Make in India?

I’m not sure exactly why I’m on a foreign markets/economies kick, but I think I’m pretty close to the end of it.

India and me

I’ve been fascinated/horrified by India economically for over twenty years.  On the one hand, the country has lots of potential, based on a huge internal market and a large, well-educated workforce.  On the other, economic success for India continues to rely on how favorable the monsoon season is.  The country’s leaders are clearly aware of, and dismayed by, the fact that nations they may regard at any given time as peers soon leave India behind in the dust.  But not that much has changed over the time I’ve been observing.

“Make in India’

“Make in India” is the marketing slogan the Narendra Modi administration has chosen to promote foreign direct investment, a time-honored tool for simulating economic progress through technology transfer.  Think:  Japan, Korea, Thailand, Malaysia, China…  The road map is clear.  The only question is whether a country has the political will to make the journey.

rules for success

I thought I’d try to list in this post, loosely in order of importance, what’s needed to attract foreign firms to create a business in a developing country.  They are:

–a large pool of trained, or trainable, workers

–roads and ports, to get output from the manufacturing site to market

–sources of electric power, clean water and telecommunications

–a stable legal system, so the rules of the game are clear at the outset and the goalposts don’t get moved after a firm has committed capital

–protection for intellectual property.  A generation ago, multinationals dealt with this crucial issue by sending to the Third World only the tools to make machines that were already obsolete in the First.  By and large, that’s no longer a viable option.   Because in today’s world technology transfer means not only how to organize and run a business but also current trade secrets, protection of intellectual property is more crucial than ever.

–it’s always nice to have a large internal market, so that the success of a factory doesn’t depend solely on export orders

–it’s also nice to have an eco-system of available suppliers and support industries grouped nearby.

How does India stack up?

It has a large internal market and a big pool of potentially available workers.

The physical infrastructure has never been great, in my experience   …and India has never seemed to me to have effectively in made infrastructure development a high government priority.

India has always struck me as distinctly unwelcoming to newcomers, and to foreign enterprises in particular.

Mr. Modi says he wants to change that.  Whether he will be able to is another question.  So, too, is whether he really means what he says.




a falling gold price–what does it mean?

Back in the day, I was, among other things, a gold mining analyst.  That period left me with an enduring fascination, not about the yellow metal itself, but about gold “bugs”–the people who are obsessed with gold and who buy it as an “investment.”  I have the same complex mixture of feelings about gold bugs that I have about survivalists, Civil War reenactors, model railroad buffs and people from Brooklyn.  It’s not exactly “There but for the grace of God…”, but that’s the general direction.

I really don’t get gold as an investment.  Yes, it’s shiny and there may actually be gnomes in Zurich.  Until the mid-1970s, gold did serve as a kind of money worldwide.  But no longer.  One exception:  developing economies where either there are no banks for businesses to use, or where people don’t want/trust banks to know about their finances.

Contrary to what I think is popular belief in the US, virtually all the demand for gold comes from the developing world.  The US accounts for 5% of purchases, the EU 10%.  Japan is a non-factor.  Last year, as usual, India was the #1 buyer of gold, at 28% of the total.  Greater China took 25%.

Before the Great Recession, the large bulk, maybe 3/4th, of the world’s demand for gold was for jewelry (although much of this did double duty as chuk kam 99.9% gold trinkets). 10% was for technology or dentistry.  The rest was gold bars and coins bought as an “investment.”  The bulk of that demand was supplied by mine production, with the rest coming from recycling and steady selling by central banks in developed countries.

The GR changed that pattern, in two ways.  Demand for gold bars and coins more than tripled.  Central banks in the developed world stopped selling, while their counterparts in emerging economies began to buy gold like there was no tomorrow.  Between 2009 and 2011–which appears to have been the peak of this activity–the gold price doubled in US$.

Gold ETFs?  They peaked in 2009 at about 17% of world gold demand.  By 2011 they had shrunk to 4%.

What’s happening now?

The gold price has been slowly declining for two years, without attracting much attention, as panicky buying by gold bugs has waned.

What’s new is India.  The biggest drain on India’s growing trade imbalance is its citizens’ continuing demand for gold–both for jewelry and because the country’s banks don’t work.  New Delhi has decided to deal with the steady flow of cash out of the country by taxing gold imports.  At least to some degree, this will put the metal’s chief buyer on the sidelines.  That won’t stop mines from churning out the stuff, however, until/unless the gold price drops below their cash cost of production.  That’s a looong way down.

Elsewhere, “investment” demand appears to be waning.  Less significant in the short term, Chinese tastes seem to be slowly shifting away from chuk kam to fashion or statement jewelry with lower gold content.  And, of course, more dentists are using ceramic teeth and PC demand is slowing.

In other words, the supply/demand picture for gold is looking less favorable for prices.  The price decline has nothing to do with inflation fears in the US or EU subsiding, or renewed faith that either area is suddenly on a sounder economic footing.

600 million (!!!) without power in India–the negative investment case in a nutshell

Indian power outages

Media reports tell us that 620 million in India have no power, due to widespread failure of the country’s electricity grid.  That’s half the population of that country–and almost 10% of the world!  And we on the East Coast of the US think we have power problems!

For the twenty years or so that I’ve been following India, the south Asian giant has been touted as being the next big thing for emerging market investors.  But the dream has never become reality.

investment plusses…

The attractions are obvious:

–a mammoth domestic market,

–a significant number of entrepreneurs,

–a large pool of hard-working, well-educated workers, and

–the fabulous success of the IT outsourcing industry in Bangalore.

…and minuses

Three negatives, however, are just as prominent:

–the immense power wielded by a small number of industrial conglomerates that control much of Indian commerce, and which are not particularly interested in foreign competition,

–highly bureaucratic government at the national and regional levels, which tends to be highly inwardly focused and which is subject to religious, ethnic and class tensions, and

–the resulting lack of infrastructure, particularly roads and electric power.

the post-WWII development model

The classic post-WWII development pattern for emerging countries is to encourage technology transfer from highly skilled foreign firms.  These are typically induced to set up operations in the emerging nation through government incentives (tax breaks and red tape slashing) and by the availability of cheap labor, good roads and ports and sufficient electric power/clean water.  Underlying all this is a national consensus to make the sacrifices needed to foster economic development.

India doesn’t fit

India doesn’t fit this model.   In fact, according to the World Bank, India has recently been losing ground in important areas of infrastructure.  In its 2012 Logistics Performance Index, the Bank rates the second-largest country in the world by population as #46 in the quality of its logistics.  That’s just below Brazil, and slightly higher than Mexico and Argentina.  It’s also an improvement of one position since the 2010 report.

If we look a little deeper, however, India has fallen to #65 from #47 in the quality of its infrastructure, to #54 from #46 in international shipping and to #56 from #52 in its ability to track and trace shipments.

Its boost in the ratings comes from the timeliness of the shipments it does make (#44, up from #56) and its skill in using the logistics apparatus it has (#38, up from #40).  In other words, the ratings improvement comes from more efficient use of what little there is, rather than having an expanding logistics infrastructure.

The country hasn’t helped its reputation either with the Vodafone cellphone network affair, where it decided to retroactively change its tax laws to subject the UK firm to a multi-billion dollar levy on profits from a sale.  True, Vodafone may have exploited a loophole in the existing laws.  That’s irksome.  But changing the rules after the fact, rather than just closing the loophole, must give potential foreign investors pause.

By the way, India does have a program that allows private companies to build their own power plants.  In theory, they could use the electricity to drive their own operations and sell the remainder to the public grid.  But the latter prices are controlled by law, and set at a level that forces private power companies to lose money.  …oh, well.


trying to move downmarket is tough–Apple vs.Tiffany and Superscope (who?!?)

going downmarket:  the Superscope example

When I got my first job as a securities analyst, rookies were assigned coverage of companies no one else wanted.  So I got a bunch of firms with bad managements, poor operating procedures and/or failing strategic concepts.  I was happy to be employed, but otherwise I was less than thrilled.  But a comment by J.L. Austin turned out to be true.  I did learn a lot more about how business works by observing things going wrong than I ever would have by watching uniformly smooth sailing.

One of my first companies was called Superscope.  The company’s claim to fame was that it discovered Sony “operating out of a quonset hut” in Japan in the late 1950s.  It obtained from the then fledgling electronics giant an exclusive license to distribute Sony’s innovative line of tape recorders in the US.  The license made Superscope a fortune.

In the mid-1960s, Superscope bought Marantz which was then an ultra high-end maker of stereo systems.

In the 1970s, preparing for the reversion of the tape recorder license to Sony, Superscope decided it would replace the lost income by launching a line of inexpensive, mass-market consumer electronics devices.   It thought it would increase the odds of the line’s success by branding its offerings as “Superscope by Marantz,” thus grafting onto its boomboxes the Marantz brand qualities of exclusivity, high quality and dependability.

As the successor company website comments, “Naturally enough, the two brands became intertwined in consumers’ minds.”

Translating this marketing-speak into ordinary language, the move completely destroyed the Marantz brand.

The appearance of low-fidelity $150 stereo systems under the Marantz name shattered the image of high quality and exclusivity that had motivated audiophiles to pay many thousands of dollars for the original Marantz systems.   As I recall, it didn’t help either that the  boomboxes were very far from best-of-their-breed.

the Apple smartphone dilemma

Why this trip down memory lane?

It’s because Apple faces a somewhat similar problem with its smartphone business, which produces half the company’s profits.

As some Wall Street analysts have been point out for over a year, the market for $600+ smartphones in wealthy countries is approaching saturation.  The as yet untapped markets are in emerging nations like China or India, where older “feature” or “flip” phones still predominate.  But if your annual family income is, say, $5000, how many $600+ smartphones can you afford.  Answer:  zero.

That’s why many phone makers are collaborating with local wireless companies to develop and market smartphones that cost $100 or less.

How can Apple compete?  Should Apple try to compete in this market segment?  The risk is that it repeats the experience of Superscope.

going upmarket is easier

Oddly, experience says it’s much easier to go up-market, although often a company will create a new, upscale brand name.  That’s what the Japanese auto companies did, for example.  Nokia, too, with its Vertu brand–which consists of making ordinary phones into jewelry with precious metals and gems.

Tiffany magic

How does Tiffany come into the conversation?  It’s the only company I know that is able to be successful both at the high end of its market (jewelry at $10,000+) and the low end (key chains and trinkets for $100-).  I don’t know how the firm accomplishes it.  I offer the example only to say that the move downmarket can be done.

why is the gold price falling?

my take on gold

I have strong views on gold.  I don’t think it’s money (it used to be, but isn’t anymore in most parts of the world).  It’s no more–and no less–an inflation hedge than any other physical asset like, say, real estate or timberlands or diamonds or oil.

One exception:  in developing countries where people want to hide their wealth or don’t trust the banking system and where barter is an accepted way of doing business.  In these cases, the facts that you can bury gold in the back yard or break off a link in a 99.9% gold chain and give it to a merchant to buy stuff come in handy.  Think:  India or Vietnam.  And, of course, these transactions, like most barter, are by and large off the books.

I began to realize this in the mid-1980s when I saw that my acquaintances in Hong Kong had long since dumped all their physical gold and had forex trading accounts instead.

worldwide gold demand is an emerging economy phenomenon

Worldwide consumer demand for gold by country in 2011, as reported by the World Gold Council, breaks out in tons as follows:

India     933.4

China     769.8  (Greater China = 811.2)

Middle East     199.8

US     194.9

Turkey     144.2

Thailand     108.9

Vietnam     100.3

Everybody else     957.3.

It’s also telling that in the US, where about one in five citizens don’t have a bank account (because it’s too expensive), we’re not set up for people to plunk down a doubloon to buy a used car.

sharply increasing money creation in the developed world

Be that as it may, over the past few months we’ve seen a substantial increase in government money creation in the EU and in Japan.  We’ve also just heard Mr. Bernanke reaffirm that he intends to keep interest rates in the US at the current extraordinary low levels for a long time to come, despite increasing signs that the economy is picking up steam.

All of this spells the increased possibility of a future inflation problem.  Why, then, is the gold price falling rather than going up?

trends in India

I think the largest part of the reason lies in India, which comprises well over a quarter of worldwide consumer demand for gold.  (If we reckon that purchases of 14k or 18k jewelry isn’t investment demand, then India alone could comprise as much as 40% of the global (non-central bank) investment market for gold.)

Two factors:

–as the economy in India has been cooling down over the past half year down and inflation picks up, Indian demand for gold has gone down, not up,

–perhaps more important, in its latest budget, the Indian government is proposing two new gold taxes:  a doubling of the import tax on the yellow metal to 4%, and a new .3% levy on all gold purchases.  In response to the latter, gold shops in India have closed down on strike for almost two weeks.

emerging markets: political risk in India

the home field advantage

No company ever goes into a foreign country expecting a level playing field.  There are always going to be rules–written and unwritten–that favor the home team.  This is the flip side of the belief that you’re always going to have at least a slight advantage over a foreign company in your domestic market.

One exception–if you’re hoping that the foreigner will buy your domestic business.  Chances are he’d be willing to pay over the odds.  But it’s equally likely the government will force a sale to a domestic competitor.  Around the world, that’s just the way it is.

in sports

We see this all the time in sports.

Olympic judging.

Your favorite baseball team plays an away game.  You can be sure the field will be manicured to minimize the home team’s weaknesses and your strengths. The visitor’s dugout in San Francisco is, unusually, on the first-base side of the field?  Why?  It faces right into the frigid wind off the bay.

The home town timekeeper will make the game clock in basketball or hockey run fast or slow, as the home team requires.

Even the referees will exhibit a home-town bias, perhaps influenced by crowd noise.

what’s not cricket

Some actions are beyond the pale, however.  One such appears to be happening right now in India.

In 2004, when Vodafone was still intent on ruling the world, it entered the Indian cellphone market by buying an interest in an existing player from Hutchison Whampoa.  Aware that if the transaction were done in India it would trigger a capital gains tax of around $2.9 billion, the parties did the deal offshore.

The Indian Tax Department ruled that the tax was still due.  Vodafone refused to pay and lengthy litigation ensued.

Two months ago, the Indian Supreme Court ruled in Vodafone’s favor–that no tax was due.

proposed retroactive tax law change

On Saturday, the Financial Times reported that in its annual budget the Indian government proposes to change the tax law, retroactive to April 1962, to make offshore transactions involving multinationals and Indian subsidiaries subject to domestic capital gains tax.

Although the proposed change, if implemented, will have much wider implications than for Vodafone alone, it is being widely seen as aimed directly at the UK telecoms company.

The issue of course, is that Vodafone has played on the home field and won–but the losing side is trying to change the basic ground rules five years after the fact, in a way that turns victory into defeat.

I think it’s ironic that this situation is arising just as the Indian government has decided to try to woo foreign portfolio investors for the first time.  If the budget documents are not just bluster and parliament makes the retroactive tax law change, that would seem to me to dim substantially the appeal to foreign investors of India’s large domestic population.  The negative effect could last for many years.  For emerging markets investors, then, I think the Vodafone situation bears close watching.



the Manpower global employment survey: a tale of two (maybe three) worlds

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the Manpower survey

Over the past two years, most of my attention, and the attention of the majority of investors in the US, has been on the employment situation domestically.  Reports like the Department of Labor Statistics’ monthly Employment Situation or the equivalent from private payroll company ADP have been scrutinized carefully for signs that a moribund labor market might be showing signs of revival.

The picture that has most recently emerged is of an economy slowly mending, but now generating enough new jobs to not only absorb new entrants into the labor force but also to chip away at the unemployment rate by about 1 one percent per year.

The international employment agency Manpower, in contrast, has for the past half century been producing an increasingly global employment report whose emerging markets content the firm boosted significantly in 2005.  Manpower research focuses on corporate hiring intentions over the coming quarter, rather than chronicling the firms’ actions in the recent past.  As a result of these emphases, the Manpower survey gives an interesting–and different–perspective for assessing the health of the world’s economies.

a diffusion index

One other factor to note before we begin.  Manpower presents its results in the form of what’s called a diffusion index. The company asks all the HR professionals it surveys whether their firms will be hiring, keeping a stable workforce or firing in the coming three months.  It takes the percentage of respondents hiring and subtracts the percentage firing.  This difference is diffusion index.

If, for example, 60% of respondents expect to be hiring and 30% expect to be firing (with 10% remaining stable), the diffusion index is +30.  If 49% are hiring and 50% firing, the diffusion index reading is -1.

the 2Q11 survey results

Here’s what the latest survey has to say:

Asia Pacific

In the Pacific region, Manpower covers eight countries. The lowest reading comes from Japan, at +10.  The highest two are India at +51 and Taiwan at +45.  The median reading is +23.  (Remember, +23 means that companies hiring outnumber those firing by about 3/2.)

The Indian reading is the highest in the six years Manpower has been surveying that country.

China peaked at around +50 in the December quarter and has fallen to +36 now.

EMEA (Europe, Middle East and Africa)

What a contrast!

Of the 21 EMEA countries Manpower follows, only Turkey (+34) and Belgium (+12) score higher than Japan.  Six countries–Austria (-1), Switzerland (-1), Italy (-2), Ireland (-3), Spain (-5) and Greece (-10) are in the minus column.  About the best you can say about these results is that they’re an improvement over the figures this region has been posting over the past two years.

the Americas

Here again, the tale is one of two regions.  The median reading for the ten countries surveyed is about +19.

The stars of the region are Brazil, which appears to be overheating at +40, Panama (+22), Argentina (+22), Peru (+20) and Costa Rica (+17).

Only two nations, Guatemala (+6) and the US (+8), are in single digits.

my thoughts

1.  Among developed countries, patterns in prospective hiring clearly illustrate the difference in the approaches–accommodation vs. austerity
of the US and EU governments in dealing with fiscal deficits generated by the financial crisis.  The healthiest country in the EU other than Belgium is Germany at +9, which falls one point below the developed world’s multi-decade growth doormat, Japan.  Everyone else, ex Greece, is flirting with one side of zero of the other.

The risk to the US is that the country won’t have the political will to rein in stimulus when the time is right.  The worry about the EU is that the cure will prove worse than the disease.  The near-term growth story, however, appears to favor the US.

2. The contrast the Manpower survey draws between the developed and developing world is very stark.  The developed countries of the globe barely break into double digits on the Manpower hiring index, meaning that almost as many employers are laying off workers as are looking to add to their staffs.  In the developing world, on the other hand, Manpower scores are soaring.  Asia ex Japan is averaging roughly 30.  Latin America is close to the same number.  Both imply that about twice as many employers are looking to hire as are looking to lay off.

Over the past several months, emerging markets have been underperforming those of the developed world.   The idea has been that governments of the former have begun to temper economic growth while those in the latter, especially the US, are still applying extraordinary stimulus.  Therefore, on a relative basis stock, markets in the developed world should be emphasized over those in developing ones.

To me the Manpower numbers argue that the preference for the US over emerging markets is a counter-trend movement that can’t last for long.

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