Arvind Singhal: A peek into 2007

MARKETMIND

The party seems to continue from 2006 into 2007. On the opening day of the stock market in this New Year, the upward momentum in the indices continued from where it had left. While there are some voices speculating that the growth rate in GDP may come down this year to 7% levels or so, the majority seems to be more bullish and many even believe that we could hit the 10% mark in some quarter this year.

My own view is one of guarded optimism as far as the economy is concerned. The oft-lamented lack of adequate investment in the previous decades in infrastructure is already beginning to manifest itself as a major speed-breaker almost all over India. The rapid increase in traffic congestion in all cities, a more threatening mismatch between demand and the availability of power and water, rising inflation rates leading to a real possibility of further increases in interest rates, and runaway increases in select input costs, e.g. real estate and salaries/wages do give enough justification for us to take a pause to reflect and perhaps make some correction in our hubris.

I am, like other Indians, justifiably proud of the economic progress made in 2006 and in the new-found confidence and aggression of our business leaders, who are now thinking big and thinking global. Having said this, I also fear that some of these mega ambitions could lead to mega corrections in the next two or three years, if not earlier. Business news in the recent months has been dominated by some really big dreams, e.g. Tata Steel's multi-billion-pound bid for Corus, increasing-by-the-day valuation for Hutch and the resolve of some Indian suitors to make this acquisition, multi-billion dollar commitments from a few leading business groups in somewhat uncharted territories such as retail and real estate, etc. Easy availability of this money""from Indian and International investors and funds""is only making such dreaming easier. I fear that some of these investments may soon turn out to be millstones around the balance sheets of some of these companies if they err in their judgment of what should be the fair value or prudent scale and timelines for such investments. As far as M&As are concerned, as per Investor's Daily of the US, 72% of the mega-deals during the 1998-2004 period destroyed value for the shareholders, notwithstanding the much-reasoned synergies and anticipated gains from such synergy.

In the same vein, mega investments are certainly the need of the hour for India and potentially rewarding for those who are entrepreneurial and capable of making so. However, it is equally important to acknowledge that such investments have to be appropriately phased; otherwise systemic bottlenecks of the Indian economy, be it physical infrastructure or fragmented and weak supply chain, or inadequate availability of qualified man-power, could make any accelerated investments a flawed business strategy since the drag caused by these external limitations could be enough to raise the operating costs of such new businesses to a point where the returns on investment could be severely impacted. For most service-oriented businesses (and as we are all aware, services now form more than 55% of our GDP), manpower and physical infrastructure expenses are the two most important cost elements. On both counts, there is a runaway inflation and hence the financial viability of many service-oriented businesses could come under a cloud as more and more of such businesses discover that there is a limit to squeezing our more efficiencies or to passing on the costs to their customers or end consumers.

Real estate, of course, is certainly due for a major correction. No matter what the pundits may have to say, I just cannot believe that there is any economic rationale in developers picking up 825-, 556- and 550-square metre "hotel" sites in Gurgaon for Rs 32 crore, Rs 21 crore, and Rs 21 crore, respectively (of course, only a government agency like HUDA can visualise what kind of hotels can be constructed on such postage stamp-sized plots). Likewise, there may be an emotional logic like Amitabh Bachchan used in an old 1980s movie titled Trishul to justify paying a ridiculous price for a building; but otherwise it makes no economic sense to pay Rs 73,000 per square foot for a residential flat in South Mumbai.

In the midst of this note of caution, are there any emerging sectors that hold promise in 2007 and beyond? Amongst others, I would like to recommend looking at healthcare and education. Both require very large investments in the face of innumerable challenges like other infrastructure-oriented sectors. However, with some really innovative business models, including some that we have visualised within our own company, I believe that they can offer significant financial (and emotional) returns in the medium to long term.

And finally, for millions of middle class (mostly urban) Indian consumers, I happily believe that the party will actually begin in 2007. We can all look forward to being wooed assiduously for a share of our discretionary spending by Reliance, Wal-Mart, the AV Birla Group, Tata Group, and ITC among others in the coming months and in the process, being offered unprecedented choice and unprecedented value under unprecedented convenience and shopping comfort.

arvind.singhal@technopak.com