Mirror to domestic reality

One of the more significant developments in the Indian corporate world during 2006 has been the surge in international acquisitions by Indian companies. As was reported in this newspaper yesterday, deals struck in the first 10 months of the year amounted to $7.8 billion, compared with $4.3 billion in the whole of the previous year. Nor is this amount concentrated in a few mega deals; there were as many as 145 acquisitions made during these 10 months, compared with an already impressive number of 136 during the previous year""an average now of three a week. A wide range of Indian companies across an equally wide range of sectors is charting out a path to global presence. So much so that the outward investment from India is comparable to and will probably soon exceed the inward flow. This is a hugely paradoxical situation for a developing economy, which by definition is short of capital. What is driving this behaviour, and is it likely to have an adverse impact on the performance of the economy?

There are, of course, good strategic reasons for many of the acquisitions. Better access to new markets, tighter control over raw material supplies and access to superior technology in possession of the target firm all figure in the list of justifications put forward by the acquiring companies. There is also an element of hubris, when small domestic players seek to acquire much larger firms abroad, but this is to be expected in the euphoric state that the Indian corporate sector seems to be in. The flip side is that Indian companies are less interested in investing in their own country than they are in other locations""as the Prime Minister said a few days ago on his visit to eastern India. As constraints on outward investment (like the availability of foreign exchange) ease, more and more companies, which might otherwise have expanded domestic capacity, are likely to look at outward investment as their growth engine. This suggests a disconnect between the rosy picture that is painted about the long-term prospects of the Indian economy and the investment decisions of domestic firms. The obvious explanation for this is that the domestic investment climate still leaves a lot to be desired and firms which want to grow their own business on the back of the performance of the Indian economy can do it by combining their domestic marketing capabilities with more cost-efficient production capabilities located in other countries. From this perspective, the great rush for foreign acquisitions by Indian firms at once re-affirms the optimistic view of the Indian economy and the concerns about an unfinished reforms agenda that leaves the country struggling to keep pace with its competitors for investment flows.

At one level, what is good for Indian companies is also good for India. It is certainly heartening to see small companies acquiring firms that are larger and technologically more sophisticated. Some of these deals will inevitably go sour, but that is par for the course. To the extent that the phenomenon reflects an undesirable state of affairs for domestic investment, it does dilute the optimism about prospects. The persistence of the disconnect will eventually hurt growth prospects. It is up to the policy establishment to read both the positive and negative signals in the overseas acquisition boom and act accordingly.