Jamal Mecklai: Will the strong Re derail 'the Big I'?*

MARKET MANIAC

No way!
To the contrary, the strengthening rupee and, more importantly, the fact that the RBI and government decision-making are being forced to cede ground to the market will result in much more efficient (=market-determined) resource allocation in India.

Perhaps, this is why the stock markets are rising uncontrollably. Everybody knows that government decision-making, even with the best intentions, results in huge inefficiency, and, what is worse, gaping windows for corruption. If the recent surge in the rupee is a signal that the government (and the RBI) has finally acknowledged the inevitable, there's no saying what it will do for productivity in the country.

Already, most companies are increasing their focus on the domestic market. I spoke with the finance head of a large BPO company and he simply said that we will now have to work harder for our margins. We'll need to move to smaller cities and towns "" we resisted going there earlier because it was just too difficult in terms of creating the infrastructure and lifestyles that we needed. But now we have to and we will.

And guess what this will do. If there are more and more jobs being created in smaller towns, the flow of people into the cities will slow down. Wouldn't that be nice? It's what our urban planners and development experts have been begging for for years "" or decades. Well, guess who's getting this organised. Not the government, not the myriad experts, not you or me individually. It's our old friend "" the market.

Now, lest I be branded as Milton Friedman's grandfather "" I know I'm nearly old enough "" let me say that while I believe fully in the market's ability to drive resource allocation most effectively, I also believe that regulation has a key role to play. However, rather than focusing on the here and now (what's the value of the rupee today?) and responding to endemic political chatter, it needs to maintain a focus on long-term economic health and act cleverly by using incentives to drive private players to ensure the sustainability of resources (in the broadest sense of the word). [The Green Indian States Trust (www.gistindia.org) has done some pioneering work on the role of the private sector in ensuring sustainability, which needs to be springboarded aggressively.] Of course, in the event of a market crisis, the regulator does need to shift its focus to current events, for which reason it needs to be continuously in tune with markets; however, as I have argued in my last article, this should be done sparingly, reflecting its role as "God's agent" in the markets.

But, returning to the strong rupee, clearly there will be some pain as companies adjust to this new less subsidised arena. But the strong and the smart and the quick will not just survive but thrive, just like India's 20/20 team.

Already, the hospitality industry has cut its risk by eliminating foreign currency billing "" their costs are in rupees, so it makes sense that they should set their revenue in rupees as well. As I mentioned earlier, BPO companies (while they continue to wail) are quietly, but quickly, looking to shift operations to cheaper centres. [This is a longstanding natural process; shifting from higher- to lower-cost centres has been a standard businesses strategy from more or less the start of time "" indeed, that is the very nature of BPO.] Importantly, IT companies are starting to focus more on the domestic market, and are beginning to start demanding price hikes from their customers "" and, about time too. Till now, sales heads at IT companies had it easy "" certainly compared to sales people in other industries. No longer. So, they'll all work harder "" or, more correctly, work differently. And, in time, the margin squeeze will ease and their market performance will begin to rise again.

Clearly, companies serving the domestic market will do brilliantly "" the stock market knows this. The stronger rupee and low inflation suggest that interest rates will not be rising any time soon, which means that domestic demand will remain strong, and, indeed, strengthen, to judge from the incredible increase in advertising columns "" pages "" in the newspapers.

With the ongoing possibility of an election early next year, the government will be committed to keeping a lid on inflation, which suggests that the RBI may not cut interest rates in the near term. Of course, this could well mean continuing upward pressure on the rupee, unless there is some new major blowout in the global credit crisis. Damned if you do cut rates (and inflation rises), damned if you don't and the rupee strengthens "" this is fast becoming the story of the RBI, who is looking more and more like Don Quixote tilting at the joyous windmill of the market.

Of course, a more prudent course would be to "" as mentioned earlier "" step back from this losing battle, and focus on things they can achieve, like accelerating structural change in the money market. It is worth noting that the long-term average borrowing spread (over risk-free) for A-rated (apologies for using this outdated methodology) companies in the US has been 120 basis points. This means that if we had a market as liquid as the US, A-rated Indian companies would be able to borrow today at 9%, that's about 2.5% better than what they pay today. That's something worth working towards.

The good news is that with the market more in control, all of these changes will accelerate.
And The Big I "" well, you tell me!

* The brand "The Big I" is a gift to the people of India from Tom Klinkowstein, designer extraordinaire and terrestrial astronaut