Manish Marwah - Advisor and Management Consultant

Appreciation of Rupee - A Boon or Bane

Millon dollar question- one of the most popular saying, might change in future to million rupees question if this present era of rupee appreciation continued to be on roll.

Indian economy is among the fastest growing economies of the world. The appreciation of rupee against dollar will prove out to be another huge addition to its economic prosperity and growth story. However the economic epidemics like poverty, unemployment etc cannot be dealt in short run.
From 2003-08 Indian market is booming in leaps and bounds, today after china India is 2nd fastest growing economy of the world with registering a growth rate of 9%. India is a trillion dollar economy and has become world’s 12th largest economy (2008 estimate). Now major question drifting in every Indian mind is “Rupee Appreciation”. The rupee appreciated by 9.8% against the US dollar during the previous financial year between April 3 , 2007 to January 16 2008.

The rupee appreciation against US dollar over the past 12 months on year to year basis (December 2006 – December 2007) was a higher 13.2 %. The appreciation of rupee against other major currencies was much less than against the US dollar.
India witnessed 2nd highest appreciation in its currency of 8.35% between January and June 2007 after 9.28 % of Brazil among the emerging economies that are in direct competition with Indian exporters and find themselves better off due to sharp rise in rupee value, revealed by ASSOCHAM eco pulse study.
After having looked at these figures, the puzzle that floats in our mind, will the appreciation of rupee adversely affect our economic growth or it is an indicator of Indian growing economy?

What Lies Behind This Appreciation

The major reason which draws attention towards this rupee appreciation has been a flood of foreign-exchange inflows, especially US dollars. The surge of capital inflows into India has taken variety of forms ranging from foreign direct investment (FDI) to remittances sent back home by Indian expatriates. The main impact of these flows is as follows:

FDI: India’s starring economic growth has created a large domestic market that offers promising opportunities for foreign companies. Moreover many companies rising competitiveness in many sectors has made it an attractive export base.

ECB (external commercial borrowings): Indian companies have borrowed enormous amounts of money overseas to finance investments and acquisitions at home and abroad. This borrowed money has returned to India, boosting capital inflows. In 2007-08 (april-september) external assistance (net) was placed at US $ 729 million as against US $ 386 million for the corresponding period in 2006-07 indicating a growth of 88.9%.

Foreign portfolio inflows (FII’s): India’s booming stock market embodies the confidence of the investors in the country’s corporate sector. Foreign portfolio inflows have played a key role in fuming this boom. Looking at the period of 2003-04 and 2006-07, the net annual inflow of funds by foreign institutional investors averaged US $ 8.1bn. Trends during first five months of 2007 indicate that this flood is continuing with net FII inflows amounting to US $4.6 bn. Another major source of portfolio capital inflows has been overseas equity issues of Indian companies via global depository receipts (GDR’s) & American depository receipts (ADR’s). Moreover FII’s registered in India has doubled to 1050 between March 2001 –march 2007 and now around 3,336 FII subaccounts also exist. FII equity flow has increased from $9.8 billion in 2004, $ 11 billion in 2005 to over 16 billion in 2007. The stock market has buoyed by strong corporate performance and these inflows have risen to 43% in 2007. However in mid-October RBI banned foreign investment via off shore derivatives called participatory notes (PN). These derivatives were used by foreign investors not registered in India (say hedge funds) to indirectly invest through registered investors. Between Mar 2004 – Aug 2007 the number of FII sub accounts that issued PNs rose from 14 to 34. Many believed that motive behind such RBI measure was to improve transparency of capital inflows and that restricting inflows via PN would have little or no impact on overall inflows coming into the country.

Investment and remittances: Another major source of capital inflows has been non-resident Indians (NRI’s) investing large amounts in special bank accounts. While NRI’s emotional connection to the country of origin is part of explanation to this, the attractive interest rate offered on such deposits also provide a powerful incentive. In 2006-07 NRI deposits amounted to US$ 3.8 bn. another large source of foreign exchange inflows has been remittances from huge number of Indians working overseas temporarily. Such remittances amounted to a colossal of US $ 19.6 bn in April-December 2006, a 15% year on year increase.

Impact on Importers - The Gainers According to an industry analyst: every 10 paisa appreciation in rupee negates one dollar upward movement in international price.
Rupee appreciation brings jovial time for importers. Major imports to India are petroleum products, capital goods, chemical, dyes, plastics, pharmaceuticals, iron and steel, uncut precious stone, fertilizers pulp, paper etc. during the periods when dollar was getting strong against rupee, when 1$ = Rs 48 importers used to pay Rs 4800 for every $100. Since the beginning of the year 2007, rupee has appreciated nearly to about 10%. With value of rupee Rs 39.35 = 1$ for every $100 importer has to pay Rs 3935 by gaining a profit of Rs 865. This gain will bring about savings in cost which can be passed on to consumers, thereby becoming immediate tool for controlling inflation.
Over 10% appreciations in domestic currencies against dollar has thrown a new M&A opportunity for India Inc which wants to reach out world by acquiring going concern on a global scale. An ASSOCHAM study of 70 deals done in the first six months of the last financial year( 2007-08) , in which Indian firms undertook buyouts worth $ 14 billion , has revealed that Indian companies would have saved Rs 6500 crore ($ 1.66 bn) just because of increase in rupee value.
Due to continuous decrease in dollar value, the US had remained the most favorite hunting ground for Indian companies. $2.9 bn valuation deals were announced with US companies in financial year 2007-08.
In terms of sector analysis steel rule the rest owing to the Tata-Corus deal. The overall valuation of M&A in steel sector was of around $5.4 bn.

Rupee appreciation is also welcomed by companies which have overseas borrowings. Significant levels of foreign currency –denominated, especially US denominated loans generate forex gains because of reduce interest payments which are occasioned by rising Indian rupee. Companies like Ranbaxy and L&T have been able to generate forex gains because they have substantial exposure to ECB’s.

Impact on Exporters -The Sufferers

With the ratio of 70:30 of imports and exports the major export destinations of India are USA, EU, Japan, Brazil and other Asian countries. Products which generate revenues from these destinations mainly compose of handicrafts, gems, jewellery, textiles, and ready made garments, chemicals and other related products. As seen for imports, if we analyze if an exporter is getting Rs 3935 now instead of Rs 4800 he is at a loss of Rs 865. This loss will lead to erosion of exporter’s profit margin and will affect their competiveness in global market.

In contradictions to the apprehensions of that there would be shrink in profit margins of exporters due to emergence of strong rupee, the latest studies of ASSOCHAM exhibit that stronger rupee will bring in rich dividends for India Inc and boost its profit margins between 12-15% in long run as exporters are brininging new technologies with cheaper imports for expanding their existing capacities.

The chamber holds that a strong rupee would reduce the cost of imports and would have some positive impact on those exporters which have large import content as witnessed from figures above. It further recommended that if companies are able to expand their capacities in rupee appreciating scenario, they would in the long run , definitely be in win-win situation as demand for Indian exports in developed countries would not slow down. The India Inc would be able to export at very competitive prices as a result of capacity building through technological advancements and increase in margins by 12-15%.
Policy Dilema
Indian policymakers are struck with difficult crisis. On one hand, the stronger rupee has benefited the economy by making imports cheaper. On the other hand due to both economic and political reasons policymakers cannot afford to ignore the problem of exporters. India‘s rapid export growth in recent years have been the major accelerator of economic growth.

If RBI intervenes to stop rupee from appreciation further , it may turned out to be a boon for export oriented units and crate more employment but at the same time this may also bring in inflationary tendency to the market. Therefore government is in dilemma of choosing between inflation and unemployment.
There is a limited extent to which RBI can intervene in the foreign exchange market in the face of large sustained capital inflows; policymakers can stem rupee appreciation substantially by easing limits on domestic firm’s overseas investments or restricting inflows – for instance, through further control on ECB’s. The RBI has already taken tentative steps in this direction making it more difficult for Indian firms to borrow in foreign currency and eliminating the exemption from ECB limits which used be previously enjoyed by real estate firms. ....

By. Manish Marwah

Manish Marwah on media

Media & Entertainment: The sunrise sector

Manish Marwah On Media Management

Media Management

Is Yield Improvement a Real Possibility?

Today it is possible to increase the yield with the combination of new sciences- based on genetically modified seeds and applying existing and traditional sciences – better use of fertilizer and improved irrigation systems. For example, in the US, new seed technologies have reduced diseases vulnerability of crops like maize and cotton. In India also us of BT cotton, a genetically modified version of cotton seed has resulted into very much improved results.

Some regions have apprehensions about the use of genetically modified varieties due to fears of unintended consequences, but most scientists so far have proven no adverse effects, even 10 years after adoption.

India’s crop yields are far below that of many regions. For example, India’s wheat yield at 2600 kg / hector is well below that of china (4100 kg / hector) and Europe (5000 kg / hector). Similarly, India’s rice yield at 3000 kg / hector is again well below that of china (6200 kg / hector), Europe (6400 kg / hector) and US (7500 kg / hector). India’s soybean yield at 870 kg / hector is far below that of Brazil (2500 kg/hector), Europe (2600 kg / hector) and US (2700 kg/hector). So, it is clearly a possibility to significantly improve crop yield in India. Honorable Minister of Agriculture Shri Sharad Pawar has also in his recent speech expressed concern over the slow pace of farm research in the country and exhorted scientists to raise productivity of crops to meet domestic demand and cut import dependence.

Long-term Measures by the Government

To counter the political implications of the poor farm growth and inflation risk, the government has planned or planning some long-term measures. The government has announced that a coordinated approach on agricultural indebtedness will be finalized in the near term to help the farming population and avert a further rural debt crisis in the country. According to the media reports, the government is likely to initiate a mega-farm loan-restructuring package covering bad and doubtful debt of about Rs300 billion (or US$7.5 billion) in the upcoming Union Budget to be announced in February 2008.

In the Union Budget (February 2007), the government increased its budgeted spending on irrigation by 54% and on Bharat Nirman program (covering rural infrastructure) by 38%. In addition, the government is targeting a net disbursement of USD 7.8 billion (0.4% of GDP) in the farm credit by the end of next year. The government is also relaxing regulations for private sector participation in agri value chain and many states have amended agri marketing acts paving way for direct transaction of private sectors with farmers. This coupled with emergence of the organized retailing is likely to be a significant catalyst for India’s farm sector growth.

India’s position in the world agro map

India has the second largest arable land (~ 162 million hectors, out of that ~ 140 million hectors is actually sown) in the world next only to USA and the largest irrigated land base of ~ 55 million hectors in the world. Due to such a large arable land base, India is the second largest producer of rice, wheat, sugarcane (for sugarcane it may be the largest for current year), fruits and vegetables; the largest producer of tea and a leading producer of edible oil seeds and coarse grains in the world. India also has second largest cattle head count and the largest producer of milk in the world. But, India is also a second largest populous country in the world (having population of ~ 1.2 billion people), so on demand-supply front, except edible oil for the most of the major agriculture items, India is largely self-sufficient, though it has started importing wheat to replenish it inventory.

But at present, the key question one should consider is – Is India prepared or capable of meeting all its future demand for food without restoring to imports from the rest of the world (and becoming food dependent country) and without having widespread inflationary effects? It is sure that rising per capital income on back of strong economic growth, exponential growth in middle income consumers, higher aspiration and changing food habits are likely to result into higher non-liner growth (compare to population growth) of food consumption in India. However, as far as the growth is concerned, India’s agricultural economy is stagnant on many (or almost all) fronts. Indeed in the last five years, the average growth in agriculture production has been below country’s population growth. Annual per capita food grain production has declined from 207 kg in 1995 to 186 kg in 2006. The rate of agriculture growth has fallen from 5% in the mid-1980s to less than 2% in the past half-decade.

Net irrigated area has just grown from ~ 50 million hectors in 1990s to ~ 55 million hectors currently , capping the growth in available land for cropping (As irrigation makes it possible to take crop two times a year instead of rain dependent land where only one crop per year is possible). The average growth in land brought under irrigation decelerated to 1.5% during F1991-04 compared with 2.4% in the 1980s and 2.7% during the 1970s. The government spending on agriculture is also hovering around 0.5% of GDP since last couple of years. On productivity front also there is not much growth. The yield per hector of food grains is around 1700 kg / hector, almost stagnant for last seven years. The government's fertilizer policy has distorted the trend in fertilizer consumption and therefore the mix of soil nutrients, resulting in low productivity. The ideal usage ratio of nitrogen, phosphorus and potassium (NPK) is 4:2:1. According to the Planning Commission of India, this is one of the proven and well-documented reasons for stagnation in the productivity and production growth rate since the early 1990s. Another problem in India is fragmented land holdings – about 60% of the farm land is owned by small marginal medium farmers who are unable to benefit from power of scale and are more vulnerable to adverse weather conditions and high level of indebtedness.

Future demand by various estimates of per capital GDP growth suggest that by 2020 India will require 270 to 290 million tons of food grain against current production of ~ 212 million tons. This can only be achieved either through increasing the yield per hector (need to achieve yield of 2100-2150 kg / hector from current 1700 kg/hector) or by increasing area under irrigation (Only 40.3% of the farming land is irrigated). India’s solution to remain food sufficient economy lies in systematic efforts to achieve both.

Worldwide food prices have risen sharply and supplies have dropped this year… The changes represent an “unforeseen and unprecedented” shift in the global food system, threatening billions with hunger and decreased access to food…

United Nations Food and Agriculture Organization on its latest food outlook

Article Author Manish Marwah

Global food inflation is on the rise …

Global wheat, rice, maize and soybean prices have increased to new multiyear highs. The CRB food stuff index has rise 23.7% y-o-y in December 2007. The FAO’s food price index rose by 40% in 2007, on the top of the already 9% increase the year before, and the poorest countries spent 25% more in 2007 on imported food.

The prices of grain-fed meat, eggs and dairy products are also significantly up spurring wide spread inflation throughout the consumer food market.

In India, healthy buffer stock and the government’s efforts to restrict exports have helped in keeping domestic food prices (especially of grains and pulses) insulated so far (In fact, NCDEX agri index is currently quoting marginally down y-o-y). However, with a lag, some amount of pass-through of higher international prices in domestic food prices will be inevitable. In India, domestic demand supply situation is also very tight in certain agro commodities like wheat and edible oil, any adverse impact on output could potentially push up the domestic food inflation sharply (as on January 2008, area under acreage for wheat is down 2-3% y-o-y and for oil seed, it is down ~ 10% y-o-y).

Rising inflation and slow response to rising demand for wheat, pulses, rice and edible oil have caused a sense of urgency for food security in the country…. The rates of growth of agriculture in the last decade have been poor and are a major cause of rural distress… Farming is increasingly becoming an unviable proposition because of the nature of landholdings.”

Honorable Prime minister Dr. Manmohan Singh speaking at 53rd meeting on the National Development Council

Approach In Agriculture

AGRICULTURE, The Next Big Opportunity

Despite India's dominent position as a producer in word agriculture, India has a Meager 1.5% share of global agritrade.This is because both, productivity levels(yields) as well as the level of food processing in India,continues to languish below that of comparable geographies. Thus,the potential for growth in this sectior is huge and could in turn trigger growth of the intire economy, driving GDP growth. Recognizing this potential, the government has decided to step up investments in this sector, open it up to the private sector by premitting contract farming which should see the growth rate of the agricultural sector more than double over the next few years helping India achieve a GDP growth of 8%.

India occupies a dominant position in world agriculture. In India, 52% of total land is cultivable as against 11% which is the world average. Also, of the 60 soil types in the world, India has nearly 46. India thus has the second largest gross cropped area (160 mn hectares) and is a leading producer of cereal crops, pulses, tea, jute and allied fibres and fruits & vegetables. It also has the second largest livestock population in the world and is the largest producer of milk in the world. In fact, India accounts for 17% of the animals, 12% of the plants (including over 10,000 species of aromatic and medicinal plants) and 10% of fish genetic resources of the world.


But India's share in international food trade is negligible. India accounts for less than 1.5% of international food trade. There are several reasons for this. Firstly, the agricultural sector is largely unorganized, dominated by small farms (in all 100 million, with farm size of less than 1.2 hectares divided into 3-10 separate plots), which constrains productivity levels or yield per hectare. Secondly, very little of the food that is produced is processed thanks to the food processing industry also being largely unorganized. Small players, which process less than 0.5 tons/day and aggregating around 9,000 units, account for bulk (~75%) of processed food output.


Thirdly, the value of wastages in food grains and fruits & vegetables is estimated at over Rs50,000 crore, as the food chain from the farmer to the consumer involves several intermediaries with multiple-point handling and long transit periods. And this in turn increases the cost differential between the mandi (wholesale) price and the market price to 60-100% or more. Fourthly, with government funding to the sector proving grossly inadequate and liberalization withheld, capital formation saw a negative growth.

These shortcomings constrained the growth of the agricultural sector, which has seen a deceleration from 3% in the 1980s to just 2% over the last 10 years, even while its counterpart the services sector grew at a rate of over 7.5%. Considering that agriculture accounts for 35% of India's GDP and nearly 65% of employment, even if the growth rate in agriculture were to double, it could spur growth in GDP to over 8%, both directly through increase in agricultural production as well as indirectly though growth in rural consumption.



India's gross cropped area of 160 mn hectares nearly equals the size of US farmland and is larger than that of Europe and China. But with only ~40% this land being irrigated, agriculture production has grown at a rate of just 2.7% per year over the last 40 years. It israte of just 2.7% per year over the last 40 years. It is estimated that a 1% increase in irrigated area generates a 1.6% increase in crop output and a RoI of 17%. Realizing this, the Indian government has been making a concerted effort to increase gross cropped area under irrigation including offering irrigation projects on BOT basis. It is also opening up the sector by allowing corporates to undertake (i) Contract Farming, (ii) Supply Chain Management, (iii) Agro Retailing and (iv) Food Processing on a larger scale.
To facilitate the same the government has asked states to change their APMC Act (which required all agricultural products to be sold only in government regulated markets) and linked credit flow to the same capital investment subsidy for renovation of godowns and setting up farm marketing infrastructure will only be given to states that have amended the APMC Act. Fourteen states and four Union Territories have already amended the APMC Act which allows farmers to sell their produce directly to buyers. Meanwhile, another six states have undertaken partial reforms and 13 states along with three Union Territories have initiated action on the reforms front.

Contract Farming

Despite India's leading position in world production, it lags behind in productivity (yields). In fact, though India ranks second in rice and wheat production, in terms of yield/hectare it ranks 52 (rice) and 38 (wheat). For pulses the productivity levels drop even further. Despite being the highest producer of pulses in the world, India ranks 138 in terms of productivity. To improve yields in agriculture, the government has allowed the private sector to undertake contract farming. This, the government believes will result in increase in seed replacement (from 12% to 20%), farm mechanization (from 25% to 40%), fertilizer (NPK) use (from 91.5 kg/ha to 160 kg/ha) and IPM coverage (from 5% to 15%) apart from improving cropping intensity from 134% to 145%. According to the Agricultural Ministry, reforms in the agricultural sector are likely to see total food grain production rise from 203.41m ton in 2000-01 to 320.0m ton by 2011- 12, registering an annual growth of over 4%, while for horticultural produce the growth would be even higher from 152.5m ton in 2000-01 to 300m ton in 2011-12, a growth of over 6% p.a.

Allowing corporates to undertake contract farming has seen the entry of large players like PepsiCo India Holdings, Bharti TeleVentures, HLL (which works in consortium with Rallis which provides agri-inputs and know how and ICICI which gives farm credit), Tata, DCM Shriram and McDonald's among others. In the case of PepsiCo, which has 75,000 acre of holdings across states on which nearly 200 farmers grow corn, tomatoes, basmati and potatoes, contract farming led to savings of 20-30% apart from ensuring steady and adequate supply of raw material for its food processing plants. In fact, PepsiCo's foray into contract farming in Punjab was on account of inadequate supply the company required 40,000 ton of tomatoes over 55 days to operate its tomato processing plant but the state could provide only 28,000 tons in one season (28 days).

However, the total area currently under contract farming covers only 7 million acres of the total cultivable land of 400 million acres, accounting for less than 2%. And even this figure drops to 200,000 acres if only corporate contracts are considered. While contract farming is attracting more players like Reliance Industries, retail chains like Big Bazzar and Metro, the challenge will be to integrate farmers as benefits of scale and technology can be achieved only on minimum 3-4 acre plots.

Supply chain management: key to profit maximization

The long supply chain starting from harvesting, packing, grading, transportation, storage, wholesale and finally retail sale involves very little value addition but huge losses in terms of wastage (15-25% is lost by the time the produce reaches the retail level). In value terms, the wastage in food grains (including post harvest losses) is estimated at over Rs50,000 crore a year. For fruits and vegetables (where post harvest loss is higher at 25-30%) it is estimated at over Rs 23,000 crores.

Further, despite little or no value addition, the price of the commodity increases by nearly 100% from the farm-gate to the retail stage, with neither the farmer nor the consumer benefiting. The share of the rice grower in the final price paid by the consumer is usually not more than 44-47%. And for fruits and vegetables the farm gate price as percentage of retail price is even lower at 25% compared to 70% in USA. According to a study conducted by Rabo India Finance, farmers share could increase to 33% of total revenues on an average after disintermediation in the supply chain, while consumers would save 10% of their spends on food if supply chain efficiencies were improved.

Terminal market complexes: As a step towards reducing wastage and increasing share of producers in price, the government has encouraged corporates to set up TMCs. TMCs offer multiple choice to farmers such as electronic auctioning and direct sale to exporters, processors and retail chains under one roof. In addition wastage is reduced as TMCs provide storage infrastructure (giving participants the choice to trade at a future date), logistics support including transport and cold chain services and cleaning grading and packing support to farmers. The TMCs would operate on a Hub & Spoke format with the TMC (the Hub) linked to a number of collection centers (the Spokes) located at key production centers. Corporates that have expressed interest to set up TMCs include Reliance Industries and ITC, which plan to invest between Rs60 crore to Rs120 crore on each TMC. In all, eight TMCs are likely to be set up in centres like Mumbai, Nasik, Patna, Chandigarh, Rai (Haryana), Bhopal, Nagpur and Kolkata. The area covered would vary from 200 acres (for Mumbai) to 55 acres (Kolkata). And the handling capacity in each TMC would range from 200,000 ton to 600,000 ton (for Mumbai) a year.

Information technology to aid growth

The Agricultural Ministry with the help of the National Informatics Centre has promoted on-lineagricultural markets for crops and horticultural produce.

Agmarknet: To ensure that farmers get a fair price for crops, the Agmarknet has sought to network all major agricultural producer markets, agricultural marketing boards and departments and wholesale markets in the country. Along the same lines it has also promoted Hortnet a horticulture informatics network (though this has been taken up on a turnkey basis with the hub having been set up at the National Horticultural Board, Gurgaon, to which 33 countrywide market centers of the Board areconnected. Prices and arrivals of fruits and vegetables are received by NHB on a daily basis from the 33 centres. To improve productivity at the farm level and help in efficient dissemination of information it has also set up a crops informatics network (Cropsnet), a plant protection network (PPIN) and a fertilizer informatics network (Fertnet).

The success of introducing IT in agricultural marketing can be gauged from the fact that Agmarknet, which has set a target of connecting 2810 market nodes in the 10th plan, has already connected 2408 nodes.

E-choupal: ITC has also made a significant contribution to the growth of e-markets. ITC's echoupal network is today the largest network in the country with over 6,000 kiosks in operation. It has already connected more than 30,000 villages across six states and is growing at a hectic pace, entering 30 new villages a day. In recognition of its contribution to the field of information technology, the company recently received the prestigious Development Gateway Award, an international award recognizing outstanding achievement in the application of information and communication technologies.

Time to Revisit

The Indian economy is booming, stock markets are buoyant, homegrown entrepreneurs are spreading their wings, exports are growing, and consumerism isrising. In this scenario, it is definitely worth revisiting the issue of full Capital Account Convertibility (CAC). Most likely, CAC would improve the business environment, giving Indian industry access to lost-cost capital and the economy more options for asset allocation, bringing in higher inflows and improving the confidence level among foreign investors.

But is the time right?
But is the time right?When Global imbalances are worsening, commodities are in strong bull cycle, interest rates are rising all over the globe, inflation is looming and asset markets sky rocketing, will introduction of full CAC will bring desired results?

Answer lies in India’s approach…Though RBI is revisiting the issue of capital account convertibility again after 1997, it will still favor a phased roll out of full CAC in India - probably a time horizon of next 3-4 years- due to its concerns over inflation, quality of credit growth, rising interest rates and some asset markets. The finance minister too does not foresee a full convertibility of rupee before 2009 when India’s revenue deficit could have been be wiped out and fiscal deficit could have been brought down to 3%.


The things have changed.The fundamentals of Indian economies has changed significantly since RBI first appointed S S Tarapore Committee in 1997 to study Capital Account Convertibility (CAC) issue taking guidance from 1997 Union Budget Speech. At that time, the GDP was growing at lackluster pace of 5% against 8.1% projected for 2005-06. The center’s gross fiscal deficit was also hovering around 5% against 4.1% today. Compare to foreign exchange reserve of USD 26 billion (covering 7 month import) in 1997; India’s foreign exchange reserve currently stands at more than USD 150 billion. Non-performing assets of banks, then at double digits (~14% in 1997) too have come down to below 5% today and to allow greater flexibility to banks the Cash reserve ratio has been lowered from 9% in 1997 to 5% in 2005.


India’s manufacturing exports has also grown from USD 35 billion in 1997-98 to USD +100 billion in 2005-06 whereas its IT & related services exports has grown from less than USD 2 billion in 1997-98 to USD +23 billion in 2005-06. Not only that, India has emerged as one of the most significant global players in IT/ ITES related exports. India is also gaining momentum in manufacturing exports mainly in the areas of Textiles, Auto ancillaries, Engineering and Specialty chemicals. India’s +1 billion population, with young age bias, rising income & growing middle class have also fueled consumption led growth making Indian economy more resilient.


Though in 1997 Tarapore Committee came out with a report laying pre-conditions for CAC by year 1999-2000, the issue of CAC was put on the back burner due to precipitation of financial crisis in South East Asia soon after (blamed to CAC of those countries). Recently RBI has again appointed a committee to set out the framework for fuller CAC, in response to the government’s declaration of revisit the CAC issue. Due to significant improvement of India’s macro fundamentals, most of the pre-conditions laid by 1997 Tarapore committee has already been achieved. (See “Road Map to CAC”)

Progress so far

Though East Asian Crisis put the government’s plan to adopt full CAC on hold, India has achieved a significant progress towards partly CAC since 1997.some of the measures recommended by Tarapore Committee in 1997.For, example, Tarapore Committee recommended that Indian Corporates should be allowed to invest up to USD 50 million in direct investment abroad, where as per present guideline, Indian Corporates can make overseas investments up to 200% their net worth under automatic route. And see the way this facility is used by Indian corporates today: Just in one quarter (first quarter of 2006), Indian companies have acquired more than USD 3 billion worth foreign entities. The overseas borrowings / fund raising by Indian corporates have also been liberalized up to certain extent but with few restrictions like overall cap, company level cap, minimum maturity, and end use. The FDI route is also now open for most of the sectors (retail trading, atomic energy, lottery business, gambling, agriculture and plantations being exceptions) with sectoral cap on few sectors.

However, capital account is still restricted for banks and individual to a large extent. For individuals, there are caps on spending limits for various purposed like foreign travel, foreign education, overseas medical treatment, etc. Individuals too have limited options to invest in overseas assets as the annual limit is US$ 25,000 per individual for overseas investment. Banks are also not allowed to raise fund through ECBs and only allowed to borrow upto 25% of tier I capital that again with certain restrictions. Along with restrictions on borrowings, there are restrictions on assets side too with banks’s money market investment restricted to USD 10 million and debt market investment restricted to USD 25 million.


Why fiscal discipline is important Success of CAC depends on balanced flow of forex, and for developing countries like India, it means attaining the right balance between exports and consumption led growth, and ensuring adequate investment in infrastructure and new capacities. (See “How India’s forex requirement is balanced”)

It has also become an imperative for India to invest continuously in infrastructure and capacities to attain the higher economic growth. India is relying on three main sources for its investment needs namely foreign investment, domestic savings, and government. Though foreign portfolio investment strong so far in India, foreign direct investment has not picked up compared to other Asian countries. Domestic savings were at 29.1% GDP in 2004-05 but due to strong consumption led credit off take, significant portion of domestic savings are diverted away from investment In this scenario, government’s role to fund India’s investment requirement, particularly in infrastructure sector, is very important. And that is where importance of fiscal discipline comes in to play. The large revenue deficit means increasingly borrowing to finance current expenditure of government rather than investing in growth. It holds the economy back by crowding out private investment, imposing heavy burden on the budget and using the resources that can be directed towards development needs. (See “How India’s Public debt/GDP compares with others”). That is why though our deficit has come down, our finance minister is also not foreseeing a full convertibility of rupee before 2009 when India’s revenue deficit could have been be wiped out and fiscal deficit could have been brought down to 3%(See “Central Government’s fiscal and revenue deficits”).


Benefits
Experience of few emerging markets suggests that a move towards full CAC could result into large capital inflows and can trigger appreciation of the exchange rate. Strong inflows can definitely have positive effects on economic growth but it also requires a very healthy financial system. Two obvious benefits of a CAC will be reduction in cost of capital and access to larger capital for India corporate At a time when India requires an imnvestment of US$ 1.5 trillion over the next five years to accelerate its growth to +10% from the current 8%, higher capital flows are definitely welcome.


Full CAC will also allow Indian corporates having operations in multiple countries to effectively hedge their risks. Full CAC will also open overseas asset markets for Indian investors/companies thus can provide them with more options and better portfolio diversification. In fact with cross border integration of global markets, capital controls over longer periods are infact costly, ineffective and distortive. A gradual appreciation of Rupee coupled with removal of infrastructure bottlenecks and productivity increase will sustain India’s competitiveness in exports markets coupled with reduction in import bill thus having positive effect on the trade deficit. A gradual appreciation of Rupee will also have a positive effect on inflation and government’s oil subsidies as oil accounts for 30% India’s import. However there are certain external risks which India faces and can result into strong capital out flow (See “Factors that can spoil party”).

Conclusion
A full capital account convertibility will definitely be a welcome move that expected to result into larger inflows of foreign savings and investments at a time when India is needing it the most. But fiscal discipline and safeguards are needed to be in place before that happens.

Article Author: Manish Marwah

Whats Driving Indian Consumerism

India’s baby boomer generation has grown up and unlike their parents who experienced guilt pangs every time they spent money, this generation has no such qualms and believes in living it up. One can attribute this largely to the fact that today’s consuming class has not only grown up in the post liberalization era but also has more choice too, both in terms of job opportunities as well as lifestyle choices.

Better economics (India is the fourth largest economy in terms of Purchasing Power Parity in the world) and the country’s growing eminence as a cheap and par excellence service provider, is seeing to it that global companies flock to India to grab a share of the growing consumer pie. Moreover, as markets in the developed nations are simultaneously getting saturated, India’s 250 million, and growing middle class is a big lure for global behemoths.

India’s ’Demographic’ DanceIndia is just the right age and is currently the youngest nation in the world with 65% of its billion plus population under the 35 years age group. What’s more>, a large percentage of this youth is urban. As a result, India’s urban/total population today stands at around 30% and is tipped to touch 37% by 2016, which is comparable to the urban-total/ population levels in East Asia. Further, the median age for India’s youth is also one of the youngest in the world. As against 35 years in USA, 41 years in Japan and 30 years in China, the median age for India’s youth is roughly 24 years.

According to a study conducted by the Asian Development Bank, the proportion of population in the consuming age (15-54 years) is also likely to increase from 58% in 2006 to over 60% in 2010, while the dependency ratio (share of non-working to working population) is likely to decline from 62% in 2003 to around 55% in 2010. In fact, as a higher percentage of population moves into the consuming class, the growth in consumption expenditure is likely to exceed growth in per capita income (12% y.o.y. for next five years).

Increase in consumption is also a direct fallout of increase in urbanization, as the average per capita urban income is twice the per capita income in rural India (See Table 1.0). Given that the average monthly per capita consumption expenditure for urban India has nearly doubled in the last decade and the fact that urban India accounts for nearly 42% of consumer expenditure (per capita consumption is 90% higher than that of rural India), one can easily attribute the rising consumerism to growth in urbanization.

A stronger rural India with growing capacities to consume is also fueling demand for products and services.Nearly 70% of India’s population lives in villages and rural consumption is directly linked to agricultural income. A supply deficit scenario is driving the firm trend in global cereal prices as stock levels are closed to 20-year low levels. Price trend of other agro commodities are equally or more firm. A combination of firm agro commodity prices, better irrigation and huge government thrust on the agriculture sector has resulted into rising farm income of rural India along with strong return of rural demand. Increased corporate participation and better infrastructure have also resulted in a meaningful impact on farm income and thus rural consumption demand. Increase in income levels: In the last five years there has been a perceptible increase in the number of households in the middle income and higher income categories. Almost simultaneously, the number of households in the lowest-income bracket has witnessed a sharp fall (See Table ). If that was not all, with rising disposable incomes and lifestyles in transition, the spending pattern of the average Indian is also changing. The top three income categories (See Table ) those earning above Rs. 180,000, those earning between Rs135, 000-180,000 and those earning between Rs. 90, 000-Rs. 135,000 will account for nearly 50% of the total income pie by 2010, a sharp increase from 28% in 2002. And as a recent KSA Technopak survey on spending behaviour of more than 10,000 urban households in India indicates, consumers in the last couple of years have started spending more on lifestyle categories like eating out, movies and entertainment (See Table ).

To keep pace with the burgeoning demand of the Indian middle class, over 200 malls are expected to come up over the next three years across the country, while over 50 million sq. ft. of retail space is likely to be added in 2007. The booming organized retail sector is in turn attracting top global brands to India. From clothes to accessories, foods & groceries to jewellery, projects have been lined up that are expected to increase organized retail penetration levels to 10% by 2010. Allowing FDI in telecom has already had a positive effect on the economy: teledensity (earlier below 1% for five decades) went up to 10% in just a single decade. With competition hotting up, tariffs came down and introduction of mobile services saw a sharp increase in mobile subscribers. The recent government initiatives of allowing 100% FDI in real estate development and 51% FDI in single brand outlets has already opened up the sector for many global hopefuls and is likely to have powerful impact on the sectors. And enabling the consumer to spend more and more are the numerous consumer finance schemes that have gained acceptance among the consuming classes. At an individual level, borrowing constraints have reduced substantially with banks/finance companies becoming aggressive lenders. Today, finance is available for almost all kinds of purchases whether large purchases (like a house) or small ones (like a television set). Low interest rates and narrowing down of the gap between deposit and lending rates is also aiding growth in consumerism. The rise in usage patterns of credit cards by the consuming class has also helped to bring a change in spending patterns. In addition, change in other supply dynamics like emergence of multiplexes, resurgence of radio, entry of large corporates in agri space, privatization of airports, increased public private participation in infrastructure projects are also supporting demand driven by domestic consumerism.
Crystal Gazing into the FutureOf course, growing disposable incomes and rising demand will automatically help all sectors of the Indian economy to ultimately ’rise & shine’, but who are the ones on whom immediate impact will be felt? Already the auto industry, consumer durables, telecom and retail banking have benefitted from rising consumerism in India and will continue to be benefitted in the future also. But, organized retail, the entertainment sector and others are now on the verge of boom. Riding the boom in aspirational products, organized retail has been booming. Retail sales which have been growing at an average annual rate of 7% during 1999-2002 are set to grow at an even faster clip of 8.3% annually during 2003-08, which is even higher than the estimated growth in consumer expenditure. Given that organized retail accounts for only 2% of the total retail market as against developed countries where most of the retail trade is conducted through organized retail outlets, there is enormous scope for organized retail to grow. At current growth rates, it is estimated that organized retail will account for 10% of the total retail pie by 2010. Strong growth for lifestyle related aspirational products/services is also predicted with increased ability & willingness to pay and availability of diverse choices (like multiplexes, low cost air, etc) to the consumer. Some of the categories that are likely to witness higher growth rates are multiplexes, organized retailing, restaurants, specialty electronics, branded jewellery and air travel. The Rs 300 billion Indian entertainment industry is also set to double in the next five years with all supply dynamics moving in a unidirectional manner. The growing penetration of C&S and a growing advertiser base in the broadcasting space, emerging platforms like Direct to Home (DTH), IPTV and consolidation of cable operators in the media distribution space, easy access to funds and corporatization of the movie production industry, digitization of cinema and emergence of multiplexes has already spawned a boom in entertainment business. Now, with FDI/FII investment of 26% allowed in the broadcasting, the number of channels have increased from a paltry few to over 200 channels and from limited transmission period of six hours to round-the-clock transmission. FDI/FII investment of 49% in cable services and 20% in DTH ventures should bring about more changes in this space. The FMCG industry estimated at Rs 450 billion is also the next big beneficiary of the boom in consumerism. Thanks to lifestyle changes and globalization, the traditional perception regarding packaged food being either stale or unhygienic is changing. Emergence of modern retail formats and better supply chain management has already made the agri sector an attractive investment opportunity to large conglomerates like Bharti and Reliance, among others. With growing consumerism, FMCG companies, which have finished their capex phase, are now building brands aggressively. Given the consumer’s preference for lifestyle segments - skin care, cosmetics and health care are the sectors to bet on in the FMCG space, while in processed foods - juices, ready-to-eat staples and refined edible oil are the areas likely to generate the highest returns. Last but not the least,the high cost structures and poor infrastructure that retarded the growth of India’s aviation sector in the past, is fast disappearing. Regulatory changes (abolition of IATT and reduction of excise duty on ATF) and competition have helped drive costs down making air travel more affordable. In fact, reduced fares have increased demand from leisure travelers (a segment that is likely to grow at a faster rate than the business traveler segment that dominated air travel until now) and the sector is likely to grow at a rate of 20% for the next five years.
Still not convinced of India’s potential? Check this…
Organized retail USD 35 billion by 2010 and USD 90 billion by 201 Entertainment business Rs 600 billion by 2010
Lifestyle related spending Rs 2500 billion by 2010
Airline traveler more than 50 million by 2010
Consumer space to treble from here by 2015
Need we say more!

Infrastructure: an India priority

Intro: India’s infrastructure spend at 3.5% of GDP is not only much lower than China’s spend at ~11% of GDP but needs to go up to at least 4% of GDP by FY12 if current growth rates are to be sustained. This would require an investment of over Rs12,265 bn across sectors over the next six years, even at a conservative estimate. But unlike in the past when most of the investment in infrastructure was made by the government, this time around the government has decided to act as a facilitator preferring to fund projects through public-private partnerships (BOT route). This has opened up several opportunities for private players and FDI investors with IRR as high as 25% even for low-margin infrastructure projects like roads. As for investors, with market capitalization of infrastructure companies set to increase by over US$100 bn over the next 3-5 years, returns would clearly outweigh risks in the medium to long term.
Base case scenario
Keeping gross capital formation (GCF) as a share of GDP and infrastructure spend as a share of GCF at its five-year average, we find that infrastructure spend corresponding to 7-8% GDP growth is likely to go up from Rs1,511 bn in FY06-07 to Rs2,664 bn in FY11-12 aggregating Rs12,265 bn over FY07-12.
Since gross domestic savings (household, corporate and public) is the main source of funds for infrastructure development, keeping the share of infrastructure spend to GDS constant, and assuming a 14% growth in the GDS rate (5-year CAGR is 12.6% but the growth rate has picked up over the last two years) one arrives at a sum of Rs15,263 bn (private sector savings of Rs14,500 bn + public savings of Rs763 bn) that is likely to be spent on infrastructure over 2007-12. FDI, the other source of funds for infrastructure development, is likely to contribute another Rs1,238 bn; even if FDI grows at a slower rate of 2% (as against 8% CAGR over the last 5 years), assuming 75% of the FDI goes towards infrastructure creation. This gives us a cumulative figure of Rs16,501 bn that is available for investment in infrastructure in a base case scenario.
Since Rs16,501 bn is available as against Rs12,265 bn that needs to be spent on infrastructure over the next 5-6 years to maintain current growth rates, even if GDP growth is higher than expected, infrastructure growth would be able to keep pace. However, these assumptions are based on a top-down analysis. Using a bottom-up approach (i.e. based on sector-wise outlays), actual spend on infrastructure could be higher at ~Rs14,000 bn over the next 5-6 years.
Estimates on sector spends based on outlays (Rs bn)

Sector Spend over FY07-12
Roads 1,520
Power 4,812
Railways 1,100
Telecom 1,227
Aviation 370
Ports 800
O&G 2,201
Urban infrastructure 1,974
Total spend 13,973
Source: RBI, Edelweiss research
RoadsCurrent status: India’s road network (3.3 mn km) is the second largest in the world and has witnessed an eight-fold increase over 1951-2004. However, over the same period, road traffic has increased by 22 times. Further, road infrastructure, especially highways (0.2 mn km network with 65,000 km of national highways, of which only 9% are 4-laned) has not kept pace with growth of user industries that depend on roads, considering that roads carry 70% of freight and 85% of passenger traffic, and needs to be expanded and strengthened.
Policies/Reforms initiated: While roads were opened to 100% private and foreign investment, the National Highways Authority of India (NHAI) constituted in 1995 for the development, maintenance and management of national highways undertook measures to boost private sector investment in road development. The 7-phase National Highway Development Program initiated in 1999 envisaged bulk of investments from Phase III to Phase VII to come from private sector participation. The private sector participant can either avail of a tolling concession or an annuity concession. In BOT-toll projects, the private sector meets the upfront cost and expenditure on annual maintenance and recovers the entire cost along with the interest from toll collections during the concession period. Apart from the 15-20 year concession period, a capital grant (subsidy) up to a maximum of 40% of the project cost is also provided by NHAI to the concessionaire. Annuity schemes under the Build-Operate-Transfer (BOT) projects mechanism allow risks and returns to be shared by the private developer and NHAI. The developer can charge an annuity to NHAI for building and maintaining the highway while NHAI is allowed to collect the toll. To encourage PSP, the government has also granted 100% tax exemption in any consecutive 10 years after commissioning of the project and allowed duty free import of construction equipment. So far 32 BOT projects valued at Rs47 bn have been taken up, of which 22 projects have already been executed. In all 37 projects valued at Rs235 bn (out of 55 to cost Rs312 bn) on offer under NHDP Phase II, III and V have been offered under BOT.
Growth potential: Roads are likely to account for ~10% of the total infrastructure spend or Rs1,500 bn over the next 5-6 years. Of this, ~60% is likely to be contributed by NHDP with bulk of the investment directed towards development of national highways and port connectivity (Rs931 bn) and the rest (Rs589 bn) towards maintenance / upgradation of existing highways. Around 95% of this investment will go towards construction and the remaining is likely to go to the input (cement and steel) and ancillary equipment space. Given the high GDP multiplier effect of 5-6 times that investment in roads have, roads would generate 3-4 times the road value for sectors dependant on roads while generating 2 times the value for contractors and developers. In other words, the Rs1,500 bn investment in roads would add Rs7,500 bn to GDP over the next six years. Early entrants with technical expertise in the BOT space would have high IRRs (Gammon India’s IRR is ~25%) while new entrants would have lower IRRs of ~15%. Given the lower IRRs, new entrants may take the securitization route (transfer beneficial rights in equity) post the development phase as Punj Lloyd has done.
Drawbacks/Risks: Low capacity and poor quality (on account of poor maintenance) are the two key issues that need to be addressed, rather than road length, for toll road projects to be viable and lead to economic growth.
PowerCurrent status: As in the case of roads, in power too though capacity grew 100-fold over the last six decades (85% of villages and 44% of households are currently electrified), supply has not matched demand with the gap at peak load exceeding 12%. While the poor financial health of SEBs have plagued the power sector on the one hand, lack of adequate investment in T&D have resulted in T&D losses mounting and adding to the existing power shortage.
Policies/Reforms initiated: Reforms in the power sector were initiated in FY02 and included one-time settlement of SEB dues, unbundling of SEBs (generation and distribution), permitting power trading, open access, widening the scope of participating in T&D under the accelerated power development and reform program (APDRP) and relaxation of norms for private investments in power transmission by amending the Electricity Act of 1910 and the Electric Supply Act of 1948. Permitting IIPs to sell power directly to end users and creation of a National Power Grid, so that inter-regional power transfers can take place, are next on the government’s agenda.
Growth potential: Given that India’s GDP is likely to grow at 7-8% over the next five years, power supply would have to grow at over 8% p.a. (as against 6% now) to gear up to meet the corresponding demand for power and power deficiency would have to be brought down to 5% from 8% currently. To achieve this, ~Rs236 bn would need to be invested in generation and Rs246 bn in T&D over 2007-12E. Thus, on an average, an investment of Rs800 bn p.a. would be required over the next five years as against Rs280 bn p.a. made between FY00-05. This investment in turn in likely to add ~60,000 MW of generation capacity over FY05-12 with the central utilities adding 36,000 MW of capacity (60%), private players led by Reliance Energy adding 16,000 MW and SEBs 8,000 MW. Though currently 2/3rd of the projects under execution are in thermal power (22,930 MW) as against 1/4th in hydro, the share of hydro power projects is likely to increase (to 1/3rd at the end of the 10th Plan) with hydro power projects gaining popularity with utilities and investors alike - e.g.1/5th of the incremental capacity being added by thermal power major NTPC is in hydro power. Also, of the 60,000 MW of generation capacity that is likely to come up over the next six years, ~40,000 MW will be on account of ultra mega power projects such as NTPC (17,000 MW), NHPC (3,955 MW) and Reliance (9,600 MW).
Drawbacks/Risks: Firstly, SEBs, which control bulk of the country’s power infrastructure, are plagued by huge T&D losses (due to under-investment in T&D), low revenue realization, un-recovered subsidies and huge outstanding loans to central PSUs. Secondly, private sector participation to date has been restricted and, despite policy changes initiated by the government, have yet to gain momentum. Thirdly, government has chalked out an over-ambitious target for the 10th Plan given its poor track record in meeting its earlier targets (it managed to achieve only ~40% of its planned target in 1992-97 and 1997-2002).
RailwaysCurrent status: Covering ~63,028 km (70% broad-gauge), the Indian Railways is the second largest network in the world and one of the world’s largest PSU employers. However, only 28% of the network is electrified and net ton km per wagon day is well below world standard. Saddled with a huge work force, the Indian Railways’ productivity per employee (net ton km + passenger km / employee) is also high in comparison to that of regional peers like China.Cross subsidization of passenger traffic by freight (freight generates 2/3rd of the revenues; average passenger fare to freight fare is 0.3%, one of the lowest in the world) resulted in freight traffic reducing and operating expenses mounting leaving the railways with no money to upgrade technology (improve speed) or improve safety standards. This in turn resulted in loss of revenue (as both freight and passenger traffic was diverted to roads) at the same time compromising safety and speed.
Policies/Reforms initiated: With a focus on improving safety, the government has set up a Special Railway Safety fund which plans to invest Rs170 bn over 2002-07 in replacing worn out assets. To improve port connectivity and strengthen the Golden Quadrilateral project, the government has meanwhile set up an SPV called the Rail Vikas Nigam Ltd (RVNL), which is likely to spend another Rs120 bn by 2008. The government is currently contemplating developing a dedicated rail freight corridor across Delhi, Mumbai, Kolkata and Chennai. The rail freight corridor along with a container corridor connecting the ports in Western India will involve setting up 9,000 km of railway tracks at a cost of Rs650 bn over the next seven years. Apart from this, rail infrastructure is likely to be improved under the Integrated Railway Modernization Plan (IRMP), which envisages an investment of Rs240 bn over five years up to 2010. The IRMP plans to introduce higher axle load, double stack container trains and light weight corrosion resistant aluminium wagons and modernize tracks with the latest signaling and telecommunications facilities so that passenger trains can run at 150 kmph and freight trains at 100 kmph along the Golden Quadrilateral and its diagonals.
Growth potential: The IR currently has 100,000 km of rail track (63,028 route km) and carries around 600 ton of freight. Given a freight multiplier of 1.25, at 6-7% GDP growth levels freight would increase to 1,000 ton in 5-7 years. This would necessitate an investment of around Rs1,200 bn (Rs600 bn in modernization including electrification, signaling and new coaches) and Rs600 bn in laying 30,000 km of fresh track over the next 5-7 years. However, as increase in freight volumes result in a sharp increase in revenues given insignificant incremental costs (high incremental capital output ratio), if the railways manage to attract higher freight traffic, it would result in higher ROCEs for the railways. Meanwhile, the Indian Railways employee rationalization programme, which targets trimming its workforce by ~16% over the next four years (up to 2010), would improve operational efficiencies.
Drawbacks/Risks: Huge pension liabilities accounting for ~15% of revenues and high overall staff costs (>40% of gross traffic receipts) along with poor productivity has hampered the profitability of the Indian Railways. Though the Rakesh Mohan Committee report has suggested rationalization of workforce (downsizing it by 1.2 mn or 1/5th by 2010), how this will be achieved remains unclear. As regards investment, though the Rail Vikas Nigam Ltd is implementing 53 high priority railway projects (aimed at improving port connectivity and strengthening the Golden Quadrilateral) for which it has proposed a spend of Rs120 bn up to FY08, most of the investments are still to be made.
TelecomCurrent status: India’s telecom network is the 3rd largest in Asia and the 8th largest in the world. The Indian telecom market has grown nearly four-fold (3.8x) over 2001-06 led by a CAGR of 100% plus in wireless or mobile subscribers (87 mn) which currently outnumber wireline subscribers (48 mn). The market size has been growing with telecom players increasing penetration in B and C circles. However, teledensity is low at 10% with 99% of rural population having no access to telephones. While urban penetration has increased to over 20% over the last 5 years, rural penetration is still very low at less than 2%.
Policies/Reforms initiated: While manufacturing of telecom equipment was deregulated in 1991, the telecom sector was liberalized in 1992 with the private sector allowed to provide value added services including cellular services. This was followed by opening up of basic telecom services in 1994 with one private operator allowed to operate in each circle (21 circles in all) and compete with DoT. In 1997 TRAI was set up as an independent regulatory authority and in 1998 VSNLs monopoly in providing internet services came to an end with private ISPs allowed to operate in India. This was followed with opening up of national long distance services to private operators in 2000 and international long distance service from India in 2002. With the government announcing a broadband policy in 2004, the composition of the internet market currently dominated by narrow band (only 10% of the 6 mn plus internet subscribers use broad band) is likely to change. Meanwhile, with the FDI limit in the telecom sector having been increased from 49% to 74% in 2005, the sector is likely to attract foreign capital especially in the telecom equipment space.
Growth potential: The telecom subscriber base is likely to increase to 339 mn by FY12 with 194 mn wireless subscribers and 10 mn wireline subscribers likely to be added over the next six years. The private sector would account for bulk of these adds ~142 mn. However, with penetration in rural markets likely to increase and upgradation of networks to support technology platforms such as WiMAX and Wi-Fi, capex requirements would be higher than in the past, at least for the next 3-4 years. Around Rs1.2 tn is likely to be spent on telecom asset creation over FY07-12 with Rs962 bn likely to be spent on wireless and Rs76 bn on wireline infrastructure. Given its high share in subscriber adds, the private sector (wireless) is likely to spend more on capex (~Rs817 bn up to FY12) than the public sector (wireline). The telecom equipment space is also likely to attract investments of Rs1.2 tn over the next six years with Rs733 bn likely to be spent on wireless and Rs311 bn likely to be spent on wireline equipment. Around 85% of this investment is likely to go into hardware (switching, transmission & cables) with the rest likely to be spent on telecom software. Among equipment suppliers, companies with exposure to specialized segments such as defence and space would be major beneficiaries once these two sectors are opened up.
Drawbacks/Risks: With competition intensifying especially in the mobile telephony and the equipment space and capex requirements likely to soar over the next couple of years, only players that can cut costs especially at the operating level, achieve economies of scale and rapidly upgrade to new technologies are likely to survive.
AviationCurrent status: From 5.1 mn passengers in the 1970s, passenger traffic has grown to ~60 mn passengers in 2005 while cargo traffic has increased from a mere 81 ton to 1.29 mn ton over the same period. Domestic air traffic has grown at the rate of 10% to 40.09 mn and international air traffic at the rate of 8% to 19.45 mn over the last five years (2000-05). Over the same period, international and domestic cargo traffic has grown at an annual rate of 12% (to 824,876 ton) and 6.5% (to 465,036 ton), respectively. However, of the 125 airports managed by AAI, only 85% are operational and 10 international airports handle 85% of the total passenger traffic and 95% of cargo traffic and generate 80% of revenues. Of the 10 airports, Delhi and Mumbai account for 49% of passenger traffic and 33% of revenues. Policies/Reforms initiated: In April 1990, the government introduced the open sky policy, which lifted restrictions on the number of flights and destinations that carriers could operate in. This was followed by repeal of the Air Corporation Act in March 1994, which ended the public sectors’ monopoly and enabled private operators to provide air transport services. In February 1995, six operators were given scheduled operator status. To deal infrastructure-related issues at international and domestic airports, in 1995 the government set up the AAI by amalgamating the International Air Authority of India and the National Airport Authority of India. AAI recently made changes in the Airports Authority of India Act to permit privatization of Delhi and Mumbai airports. As regards FDI policies, while FDI up to 100% is permitted in airports, FDI in domestic airlines is restricted to 49% with no direct or indirect participation by foreign airlines allowed.
Growth potential: A study conducted by CII-NCAER shows that for every 1% increase in GDP, domestic passenger traffic increases by 1% and international passenger traffic by 1.3%. Thus, domestic and international passenger traffic is expected to grow at an annual rate of 8% and 12%, respectively over FY06-12. As over 60% of the cargo is carried in the belly of passenger aircrafts and given increased momentum in trade, international cargo traffic is likely to grow at the rate of 8% and domestic cargo traffic at 14% over FY06-12. To be in a position to handle this traffic, utilization of airports across cities would have to improve and Delhi and Mumbai airports upgraded. The government has proposed to build/upgrade/modernize airports in 41 cities (including metros) over the next six years. Additionally, greenfield airports are proposed to be built in Mopa (Goa), Kunnur (Kerala), Navi Mumbai, Ludhiana, Chakan (near Pune), Pakyang (Sikkim), Kohima (Nagaland), Devanahalli (near Bangalore) and Shamshabad (near Hyderabad). The cost envisaged for the same is likely to be in the region of Rs370 bn, a large part of which would be construction expenditure. Going by the bids awarded for the Mumbai and Delhi airports, the private developer’s share in revenues is likely to be in the region of ~40%.
Drawbacks/Risks: Navigation charges continue to be 60% higher and fuel sales tax 80% higher than international benchmarks which increases the cost of operations of private airlines. Meanwhile, vast overstaffing (450/aircraft for Air India v/s 125/aircraft for a full service legacy carrier in the West and 394/aircraft for Indian i.e. Indian Airlines v/s 155/aircraft for Jet Airways) continues to impact profitability of PSU airlines.
PortsCurrent status: India has 12 major ports (which falls under the jurisdiction of the Union government) and 180 minor ports (which are under State government control) that handle around 77% of the total cargo traffic estimated at ~383.6 mn ton in FY05.
Policies/Reforms initiated: The government undertook privatization of ports in 1996 with the private sector allowed to (i) construct new facilities within existing ports, (ii) improve productivity at an existing port or (iii) develop new ports. In response to the government initiative, private sector investment in the port sector has been steadily increasing. To date, 19 projects involving an investment of over Rs64 bn has been approved and are already operational and another 17 projects involving an investment of Rs33 bn under consideration for approval. Since 1998, 100% FDI in the ports sector has also been allowed which has attracted foreign players like P&O which set up the International Container Transshipment Terminal at Nava Shava. The success of this venture in turn attracted other players like the Port of Singapore, Dubai Port Authority, Maersk Logistics and Stevedoring Services of America among others.
Growth potential: Port traffic has grown at a compounded rate of 8% over the last four years (FY01-05). Assuming the same growth rate continues, it would touch 950 mn ton by FY14. This would imply that capacity addition would have to grow at the rate of at least 9%. To achieve this, the government is currently implementing the National Maritime Development Programme (NMDP) that proposes to invest Rs603 bn in ports till FY14 taking capacity to ~915-920 mn ton. Around 65% of the investment being proposed is likely to come from the private sector, budgetary support is likely to provide 19%, internal resources 8.5% and the balance 7.5% likely to be met by rail and road connectivity projects.
Drawbacks/Risks: Though port efficiency has improved over the last five years thanks to private sector participation with the average turnaround time having reduced to 3.5 days in FY05 as against 8.5 days in FY96, productivity at terminals continues to be low, hinterland infrastructure facilities inadequate leading to poor port connectivity and delays at customs leading to higher lead times for trade. This has been the main reason why international shipping lines have avoided choosing an Indian port as a regional hub, preferring Singapore and Dubai instead. Also, though privatization has been allowed, privatized ports were forced to retain existing port workers, which hampered productivity. Further, the major ports (which control 75% of cargo traffic) are PSUs and lack autonomy in several operational matters which reduces their flexibility.
Oil & Gas Current status: India’s oil consumption at 2.32 mn bbl/day is met largely by imports of 2.09 mn bbl/day. Thus, with crude prices having moved up, gas has emerged as a more viable alternative. Currently, India has proven reserves of 5.7 bn bbl of oil and 853.5 bn cu m (853,500 MMCM) of gas. The oil & gas sector was highly controlled till 1992 but with approval of the New Exploration Licensing Policy (NELP) in 1997, the sector has been steadily opened up.
Policies/Reforms initiated: To allow equal opportunity to the private sector in exploration, in March 1997 the government approved NELP. In 1998, pricing controls in the refining sector were removed and in 2002 the Oil Pool Account (for E&P) and Administered Pricing Mechanism (for marketing) dismantled. In 2004, FDI in E&P and marketing was increased to 100%.
Growth potential: Within the oil & gas space, demand for natural gas is likely to grow the fastest. According to the India Hydrocarbon Vision 2005, the demand for natural gas is likely to be 322 MMSCMD by FY25, assuming a rate of US$ 4/MMBTU for imported natural gas. With crude prices rising and demand for oil and gas on the increase, the sector is likely to attract investments of ~Rs2.3 tn till FY12. Most of these investments are likely to be in the exploration & production (Rs861 bn; 38%) and refining space (Rs679 bn; 30%), but a significant amount is also likely to go into petrochemicals (Rs341 bn; 15%) and building pipelines (Rs199.6 bn; 8.7%). Drawbacks/Risks: Rising crude prices have not only brought ongoing reforms in the oil & gas sector to a standstill, but, with the oil companies’ inability to pass on the price increase to consumers, led to huge under-recoveries. As a result, oil marketing companies suffered losses while upstream companies saw an increase in subsidy burden so that investments even in planned projects have been delayed.
Urban infrastructureCurrent status: World over there exists a strong co-relation between per capita GDP growth and urbanization. With per capita GDP growth on the back of expansion in services and manufacturing industries picking up, urban population has grown at a rate of 8% over the last five years from 285 mn in 2001 to 307 mn in 2005. With strong growth in services likely to continue, urban population is estimated to reach 550 mn by 2021 and the share of urban population to total population likely to go up to 41% from ~28% currently. Growth in urban population is likely to see an increase in demand for housing, which in turn will necessitate a corresponding investment in water and sanitation facilities. However, despite the contribution of urban India increasing in India’s GDP, investment in urban infrastructure has been abysmal – at 0.6% of GDP (v/s 4%+ in other developing countries), public expenditure on urban infrastructure is one of the lowest in the world.
Policies/Reforms initiated: As urban infrastructure development failed to keep pace with GDP growth, the National Urban Renewal Mission (NURM) was launched in December 2005 to address integrated development of urban infrastructure services (primarily housing, water supply, sanitation and slum improvement) with assistance from the Centre, state and local bodies. The Mission will cover 60 cities likely to have a 1mn plus population over the next 6-7 years and invest Rs837.1 bn over FY07-12.
Growth potential: Apart from the Rs837.1 bn that has been earmarked for development of urban infrastructure under the NURM, metros would require an additional investment of Rs505 bn, SEZ development will need another Rs392 bn and investment in land development for commercial and residential properties another Rs181 bn over FY07-12.
Drawbacks/Risks: Apart from a housing shortage (which is widening), urban India also has poor sanitation (less than 63% of urban India has access to sanitation as against the developing world average of 75%) and low drinking water availability (only 85% of urban population has access to drinking water as against 95% which is the developing world average). If urban population continues to grow at the current rate, urban India could well head for a water scarcity by 2050.
Construction companies will benefitOf the Rs14 tn likely to be spent on infrastructure development over the FY07-12, nearly 42% (~Rs6 tn) is likely to be spent on construction. The highest construction spend as a share of total spend is likely to be made by roads (Rs1,444 bn or 95% of total spend) followed by the urban infrastructure segment (Rs1,406 bn or 71% of total spend). The lowest expenditure on construction is likely to be made by the telecom sector (Rs61 bn or 5% of total spend). Operating margins (OPMs) will however be lowest for road projects (~6%) and highest for telecom (>25%). The construction sector’s revenues are likely to gather momentum over this period as construction activity moves from completion of existing projects to new project execution and companies move up the value chain i.e. from contractors to developers-cum-operators. Thus, the industry is likely to see revenues grow from Rs731 bn in FY06 to Rs1.2 tn by FY12 at a CAGR of ~8%.
Cumulative sector wise spend likely over FY07-12 Rs bn

Sector Total spend likely Construction spend Const. Exp/ Tot. Exp (%)

Rail 1,110 440 40
Ports 800 320 40
Oil & gas 2,201 220 10
Power 4,812 1,837 38
Telecom 1,226 61 5
Road 1,520 1,444 95
Aviation 370 185 50
Urban infrastructure 1,974 1,406 71
Source: Edelweiss

Article Author: Manish Marwah

Media & Entertainment: The sunrise sector

It’s truly the dawn of a new era of entertainment. For the Indian consumer it is a time of multiple choices as he can choose from a bouquet of over 300 channels on TV, several FM stations on radio and has a choice of 3-5 movies at multiplexes. For the entertainment industry is time to rake in the moolah as the share of consumer spend on entertainment is increasing and to gain mind share advertising companies are increasing spend. And for the government, it means more revenues by way of taxes. Sure the multiple choices come at an extra cost. But with technology having made significant advances and the quality of entertainment having improved, the Indian consumer is not complaining.
The turnover of the Indian entertainment industry is estimated at ~Rs250 bn in FY05 and likely to witness a CAGR of ~20% between FY04-10 to touch Rs606 bn by FY10. The highest growth is likely to be witnessed by Radio (~31% CAGR) followed by Television (~20% CAGR) and Films (19% CAGR). However, it’s the Television sector that would drive growth of the entertainment industry with a 65% share of revenues in 2010. The share of Radio in overall revenues of the entertainment sector in 2010 would be ~2% only. Over the same period (FY04-10), revenues of the Print Media industry would grow from Rs98 bn to Rs195 bn (12% CAGR).
A host of factors are likely to drive growth of the media and entertainment industry. Some of these are general to the entire industry while some are specific to a particular segment within the industry. For instance among the general economic factors, increasing consumer spend on lifestyle related products, especially entertainment, and rising urbanization would see demand for Television, Films as well as Radio go up, while rising literacy rates would translate into higher demand for Print Media. Among the more specific factors, the pace of reforms undertaken by each segment of the industry (for instance, films and television was opened up to private and foreign investment first and radio and print only recently) is meanwhile likely to determine the extent and rate of growth of each segment.
Even a slight increase in media penetration levels in lower economic classes (C, D, E1 and E2) is likely to see demand for media and entertainment, especially Radio and Films, increase substantially in absolute terms as the lower economic classes have a large population base. Whereas an increase in advertising spend (currently 0.34% of GDP which is one of the lowest in the world and lower than the global average of 0.98%) could result in substantial increase in revenues for this industry.
But apart from the economic factors driving demand for Entertainment and Media, the emergence of new distribution channels such as broadband, internet and wireless communication would also contribute significantly to the growth of this industry.
Television: entering a new growth channel The Indian television broadcasting system is one of the most extensive systems in the world providing coverage to over 90% of India's 900 mn people. Television has been the main contributor to the growth of the entertainment industry accounting for a 64% share of entertainment revenues in FY04. However, the growth of the television sector which was over 20% in the 1990s slowed down to less than 15% in the 2000s as the sector attained maturity. Analysts, however, believe that growth is likely to pick up to 20%+ levels over the next five years driven by demographic, technology and policy level changes.
Liberalization drove growth between 1991-2004: With the liberalization of Indian television in the 1990s, the number of channels multiplied from a single television channel in 1991 (Doordarshan), to over 100 by 2001 and over 300 by 2005. By 1998, most of the leading transnational media companies (eg. Star TV, BBC, Discovery, MTV, Sony, CNN, Disney and CNBC) were operating in India through cable and satellite networks.However, most of these transnational companies had to adapt their content for Indian viewers. Star TV, which started operations in India in 1991, realized by 1993 that its US originated programming was reaching only a fraction of Indian viewers and to reach a larger audience, it would have to modify its content. It began by subtitling Hollywood films broadcast on its 24-hour channel in Hindi, followed this by dubbing popular US soaps in Hindi and in 2003 went into exclusive Hindi programming for its flagship channel Star Plus. The move to localize content saw Star TVs reach go up from 0.5 mn households in 1992 to over 19 mn households in 1999. By 2005, Star TV had a viewership of over 22 mn homes (90 mn viewers/week) with 80% of Indian viewers watching at least one Star channel. Following on Star TV’s footsteps, Walt Disney too has switched to dubbed Hindi programming on both its channels while ESPN-Star Sports has a dual Hindi feed.With Indian viewers clearly preferring local content over international, the number of hours of television programming produced in India increased nearly five fold between 1991-96. The TV software segment’s revenues saw a 30%+ annual growth between 1999-2005 to Rs7 bn in 2005. Advertising on television also saw a substantial increase post liberalization, with ad revenues increasing from $5,400mn in 1990 to Rs54.5 bn in 2005. However, Doordarshan’s share in total advertising revenues declined post liberalization with Star TV and Zee Telefilms eating into its share. It is estimated that ~20% of mass brands and ~50% of niche brands moved their advertising from Doordarshan to Star TV post liberalization. By 1993, just two years after liberalization, Star TV and Zee Tele together accounted for ~20% of the total advertising pie.
Demographics and technology to drive growth hereon: At the demographic level, growth over the next five years is likely to be driven by increase in urbanization, higher income levels and changing consumption pattern in favour of lifestyle products which in turn is likely to see penetration levels, especially in rural India, increase. In fact, if recent trends are an indication, rural demand is likely to be a significant driver of television sales. According to a recent report by KPMG (Focus 2010: Dreams to Reality), of the 25 mn households that bought television over the last three years, 19 mn (77%) were rural households. Currently, television reaches only half the population of India ─ 78.9% of urban population and 39.8% of rural population. In all, only 105 mn Indian households of the total 191.96 mn households in India (Census of India 2001) have television, of which only 55 mn households have cable and satellite TV (PWC-Ficci report on the Indian Entertainment industry, 2006). Hence, even though the base is higher than what it was five years ago, the potential for growth of the television sector hereon remains enormous. Apart from demographics, technology is likely to be a key growth driver for television. Introduction of alternate technology platforms like DTH and IP-TV, though currently facing resistance (on the cost-structure and licensing front), is expected to drive the next phase of growth from FY07-10. This is because these systems will not only increase transparency and make revenue share between different distribution segments (broadcasters, multi-system operators and local cable operators) more equitable, but also offer consumers greater addressability through the conditional access system (CAS). Currently, low subscriber declaration by LCOs allows them to corner bulk of subscription revenues (79%), leaving only 17% on the table for the broadcaster and 38% for the MSO. Greater transparency would also reduce disparities in cable subscription charges (which is Rs60/month for 100+ channels in rural and semi-urban areas v/s Rs300/month for the same number of channels in urban areas) that currently have no co-relation with quality or service.
Distribution segment will grow the fastest: An increase in the number of TV homes in Rural India and second TV homes in Urban India along with increase in subscription rates and demand for pay services will drive television revenues over the next five years.The number of TV homes is likely to increase from 102 mn to 128 mn (C&S homes to go up from 50 mn to 90 mn) while average subscription rates are likely to go up from Rs130/month to Rs250/month over FY04-10. Increase in TV homes (number of subscribers) and subscription rates (with C&S homes likely to grow faster than TV homes and a percentage of C&S homes opting for CAS) would in turn result in an increase in subscription revenues from Rs78 bn in 2004 to Rs270 bn in 2010. Subscription revenues would thus see a 26.5% CAGR over 2004-10.Television advertising revenues would meanwhile go up from Rs48 bn in 2004 to Rs106 bn in 2010 witnessing a 14.2% CAGR on the back of growing number of channels while TV software revenues would increase from Rs5.7 bn to Rs16 bn at a CAGR of 18.77% over FY04-10 on the back of rising demand for Indian (Hindi) content both from within India as well as from overseas.
Foreign investment will spur growth: A host of foreign collaborations were announced in the television industry during 2005 covering all areas of operation including broadcasting, distribution and content. Key among them were the Thomson Group’s tie up with VSNL, a Tata group subsidiary, for managing and delivering content for broadcasters and content providers. Meanwhile, regulations forced broadcasters including Walt Disney, ESPN-Star Sports, Star, Discovery to set up foreign investment subsidiary companies for content development and advertisement airtime sales. The distribution space saw the entry of foreign MSOs such as Hathway and Hindujas. And the television content space saw UK-based 3i and Mauritius based Americorp Ventures pick up equity stakes in Nimbus Communication.
Policies need a re-look: In terms of policies, the most significant development was the appointment of the Telecom Regulatory Authority of India (TRAI) in 2004 as a regulator for the television industry (with its scope increased to cover broadcasting and cable services) after the Supreme Court in 1995 held that the government's monopoly over broadcasting was unconstitutional. However, TRAI’s role so far has been restricted to providing recommendations to the government most of which (including those relating to rates for free-to-air and pay television channels) are still pending with the Information and Broadcasting (I&B) ministry. Meanwhile, though FDI has been allowed in various segments of the television industry (100% in software production, 49% in cable networks, 49% in DTH ─ of which strategic FDI is only 20% ─ and 26% in news channels), the cap on foreign investment clubs FDI and FII investment in most cases, which has hindered FDI flows into this sector. Apart from this, issues relating to double taxation of foreign telecasting companies (which earn ad revenues from India) and foreign satellite companies (which charge a satellite usage fee from broadcasters) and absence of cross-media ownership rules are also acting as deterrents to foreign investment.
Radio: the fastest growing segment One of the last sectors in the media & entertainment industry to be opened up to FDI, Radio which was liberalized in 1999-2000, has seen a sharp increase in the number of radio stations since then. Though AM frequencies are still controlled by AIR, opening up of some of the FM frequencies and the relative success of channels that were launched has attracted a huge number of players. Nearly 338 licences for FM channels have been granted so far across 91 cities. And the number is likely to increase with the convergence of technologies, with platforms like satellite and internet addressing different distribution channels through a single delivery chain. For eg: cell phones which double up as FM radios.
Plagued by losses: Radio was the first form of broadcasting to be introduced in India with the first private radio service being introduced in Madras in 1924. Though initially operated by a private entity, it was taken over by the British government when it went bankrupt in 1930 and in 1936 was renamed All India Radio (AIR). In 1947 when India gained independence, Radio continued to be government controlled and operated as a department under the Ministry of Information and Broadcasting.
The last 5-6 years has seen Radio being progressively opened up but even today it continues to be dominated by AIR ─ AIR covers 91% of the country by area and 99% by population. Opening up of FM frequencies in 1999 has seen 21 private FM stations in 14 major cities become operational. But the number of channels operational account for less than 20% of the licences made available (bids were called for 108 FM frequencies in 40 cities for a 10-year period) and are significantly lower than the number of licences issued (~37). This is because the annual licence fee (which had to be paid over and above the licence fee charged at the time of issuing a licence) was significantly higher than the earning capacity of most industry players which along with high manpower costs (as most of the talent was drawn from high-wage industries like television, advertising and FMCG) made operations unviable.Ad revenues earned by Radio channels being one of the lowest in the world ─ ad spend on radio as a share of total ad spend in India is just 2% as against the global average of 8% ─ and highly skewed towards a handful of advertisers (11% of the advertisers accounted for 60% of revenues) could cover only 50% of operating expenses and many channels were forced to shut down.
Potential remains untapped: This, however, does not mean that the FM radio sector should be written off. The sector not only enjoys wide coverage (180 mn sets reach 99% of India’s 1 bn population) but is also one of the most cost effective (advertising on radio costs just 15% of what it does on television). Further, with the median age of India’s population at just 24 years (making it one of the youngest in the world), radio should be a major beneficiary. This is because, younger audiences, especially those below the age of 25 years form bulk of radio listenership worldwide which in India’s case translates into a captive audience of 650 mn. The easy availability of FM radio sets at affordable prices (Rs40-150) and its compatibility with cell phones meanwhile offer radio the highest scope for mass penetration among all sectors of the entertainment industry.
Higher growth rate required: If the growth in licence fees continues at the current rate (15% p.a.), the FM radio sector would have to grow at ~40% p.a., nearly double the rate at which it is currently growing over the next three years. This would imply a higher share of FM ad revenues in the total ad spend pie of the media and entertainment sector. Since the global average is 8% (of total ad spend) for radio and 5-8% for media categories in the growth stage, in the short to medium term (2-3 years), the FM radio industry’s CAGR could be in excess of 60%. This means that over the next 2-3 years the industry has the potential to touch a turnover of Rs9.6 bn. Assuming that in the medium term (~5 years), the industry attains maturity and its ad revenues increase to account for 10% of total M&E ad revenues (globally in the mature phase radio advertising revenues account for 10-12% of total M&E ad revenues) the turnover of the industry could go up to Rs12,000 mn from Rs3,144 mn in FY05, a CAGR of 31% over FY05-10. But given the existing size of the industry (21 stations in 14 cities), achieving this growth will be close to impossible, at least under the existing licencing regime. A CII-KPMG study thus estimates that the industry would have to grow in size from 21 stations in 14 cities to 300 stations in 100 cities. Assuming an investment of Rs40 mn per radio frequency, this would require an additional investment of Rs11 bn according to the study. To achieve break even the minimum growth rate for a radio station would have to be in the region of 40% p.a. over a three-year period.
Policies need to be reviewed: To help the radio industry achieve a turnaround, TRAI has suggested that the current licence fee regime be replaced by an entry fee + revenue sharing one (4% of gross revenues) and existing players be allowed to migrate to the new model. Apart from this, TRAI has also suggested that the foreign investment regime be reviewed and FDI investment in areas like news and current affairs be allowed up to 26%. In addition to this, TRAI has recommended that restrictions on owning multiple stations in the same city by the same player be lifted and licence fees for niche channels be rationalized. However, the government has opposed TRAI’s recommendation to move to the revenue-sharing model claiming that it is difficult to monitor revenues and opposed TRAI’s suggestion to grant multiple licences to the same player in a particular city.
Films: Multiplex screens & digital cinema to drive growth
After being given industry status in 2000, all spheres of the Indian film industry (production and post production, distribution and exhibition) saw an increase in corporatisation. As a result of corporatization, the industry’s turnover which was in the region of Rs60,000 mn in 2000 (Arthur Anderson-FICCI report, 2001) increased to ~Rs 98,600 mn in 2005. As the trend in corporatization continues (2005-06 saw several exhibition and production companies go public), the 20%+ growth witnessed by the industry over the last two years is likely to pick up. Though different segments of the industry would witness different growth rates, the overall industry size is likely to touch ~Rs194,300 mn by 2010 witnessing a CAGR of ~25% in revenues over 2005-10.
#1 in volume but lags in revenues: One of the oldest segments of the Indian entertainment industry, films (motion pictures) were first introduced in India in 1896. Since then, the industry has come a long way. In fact, in terms of number of movies produced (estimated at >1,000/year v/s <500>70% of the admissions in Asia-Pacific) India ranks first in the world. This is because with movie tickets priced at less than US$0.40 (US$6.41 in the US), the country’s 1 bn strong population visits a movie theatre at least once in three months. Despite this however, the industry lags in terms of revenues accounting for just 1% of global film industry revenues.
Box office collections to drive growth: The Indian film industry earns bulk of its revenues from box office collections, which account for a share of 86% in the overall revenue pie (77% domestic box office; 9% overseas collections). Apart from this, the industry earns ~6% of its revenues from the home video segment and 9% from sellingrights to mobile companies, television broadcasters and television distribution companies (MSOs and DTH players). Till now, growth in domestic box office collections have been constrained by low average price of movie tickets (at Rs18-19) and occupancy rates at theatres (~35%). However, since multiplexes came up, both ticket prices (multiplexes charge Rs50-80 per ticket v/s Rs17 charged by single screen theatres) and occupancy rates at theatres (as multiplexes have a better ambiance and other draws) have seen an increase. Though the share of multiplexes in the total number of screens is just 2%, given the growth rate in multiplexes and in view of the aggressive roll out plans announced by film exhibition companies, their share could easily go up to 8% of total screens over the next five years (plans for 400+ additional screens have already been announced by four of the leading players ─ PVR, Shringar, Inox and Essel).
Multiplexes to expand revenue base: As multiplexes charge ~3x what is charged by single screen theatres, their share in value terms (@Rs50/ticket) would increase from ~6% in 2005 to 24% in 2010 (assuming a 5% increase in average ticket price) with number of screens assumed to remain constant on account of low occupancy rates and the possibility of some theatres closing down. A higher share of multiplex screens and upgradation of existing screens into digital cinemas (as the cost of upgrading a theatre to digital format is Rs1 mn only) would result in average ticket prices going up from Rs17 now to Rs31. This along with marginal increase in admissions (by ~200) due to higher occupancy rates could result in domestic box office collections increasing from Rs75,920 mn in 2005E to Rs130,200 mn in 2010E even if the share of domestic collections in the overall pie goes down to 67%, given a higher growth rate by the home video segment which is likely to see its share in the revenue pie go up from 6% in 2005 to 14% by 2010. (See table on pg 44 of FICCI-PWC report).
Organized funding would reduce cost: Since the sector was given industry status in 2000, the number of films that went in for organized sector funding has been on the rise with corporates accounting for ~50% of the films produced. Organized financing has significantly reduced the average financing cost in the sector as well as the risk with banks financing 50-70% of the project budget. However, despite revenues of the industry trending upwards and cost of production trending downwards, earnings would come under pressure as a 60% average entertainment tax (one of the highest in Asia) shaves off a large proportion of theatre ticket receipts.
Music: on a slow track The Indian music industry appears to be following in the footsteps of the global music industry, which has been in recession for nearly four years. While globally the industry is undertaking several cost cutting measures to get back on track and making a slow recovery, in India a reduction in offtake of cassets/CDs on the one hand and stagnant cassette/CD prices on the other have resulted in degrowth.
Moreover, the last few years have also seen remixes and music videos of original soundtracks gain more popularity than the original soundtracks. And, this in turn, has reduced sales of original music companies. Piracy has meanwhile been taking away ~42% of the industry’s revenues. Thus, though the audio-video market has been growing at nearly 300% p.a., the same growth is not reflected in legitimate industry sales. Huge production of CDs / DVDs far in excess of demand for the same has only resulted in increasing the incidence of piracy. Apart from physical piracy, digital piracy (thanks to MP3 technology and PC penetration) is also on the increase with easy availability of free downloads from various sites.
Current revenue mix: Currently the industry derives 92% of its revenues (estimated at Rs7,000 mn in 2005 by PWC) from music sales and the rest from non-physical formats ─ 5% from ringtones and 3% from royalties. Of the 92% that it generates from music sales, nearly 60% comes from film music (40% new movies; 20% old movies). With piracy accounting for 42% of revenues, the music industry industry which has already seen its share in the overall entertainment industry shrink to 3.3% in 2005 could see its share go down even further to 1.2% by 2010. PWC estimates the industry to grow at 1.7% CAGR over FY04-10 and touch a turnover of Rs7,400 mn by FY10.
Innovative service offerings could help increase revenues: While the Indian industry has been focusing on curbing piracy by enforcing checks (~Rs40 mn is spent by 50 music companies towards this) and lobbying for legal changes (amendment of the Civil Procedure Code and introduction of the Optical Disc Law), the US industry is turning to innovative service offerings to increase revenues. For instance, Apple Computers, which launched a music store called iTunes, sells individual song downloads for 99 cents and has sold over 200 mn songs to date from its 1 mn song collection. Audio books, exclusive tracks, customized playlists /on-demand videos, internet accounts (that can be accessed from anywhere), monthly subscriptions or pay-per-song facility etc offered by service providers in the US have helped the music industry generate higher revenues.
Conclusion While the entertainment industry itself is likely to see its revenues go up from Rs209,300 mn to Rs605,700 mn over FY04-10, the traction witnessed by various segments of the industry would in turn drive revenues of several sub-sectors. For instance, increase in TV penetration and migration to digital format would see sales of the TV hardware & equipment (HDTV, set top boxes) sector increase. While demand for Indian content and outsourcing would see demand for industries, such as animation, increase. The growth in films would meanwhile go hand-in-hand with the growth in multiplexes (exhibition companies).
The entertainment industry would meanwhile be driven by Integration and Convergence. While integration would increase once cross-media-ownership regulations are in place, convergence with its ability to collapse previously distinct media distribution channels (broadcast/cable television, radio, print and online) into a single delivery chain has already started defining industry trends. Increased standardization of networks and devices to use the internet protocol and rising broadband penetration has seen an increase in convergence and while convergence has helped some industry segments see an increase in growth rates, some like music have seen revenues decrease.
Article Author: Manish Marwah