Divide to rule

To reduce currency risks, companies should separate their facilities catering to domestic and export markets

Many investors have come to grief while timing the market. The market has the capacity to prove even the most conservative projections about its direction wrong. Early this month, the hiking of short-term policy rates by the Reserve Bank of India and the beginning of the second round of injecting liquidity by the US Federal Reserve were expected to increase the inflow of foreign funds. The market even came close to crossing its record high level of 21,000. The central bank was getting restless and was hinting at controls to make managing the currency and inflation easier. But, within days, the tide turned. Lower manufacturing growth in September and fear of the debt crisis spreading to Portugal and Ireland after the European Union bailout of Greece prompted foreign investors to withdraw from the emerging markets. In addition, expectation of China raising interest rates, following some other Asian countries, to cool its economy raised fears that demand for commodities would dip. The 2G telecom scam weighed on market sentiments. The flashpoint in the Korean peninsula shaved off nearly 600 points in intra-day trading. Suddenly, the world looked a much different place than it was a fortnight ago. Possibility of another round of slowdown seems real. After remaining subdued during the book building of the Coal India IPO, the Indian market had bounced back after its closure early November. On 16 November it slipped below 20,000 in intra-day trading and on 24 November was down nearly 1,500 points from its peak.

The volatility in the market reinforces the belief propounded by this column that, for sustainable growth, the world has to become flat once again. The bull-run in 2003 was due to low interest rates throughout the world. Similarly, central banks around the globe coordinated their quantitative easing following the credit crunch triggered by the collapse of Lehman Brothers in September 2008. Subsequently, major economies including the US, China and India announced fiscal stimulus of tax cuts to revive consumption. These measures were expected to pull up global economy. This did not happen. Only the emerging economies spurted as the debt crisis spread in Europe and the US’s slow recovery was not accompanied by growth in employment. The net result has been soaring prices of commodities despite half the world’s economies still in slow motion. This has had the effect of boosting input prices at a time manufacturers in the emerging economies had embarked on ramping up production anticipating rise in usage. The choice was to absorb the cost or pass it to the consumers. Some sectors where consumption exceeded supply did so. Margin of others is under pressure because any sudden price hikes would have had an adverse impact on their share in competitive markets. The domestic market is, thus, mimicking the imbalance in recovery of global economy.

Integration implies that the distortions of the kind seen today are erased. Manufacturers or services providers can achieve economies of scale by viewing the world as their supplier as well as the marketplace. Outsourcing of some back-office functions, production of parts, and assembly of finished products from components sourced from different corners of the world enables companies to make available products and services at the same price across the world. But the global financial crisis has disrupted the rhythm. Companies scaling up to global benchmarks may have to turn inwards to keep their capacities running. All may not be able to do so. The Indian market does not have enough capacity to absorb the IT services currently being exported to the US and Europe and China’s factories need the US market to keep humming. Infrastructure projects are dependent on capital from the developed economies. Instead of spurring local industry, low interest rates in the US have resulted in funds flowing to countries with better yields. Hence, reverse outsourcing is required, with companies in emerging economies using home capacities to service the huge domestic markets and snapping up distressed assets in the west by taking advantage of the cheap money, thereby boosting local jobs and market for their products and also cushioning the home facilities from currency risks. Many Indian manufacturing and services companies including those in the IT sector and Bharti Airtel in the telecom space are embracing this model. The most remarkable has been Tata Motors’ revival of the ailing Jaguar Land Rover company to cater to the western markets instead of trying to build and export luxury cars out of India.
MOHAN SULE