Opportunities lurk in India’s current financial woes. Although the rupee has been falling and growth has slowed, contributing to a record deficit, the country has embarked on a series of measures designed to reverse the negative trend. Among those efforts to bring in outside capital and boost growth, as well as to shore up the rupee, the government has proposed to relax its rules on foreign direct investment (FDI) in several industries, with perhaps the largest change coming for phone service providers.
Ownership of phone carriers by foreign investors is currently capped at 74%. But among the actions announced by Commerce Minister Anand Sharma, that will rise to 100%, an action that Nitin Soni, associate director, Fitch Ratings, says will not only pique the interest of investors outside the country but will also benefit the telco industry.
“The Indian government’s decision to remove the FDI limit in the telecom sector will help reduce leverage and strengthen balance sheets in the medium term,” Soni stated in a research report. “The move could encourage foreign investors—who have previously been put off by FDI rules—to look again at the sector, and allow existing foreign investors to increase their stake in subsidiaries to 100%. Taking complete ownership would remove the burden of dealing with a local partner.”
Soni also said, “Vodafone, Telenor, Maxis and Sistema may be among the first to take advantage of the change, as they are already at the current 74% holding limit.” Other Indian telcos whose foreign ownership is well below the cap would be likely to see benefit in the medium term. He said, “Such telcos could invite equity injection from existing or new foreign investors to improve leverage.”
Other industries likely to see some benefit from relaxed FDI regulations include defense production—currently capped at 26%, but rising if India gains access to modern technology; petroleum, natural gas and refining, which will be permitted to rise to 49% without requiring additional approvals, and commodity, power and stock exchanges, which will also be allowed to rise to 49%. Single-brand retailing will be allowed to rise to 48%, and could go beyond that—but FDI from 49%–100% in that sector will require government approval.
The changes in policy began last September, with an initiative by Prime Minister Manmohan Singh launching policy changes to help boost expansion and avert a downgrade in India’s credit rating. Those earlier government actions have already shown enough promise that in June, Fitch Ratings changed India’s outlook to stable from negative and reaffirmed its BBB- rating. This latest move by the Indian government to relax FDI regulations “supports our view that regulatory risk is fading away,” according to Soni.
Among the other positives, besides the relaxation of FDI, that played into Fitch’s outlook upgrade was the fact that “[t]he authorities have also begun to address structural factors that have weakened the investment climate and growth prospects, notably regulatory uncertainty, delays in government approvals of investment projects and supply bottlenecks, for example, in the power and mining sectors.”
Also, “[t]he establishment of a Cabinet Committee on Investment should help to fast-track infrastructure-related projects.” Fitch also said that additional reforms that could also help the investment climate were “the new land acquisition bill, some liberalization of insurance and pension provision and public procurement, which are pending parliamentary approval. Addressing the structural issues in the power and mining sectors would further boost investor confidence.”
All was not smooth sailing, however. Singh’s efforts to change government policy has encountered a number of roadblocks along the way, such as protests that arose over alleged graft in government. They caused disruptions in Parliament and held up bills that would have allowed companies outside India to invest in the country’s pensions industry for the first time, and to be able to hold as much as 49% of insurance businesses.
India’s currency has fallen more than 20% over the last two years, but it has taken a nosedive since the prospect of U.S. quantitative easing reared its head, falling 10% against the dollar since the beginning of May. The telco industry has been hard hit by the slide, since more than 40% of its massive debt load of $40 billion is denominated in U.S. dollars. Other industries suffering under a low rupee include chemical companies, the paper industry and fertilizer manufacturers.
However, some industries, such as oil and gas companies and metal producers, according to Fitch, can insulate themselves against a weak rupee, since they are somewhat “able to pass on higher import prices via the import parity price (IPP) practices … or to also have significant exports that help offset the rising cost of imported raw materials. Companies in the auto ancillary sector also typically have contracts to pass on higher costs to original equipment manufacturers, but may be forced to absorb some of the price increases due to falling end-user demand.”
Exporting companies in the fields of pharmaceuticals, technology, textile and mining companies, according to Fitch, can actually benefit from a low rupee, although perhaps not as much as they have in the past: “[T]he beneficial effects on operating margins and leverage are likely to be weaker than during previous periods of depreciation. This is due to lower global demand, aggressive price renegotiations, hedged foreign-currency exposure and the additional cost of servicing foreign-currency debt.”