The India Story: A Twist in the tale.
by S Shankar
According to the Oxford dictionary one of the meanings of the word Volatile is
- ‘liable to change rapidly and unpredictably, especially for the worse’.

Investors hear and market commentators use the word “volatility” in India and the world over without knowing what it actually means. They think volatility is a zig zagging market, though in reality it means rapid change for the worse.

We also have been hearing often about the phrase “India Story”

We shall in this article, not delve into the merits of India Story that was being parroted by everyone from politicians to fund manager’s ad nausea. Rising oil prices have shook India. Let us see if the story holds good, given the current turbulence in the world markets.

The growth story can continue as the usual suspect’s - favorable demographics, burgeoning middle class, high savings rate and infrastructure spending among others are still around. It will however hit some speed breakers primarily inflation and its effects on the growth. Indian inflation to a large extent is driven by oil and rising food prices. India imports close to 70% of its oil requirements. The rising oil price was the major trigger for the markets to plunge more than the sub prime / the credit crisis. The chart shown below highlights the correlation between “Oil Prices” and India’s Benchmark Index - the “BSE Sensex”. It reveals the extent of the relation and the fast damage done to the economy at large by the rising oil prices. We will now look at this story from an angle that is being largely ignored today and analyze if things can augur well for India in the future.


There are two parts to the twist in this tale:


1. Discovery of Oil Reserves in India

The discovery of oil reserves in India could play a key role in sustaining the current growth. Companies like Reliance, Cairn India, Gujarat State Petroleum Corp., and the state run ONGC are discovering oil and gas in key areas like KG basin and Rajasthan.
Oil prices trading for more than 120$ and theories like peak oil finding their way into global investors vocabulary has increased the viability of exploration. The high prices are likely to sustain for some more time. In the past 20-25 years, India ranks first in the significant finds of oil reserves apart from Brazil.


The story started unfolding in 2000, when India awarded New Energy Licensing Policy (NELP) 1. Since then, up to NELP VII have been awarded and only 25% has been explored. Out of the remaining 75% up to 65% is considered as high prospect areas.



The total number of significant discoveries made during the last five years stands at 97. Most of the discoveries are located in the East coast basins of:
Krishna Godavari
Mahanadi – NEC
Western Offshore
On land in Rajasthan
Cambay
Assam Arakan






A study by Enam Securities highlights the following:


New gas finds could potentially bring in annual savings of 48 billion USD by FY 2012 which is 2.2% of the GDP estimated at two trillion USD.
Gas could also replace 35% of current oil consumption.
Reliance Krishna Godavari (KG) D6 Block to bring the first gas by H2 FY 09.
Reliance’s KG D6 block alone will take the supply from current 104 mmscd to 260 mmscd.
Gas replacement is an ideal solution to growing energy consumption of India and in reducing the strain on fiscal deficit.

The benefits of the above mentioned study will percolate across sectors such as fertilizers (Remember that around 50% of the country is dependent on agriculture), power (shortages of which has recently forced state governments to cut supply to industries and households in a big way) and city gas distribution and refineries.

Development of gas distribution networks especially in Gujarat and Maharashtra are likely to be replicated in 200 cities in a phased manner.

Sundaram BNP Paribas which runs a dedicated fund focusing on the new energy finds opportunity estimates that the gas finds could be as high as 89% of the current software exports which was responsible for placing India in the global investors map.

Reliance is working on the expeditious monetization of the discoveries made in the Krishna Godavari and Mahanadi basins. This entails one of the largest gas development projects in the world to transport gas through a 48 inch, 1,386 kilometre east coast to west coast pipeline, This pipeline traverses the states of Andhra Pradesh, Karnataka, Maharashtra and Gujarat. Reliance is implementing this project through Reliance Gas Transportation Infrastructure Limited (RGTIL) in a contract and common carrier framework. This project is on schedule, with all necessary Government approvals in place, major contracts awarded and delivery to consumers envisaged to take place by the second half of the financial year 2008-09.








This story is not just about oil and gas coal has been a neglected source as it is highly government dominated. The government has now started awarding exploration rights for coals just like NELP to Reliance power, Tata Power, Sterlite and NTPC. It is expected that the captive mining is expected to go up from less then 5% to 20% over the next five years. Power plants of the above companies that use these coal sources would be able to free price their power.

Finally there may be a dark horse in the energy story of India with the discovery of abundant gas hydrate reserves. It is estimated that National Gas Hydrate Program India has reserves of about 2000 trillion cubic feet of gas hydrates. Gas Hydrates are naturally occurring ice like combination of natural gas and water that have the potential to be a new source of energy. These reserves according to Director General of Hydrocarbons Mr VK Sibal have been found in the KG Basin, Mahanadi and Andamans.




The dark side of the story:

2. How would India Fare During A Global Slow-down

Just over six months ago, the India story was taken for granted, what with 9% growth, corporate profits at 20%, huge consumer demands for everything from mobile phone to home loans. Inflation was at less than 4%. You get the picture. Hardly anyone dared to ask what could go wrong and at the lofty valuations it seemed like nothing could. We were the champions till oil decided otherwise.

In December last an expert panel was asked whether India will be affected by a US slowdown and none thought so, which says something about the heady days of December. Though they were right that US has not been the reason for this slowdown, it can certainly help in speeding up the slowdown, if one may say so.


The only thing growing in Indian growth story is the inflation at a 13 year high of 12%.

Today, India according to DSP Merrill Lynch’s Andrew Holland “ has gone from hero to zero in six months flat”.

So where did we go wrong? Before answering, it would be better to ask were we right in the first place to claim a unique growth story. Or was the growth due to global liquidity sloshing around everywhere and India received its fair share thanks to being in the right place (favorable demographics among other factors) at the right time (global liquidity surge, high risk tolerance, low oil prices and low inflation)

The once popular perception that India is decoupled doesn’t fit well as any country which is so dependent on oil can not be decoupled by any stretch of imagination. Decoupling occurred only in the credit crisis in which India had little part to play.

Robert Blackwill, former ambassador to India and considered as a friend of India, warned on the World Economic Forums annual Delhi conference in December last year that with the Iran – US tensions rising, India’s growth story could be jeopardized by oil, He quoted Asia Development Bank report that says for every ten dollar hike in oil Indian growth would slow by 1%, If the oil prices trade at 150$ and above the India growth rate may be a disastrous 3-4%

Today he seems bang on target.

(Source http://ridingtheelephant.blogs.fortune.cnn.com/category/india-oil-prices/)


India is more vulnerable owing to poor macro fundamentals as compared to other emerging economies. This is primarily due to high deficits, risk of rupee depreciation and short term money flowing externally.


Also we are yet to see how the credit crisis will play out on the burgeoning IT , ITES, companies as exports BFSI sector was contributing as much as 40% of the revenues of Indian IT. Now, when the same BFSI companies are likely to go through a rough period of consolidation and management changes, their expenses on IT may altogether stop if they are too small and close shop. While the big BFSI companies may cut down on IT spending. This will pan out as the most painful scenario for India as its upper middle class predominantly works in IT, ITES and financial services which directly or indirectly benefits from the outsourcing boom. The off-shoring business employs a huge support staff which typical is at 4-5 non-IT blue collar work-forces for every white collar. This could be a spanner in the works for the consumer led story of India where the typical professional was expected to spend and be the reason for the retail boom be it realty, financial services, leisure and retail. 80% of India’s 40 billion $ revenue from IT and ITES comes from exports. Exports to US accounts for half of that amount.

HCL Tech, a top IT company recently announced that the company shall not give guidance on future earnings henceforth, another off shoring major Cognizant said that the future looked highly uncertain and the negative news flow from BFSI is not yet over.

Harish Rajagopalachari Executive Director of PWC says about the impact of US slowdown that the implications for all of India’s externally linked sectors are significant and that the strongest and most immediate impact will be on India’s IT & ITES sector.

Chetan Ahya, Managing Director of Morgan Stanley Asia quipped last year that India’s growth acceleration had more to do with globalization of markets than globalization of trade. Favorable sustained global risk appetite towards India is one of the main reason for its growth according to him. He goes on to add that rise in risk appetite and growth is linked both on the upturn and the down turn.

He further states that most of the improvement in fiscal deficit was due to rise in corporate tax to GDP ratio inline with the corporate profit cycle and this leaves little room for maneuvering in case a global slow down hits India as the corporate profit cycle would be down by then.

Rise in Non FDI capital inflows leads to lower rates leads to strong credit growth. The reversal will happen due to lower global risk appetite trend and not domestic fundamentals per se.

“If asset prices are unrealistically high, they must eventually fall. If savings rates are unrealistically low, they must rise. And if debt cannot be serviced, (it) must be written off. Trying to deny this through the use of gimmicks and palliatives will only make things worse in the end.” – Bank of International Settlements latest annual report

Let us consider what this means for an investor – over both short and long time frame. Short term investors should avoid the markets unless they are ready for stomach churning ride as the inflation may not fall till early next year. The India oil and gas story will take at least next three to four years to make a meaningful impact. So, in the short term we are still more coupled with the world oil prices and the credit market crisis fallout.

Moreover, we need to be reminded that there is no hard and fast rule that if an economy does well its markets would do well too. This may eventually happen, but it is not a sure thing.


Over the long term the India story remains intact, if you add the new oil and gas finds it becomes even more lucrative. The current crisis may in fact be the exact medicine required to quell the inflationary pressures. This would make the valuations come to a meaningful level. This will also enable us to concentrate on capital formation, competitiveness and long term growth instead of non-FDI capital inflows.

Every investor need well remember Warren Buffett’s quote on Noah’ Ark “ Predicting rain doesn’t count, building ark does”

(The article above is a reproduction from Moneyworks UAE magazine)