Ravi, in Conversation

It is becoming increasingly clear that India is no longer shielded from the global credit squeeze as it once used to be. The effects of the collapse in the financial industry in U.S. and Europe are evident in the heavily U.S. dependent Information Technology sector that has started lay-offs, as well as the Real Estate Industry which is facing dropping property rates. Both I.T. and non-I.T. companies in India are already facing a liquidity crunch as international investors are pulling their money out and banks are becoming more cautious with their lending. Traditional low leverage financial management methods and operational efficiencies are going to be the strongholds for India Inc. to survive this economic turmoil. Unless the recession extends beyond a year, much of this crisis does not seem to trickle down to India’s common man unlike in the West, mostly due to cultural differences due to which people save for a rainy day coupled with the effects of internal consumer demand.

IT and Real Estate

I had heard that Real Estate prices in India, especially in Bangalore, were undergoing huge correction as early as April or May 2008[1]. I believe this correction is going to continue in most other cities as well, because the property valuations have been sky-high until now, triggered by the booming I.T. sector and property purchases by cash-rich NRIs. On the lending side, Indian banks continue to be commendably conservative, and do not carry any “sub-prime”[2] mortgages in their assets like their U.S. counterparts. Indian loans are mostly fixed rate[3] mortgages and the family-backed and savings-oriented culture of the Indian population, combined with the shame of going bankrupt will come to the rescue of I.T. people facing job-loss. Therefore, loan delinquencies will not be too high, and the markets will not turn as sour for the common man as it is happening in the U.S. But definitely the real-estate brokers and land-owners are going to be hit hard[4] - in fact deservingly, because they were until now making too much money way too effortlessly.

The effect on the Indian I.T. industry is two-fold. I.T. companies will lose a string of projects, because the clients themselves are not going to sustain their business. Companies like TCS[5] and Infosys that have a bigger BFSI and retail component[6] will have a higher impact. This said, I.T. companies recognize that there is light at the end of the tunnel. They are sure use this opportunity to prune their workforce by laying-off non-performers, and correct salaries, in a job market which had been highly inflated until a year ago.

In tough times, like for individuals, cash is king for I.T. companies (even for any other company, since credit is soon going to be tight even in India). I.T. companies in India have been traditionally effective in managing their cash, and will be able to survive with what they have for the next year or so. As U.S. and European banks consolidate and re-configure their operations, opportunity knocks in two ways – projects to integrate I.T systems of merged entities, and further out-sourcing of non-core financial analysis activities. Companies like TCS are already active in the latter. With the acquisition of Citi’s BPO division in India[7], TCS is trying to cash-in on the opportunity to bring a larger part of the banking pie offshore[8]. HCL’s acquisition of U.K.-based Axon Group[9] beating Infosys is an effort to provide more value-adding end-to-end services. Acquisitions will trigger growth as long as companies do not compromise their cash position.

All the small I.T. start-ups mushroomed by the thriving industry which are not in a position to offer end-to-end services will eventually get washed away or taken-over as they face a dwindling client-line and worser cash-position. Of course, the super-specialized ones that have a solid value proposition on offer have a chance to survive. The last thing I would want to see in such a scenario is some big company panicking and removing talented people, which will in turn affect all the other players and spiral into a much larger crisis. But I believe that NASSCOM, CII, FICCI and other industry associations are strong and experienced enough to proactively prevent such a situation.

Therefore, not everything is bad for I.T. companies in India. India still maintains a huge though comparative advantage over other countries. This advantage will eventually erode as cheaper economies adopt similar game-plans, but such an effect seems to be a long way away. A recession can even be good for Indian IT[10] because companies suddenly find that land costs are back to normal and talent is getting cheaper helping them bring in more outsourcing investment to the country. Indian I.T. companies have grown large enough to establish themselves outside India as well – going where the money is. Moreover, as long as the dollar remains stronger against the Rupee, the I.T. exporters are better off, and have enough clout that the government will not do much to help the other importing companies for whom stronger dollar brings bad news.

Causes for the crisis and overall effects on India

At the core of the U.S. crisis, is the lack of regulation in two key areas, one, the derivatives market (which led to soaring oil prices, which are back to normal now due to slackening demand) and two, the investment banking area (which led to crazy subprime mortgages and securitization).

Second is the huge dependence of U.S. companies as well as individuals on credit, whereas Indian companies traditionally keep cash in their balance sheets. The bailout package will temporarily ease credit for a few months, but as many economists predict, might not be enough to completely reverse the effects of a recession. In fact most of the effects of the infusion of taxpayers money into the financial system are yet to be seen, and may be beyond prediction since it depends a lot of human behavior in times of crises.

Third but not the least, is the mishandling of the economy by a frightened U.S. government, reducing interest rates and prolonging the effects of recession rather than waiting for the system to cure itself. Allowing Lehman to fall has already shown up a strategic mistake since it triggered a lot of panic among investors, spreading the crisis to Europe and resulting in WaMu’s and Wachovia’s sell-off at a fire sale prices.

The derivatives markets in India are relatively undeveloped, and investment banking activity is limited and regulated. Indian interest rates are still high, and Indian companies are not credit dependent, and do not have a huge investment in the US markets. The only predictable effects on India will be due to the slackening I.T. sector, reduced international trade opportunities and withdrawal of funds by FIIs. As long as Indian consumers keep their jobs and keep spending and infrastructure needs keep growing, India will still keep a healthy 6 - 7 % growth (not as high as last years' 9% or the predicted 8%)[11].

Nevertheless, India should look at this crisis as an opportunity to learn from what went wrong in aggressively capitalist Western economies and proactively implement regulations to avert such a crisis in the future.