working in India even in the most globalized firms in the most globalized industries such as finance used to be paid a fraction of what their counterparts in other countries earned. But as competition for top talent heats up, they are swiftly climbing the pay ladder.

Both foreign multinationals and local companies, even in relative backwaters like Calcutta that are far from the feverish centres of the New Economy such as Bangalore, are offering salaries to top managers equivalent to those paid in New York or Silicon Valley. Gupta got a taste of the wage explosion as he searched for employees for his start-up. In the several weeks between the time he poached his first employee from a pharmaceutical company to the time he went after his second, he found salary expectations had shot up 30%. The implications of this rapidly growing group of well-off consumers are widespread. Their presence and spending create economic opportunities for entrepreneurs further down the food chain. And the spreading wealth makes India a more attractive place for multinationals to ply their goods and even produce them. The ripple effects are not endless or exhaustive, but they are substantial. "This is a new age which we couldn't have imagined even two years ago," says Nanoo Pamnani, the Bombay-based head of Citibank's India operations.

Neither the new optimism nor the vast potential of Indian companies, however, completely outweigh the dangers of investing in India. The Bombay stockmarket is volatile, even by the dizzying standards of Asia, especially now that the technology, media and telecoms industries account for 42% of Morgan Stanley Capital International's India index. When the Nasdaq market dropped in March and then fell more violently in April, the Bombay Stock Exchange plunged even further, losing 25% of its market capitalization in weeks (and taking the market to the level it was at six years ago).

"Appealing valuations, nerve-racking volatility" is how Ridham Desai, head of research for JM Morgan Stanley in Bombay, describes the Indian market after the violent fall. Many macroeconomic indicators also remain dismal. Foreign direct investment is declining despite all the anecdotal evidence of South Korean computer makers, Chinese television builders and American car companies piling into the economy. Nonoil imports and capital spending both remain subdued. That means timing the Indian market requires great skill. But the changes under way have convinced most analysts that it's only a matter of time before both the market and its listed companies come of age.

NEW ACCESS TO CAPITAL Gupta's go4i.com highlights some of the factors working in India's favour. The portal was founded by the influential Birla family, which runs The Hindustan Times, one of the country's main daily newspapers. The start-up received $11 million in seed capital from Chase Capital Partners, the private-equity arm of Chase Manhattan Bank. Indeed, Chase is so optimistic about the New Economy in India that it has made Bombay, not Hong Kong or Singapore, its centre for Asian technology investments.

And that's part of the story as well. Money used to be both a major constraint and a competitive disadvantage for Indian companies. At about 27%, Indian savings rates are low by Asian standards. That low savings rate and the government's voracious appetite for funds has led to a combined state and federal fiscal deficit approaching 9% of GDP and interest rates much higher than those elsewhere in the region. But that was yesterday's drawback. Now, as equity investors discover the Subcontinent, Indian companies have access to another source of capital.

Nobody better understands just how dramatically circumstances have changed than Ajit Balakrishnan, one of India's few and foremost serial entrepreneurs. At the end of June, Balakrishnan's rediff.com listed on America's Nasdaq market, becoming the first Indian portal to do so. The initial public offering was 19 times oversubscribed and the stock price rose 61%, to $19.31, on the first day of trading. The timing of the listing was especially noteworthy, coming when dotcoms were universally out of favour with investors.

"The advent of all this capital is a wonderful thing. It has unleashed an energy here which is unbelievable," says Balakrishnan in his Bombay office. "In the past, there was no risk capital. There was no way to bring innovation to fruition."

When Rediff was founded in 1995, Balakrishnan funded the company himself using profits from an advertiing business he had built up earlier. He later raised $20 million from offshore investors including Draper International, Intel, Citicorp, General Electric and Warburg Pincus. The capital that Balakrishnan and other entrepreneurs have raised is smart money. "Investors like Bill Draper gave us a road map for how a company evolves," he says. "The capital we got gave us both connections and insight."

These top-flight investors are drawn to companies like Rediff because they stand up to international comparisons in a number of areas. These include cost the "burn rate" at which Indian companies spend their backers' money is lower than elsewhere as well as product quality and the size of the potential market. Rediff, for example, offers an English-language site in addition to sites in Hindi, Gujarati, Tamil and Telugu, all major local languages. That means it already competes with Yahoo! and other international giants.

By the time Rediff listed, the combination of Balakrishnan's vision and his investors' experience had created a world-class company. The company now has a market capitalization of $600 million, despite the fact that India has just 1 million Internet users. China, by comparison, has 10 million Internet users.

Rediff is about content. But most companies that are powering the New Economy are more about technology. Many analysts expected them to be a passing phenomenon, so-called body shops tuning up Old Economy companies fearful of the millennium bug. Instead they have upgraded themselves into software-services companies that are increasingly getting the crucial assignments that used to be kept in-house. "They can do the mission-critical tasks on a timely basis," says Ajay Kapur, regional strategist for Morgan Stanley Dean Witter in Hong Kong.

ATTRACTING FOREIGN INVESTORS The magnetic pull of India's software industry is attracting more than just foreign investors. Some of the world's most impressive technology powerhouses, such as Lucent Technologies, are now also on the ground in Bangalore. And they are seeing results. The work that Indians at Texas Instruments' Bangalore centre pioneered on integrated circuits and software design was the basis for several patents that TI applied for back in the United States. Would-be competitors are now flocking to Bangalore to learn the secret. "Fifteen out of the twenty companies which have received the highest international recognition for software are Indian," points out Lu Ke, head of the Bangalore research efforts of Huawei Technologies, a Chinese telecoms equipment maker based in Shenzhen, near Hong Kong. "The software-management process is so good in India. We can improve so much if we study why Indian software is so good."

The changes aren't just confined to the New Economy. The traditional business families of India, urged on by the cruel realities of the market, are also transforming their Old Economy behemoths at a speed that makes most of the tycoons of Southeast Asia seem somnambulant by comparison. Two of India's leading families, the Tatas (with 80 group companies in everything from steel to telecoms) and the Birlas (with a conglomerate ranging from cement to financial services), used to be arch rivals. Now they are working together in select areas to take advantage of new opportunities and inviting foreigners with strategic knowledge to join them. "If you aren't forward-looking, the market is penalizing you," says Desai of JM Morgan Stanley in Bombay. "That means no market cap and no capital to restructure."

Although the Indian government isn't known for business-friendly attitudes, it's hard to see how it can derail the promise of India. At this point, it can only slow the growth or feed it. The Indian miracle is partly built on the country's fiercely competitive technical and management institutes, which produce about 10,000 graduates a year. But that meets only about one-tenth of current demand for hi-tech workers. The government needs to upgrade and expand its other engineering facilities and push forward in deregulating key areas of the economy. Had it been speedier about deregulating telecoms, for example, the nation's Internet industry would be more advanced than it is today.

"There is no comparison between a Shanghai and a Bangalore in terms of infrastructure," says Narayana Murthy, CEO of Infosys Technologies, a top software-services firm that listed on Nasdaq in March last year. "But we can't wait for the government. We have found solutions despite the government. We've shown we can succeed in spite of the environment."

No firm in India has a better shot at future success than giant Reliance Industries. As one of the world's largest and most competitive petrochemical and refinery operations, Reliance accounts for 3% of the country's GDP, according to company data. It has started implementing plans to automate its entire procurement process and is considering how best to position itself in a virtual chemicals marketplace. Moreover, Reliance has announced a new telecoms strategy and has a $15 billion market capitalization to help finance its ambitions. Reliance holds the right to provide booming Gujarat state with basic telecoms services and has cellular rights for a vast expanse of north and eastern India.

Perhaps voicing the hopes of the new professionals returning to and being developed in India, Reliance Chairman Dhirubhai Ambani told his company's annual general meeting in mid-June: "We believe there is a one-time opportunity for the Indian economy to leapfrog from its current inadequate infrastructure to a super, world-class digital infrastructure." Making that leap and landing on its feet will take all the talent and brainpower India can muster.