What is luring the big players to India?

Almost all the big players have, by now, started playing in India. Companies, such as, Goldman Sachs, JP Morgan Chase, Morgan Stanley, Merrill Lynch, Barclays, Fidelity Investments, and the like, have operations in India. Now, one obvious question is that what makes them come down to India to have operations here. What benefits do these companies reap out of India? And, if they make profits, then how do they so? Well, to answer all these questions, I would like to use a hypothetical case study.

Let us assume that there is a company X operating in the US. So, this is an American-financial firm, which deals in Mutual Funds, Derivatives, Futures and Options, et al. We are assuming that X deals in almost all types of financial products. Now, X asks US citizens to invest in its company to make money, say, at the rate of 10% annually. This is a very lucrative offer to American investors. So, American investors start investing in X.

Let me give you some background information about the US economy: According to 2006 data, the inflation rate of the US economy is around 2.5%, and the US economy is annually growing at the rate of 3.2%. And, American banks, annually, pay nearly 5% in interest to their money-depositing customers. Plus, generally and mostly, businesses in the US, unlike those in India, don’t grow at the pace of 8-to-10 times that of the national economy.

Once it collects huge amount of money from the investors, X creates funds and does hedging, risk mitigation, of those funds, in order to make sure that X pays the committed 10%, hypothetically assumed for this example, interest rate to its investors. X starts investing in those economies where growth rate is very high or, at least, higher than that of the US economy. Thus, companies, such as X, come to Asia, a continent of some very-fast-growing economies, such as, China, India, Japan, Pakistan, South Korea, Singapore, Hong Kong, and a few more.

Now, X comes down to India through the gateway of and/or with a facade of either an FII (Foreign Institutional Investor) or an FDI (Foreign Direct Investment). So, the Fund Managers of X start spending in the funds, stocks, futures, options, shares, or any combination of these things of some promising Indian firms – typically, IT, Pharmaceutical, Construction, Financial, Telecommunications, and Insurance.

Now, let me give you some background information about the Indian economy: The inflation rate of the Indian economy is around 5.3%, according to 2006 data. The Indian economy is annually growing at the rate of 9%, according to 2006 data. And, most of the businesses - especially, IT, Telecommunications, and Pharmaceutical firms - in India are thriving at the Cumulative Annual Growth Rate (CAGR) of 30%. Thus, it is obvious that why it is NOT possible for international firms to keep their hands off these Indian firms.

So, after doing all sorts of analyses, company X invests in promising Indian firms, which are earning and growing at the rate of 30% and above. Now, to make some calculations very simple and lucid, let us assume that company X has come with US $100 to India. X converts this amount to Indian rupees to do business. Thus, X gets INR 4500 (assuming US $1 = INR 45). Now, after being invested in promising Indian firms for one year, X makes a profit of 30%. Thus, after one year, X has INR 4500 (initially brought by X as Cost Price) + INR 1350 (profit made by X at the rate of 30%). So, the total amount X now has is INR 5850.

At this point of time, X has several options: to stay invested in promising Indian firms or to go back to its native market with the total amount it has in the Indian market, or to just pull out the profits it has made and be invested with the initial investments or to put some more investments in Indian firms. This decision is based on X’s business strategies. We are not going to discuss those right now. But, surely, we will come to those later.

If X now decides to go back with the entire amount it has in the Indian market, then X would part with INR 5850, which is US $130. X would pay US $110 (US $100 were borrowed from the investors and US $10 as agreed-upon interest amount) to its investors in the US. In the end, X would pocket US $20 as a year's profit made on a capital of US $100.

On top of all these, if the Indian rupee appreciates against the US dollar, then won’t it be an icing on the cake? Here is the explanation: Earlier, US $1 = INR 45 (roughly). Now, US $1 = INR 40. So, how much money, in US dollars, does X take away with it? The amount would be US $ (5850/40) = US $ 146.25. Isn’t it a whopping figure? What could be one of the possible reasons of appreciation of the Indian rupee against the US dollar? Is it that you cannot afford to stay off this ground, if you want to play the real game!!!?

Please, note, that, had X been doing business in the US, then it would not have been possible for X to make such a profit for itself and for its investors, simply, because such a high growth rate was not possible to achieve in the much stable-and-saturated US economy. Playing on the Indian ground is a win-win situation both for X and for its investors. Now, is that a win-win situation for the Indian economy, too? It is, obviously, worth pondering on! Actually, it depends on the way X exits the Indian economy!!!

Let’s see a situation, wherein, X and other similar companies keep on investing in the Indian economy. Doing so will set the Indian bourses on fire. The SENSEX will shoot up to the sky. Everyone would be confident of the Indian bourses and the Indian market. Then, suddenly, X and other similar companies pull themselves out of the Indian market by selling their stakes - obviously, to make huge profits on their investments . What happens next! - the SENSEX plummets, thus making hundreds of thousands of the investors in the Indian economy paupers in single shot!!! - Uncle Sam smiles and India cries foul!!! This is what happened in India in the first half of the fiscal year 2006-2007. The game doesn’t end here!!! The real game is about to begin!!! After plundering the Indian bourses of their sheen, Uncle Sam comes back with sheepish and sympathetic looks to re-run the cycle! He starts buying heavily because the shares are so dirt cheap and the Indian market needs money, badly. Thus, bourses start soaring once again only to fall flat on their backs! So, why on earth wouldn't Uncle Sam want to play on this highly vulnerable Indian playground by his own rules and free will to walk-in and walk-out the way he wants to?

Surprised? I am not!!!