May 22, 2014 12:00 am JST

Five economic challenges for India's new boss

Welcoming foreign retailers like Walmart

Dozens of small shops line the streets of Worli, a township in the southern part of India's commercial hub of Mumbai. Each shop is less than 5 meters square, but they sell a wide range of daily necessities, from grains and sweets to detergent and soap.

     These kinds of shops, called kirana, are essential to the residents of this bustling city, particularly those on the lower end of the economic ladder. "They are handy because they are close to my home. I'm on familiar terms with shop owners, so I sometimes ask them to wait for me to pay my bills until payday," one customer in his 30s said.

     Kirana shops are everywhere in India, accounting for 90% of the country's retail market. By contrast, not a single signboard of global retailers such as Walmart or Seven-Eleven can be found.

     Outgoing Prime Minister Manmohan Singh proposed in September 2012 allowing foreign multi-brand retailers, including supermarkets, to enter the Indian market. But the proposal was fiercely opposed by small and midsize business operators, mainly kirana owners, who make up the key supporters of Singh's Indian National Congress party. The government responded by setting stiff requirements for foreign retailers, such as procuring a certain amount of products from local suppliers, that have effectively closed the door to India's retail market.

     Local opposition has hit the world's largest retailer, Wal-Mart Stores, particularly hard. The U.S. company entered the wholesale business in India by teaming up with Bharti group in 2007. In response to the government's proposal for deregulation, it began drawing up investment plans for retail operations, but those plans stalled almost as soon as they were made.

     In December 2012, the Communist Party and other opposition members argued that activities by Wal-Mart that were considered lobbying in the U.S. amounted to bribery in India. Its purchase of Bharti's convertible bond was also criticized as exploiting loopholes in foreign capital regulations. Wal-Mart dissolved the partnership with Bharti in October 2013, putting its Indian retail ambitions back to square one.

Ready to open?

The Bharatiya Janata Party, which enjoyed a landslide victory in the recent general election, has promised sweeping economic reform. But even though Modi told The Nikkei last November he would not oppose foreign retailers entering India, the BJP's manifesto released in April made it clear that his party is against the idea.

     Opening the door to foreign retailers would bring far-reaching benefits. An estimated 20-40% of vegetables and other perishables in India never make it to market because they spoil during distribution. Major foreign operators can bring the infrastructure and know-how for refrigerated logistics that India lacks. Additionally, middle-income consumers are no longer satisfied with the selection available at kirana shops. Some industry sources say the BJP's opposition to foreign retailers was merely a campaign tactic and the party will change its position once it assumes power.

     Foreign retailers are keen to gain a foothold in India's market of 1.2 billion people. British supermarket operator Tesco submitted to the Indian government an investment plan for retail operations last December. Wal-Mart Stores announced in April a plan to expand its wholesale business. Scott Price, president and CEO of Walmart Asia, says he is excited about his company's growth plans in India.

     The Singh government considered the opening-up of the general merchandise market the centerpiece of its economic reform initiative, but it failed to make that happen. Retail market liberalization will test the Modi government's commitment to economic reforms.

  

Reforming Indian Railways

Modi has a long to-do list waiting for him when he assumes the post of prime minister. Near the top of that list is revamping the antiquated and inefficient rail services that are hampering India's economic growth.

Dangerously outdated

On May 4, a passenger train derailed roughly 100km south of the western city of Mumbai, killing 18 people and sending more than 100 to hospitals for treatment. Railway Minister Mallikarjun Kharge immediately promised a thorough investigation into the cause of the accident, but nearly three weeks on, little is known other than the fact that the locomotive and four front cars left the tracks right after exiting a tunnel.

     If this kind of story sounds familiar, it is because serious rail accidents are all too common in India.

     In December, 26 passengers died in the southern state of Andhra Pradesh when a fire broke out on a sleeper train, completely destroying one car, giving those who were asleep no time to escape. Four months earlier, 37 people died after they were hit by an express train while they were crossing the tracks at a station in the eastern state of Bihar.

     According to local newspapers, India accounted for 15% of the world's railway accidents between 2007 and 2011.

Oversized and inefficient

India's railway system dates back to 1853, during the British colonial period. Today, state-owned Indian Railways employs 1.36 million people and operates 12,000 passenger and 7,000 cargo services daily over a railroad network stretching 64,000km.

     With revenue exceeding 1 trillion rupees ($16.9 billion) -- more than 2% of the country's gross domestic product -- Indian Railways operates on a scale that none of its counterparts in other countries can even begin to approach. But it has been plagued by a number of challenges, including not just safety issues but also aging equipment and inefficiencies.

     For 2013, only about 76% of rail services ran on time, making railway reform a pressing priority.

     Economic losses owing to inadequate transportation infrastructure, including fragile rail and road systems, exceed 2 trillion rupees each year,  according to the Associated Chambers of Commerce and Industry of India. The organization warns that without action, those annual losses will balloon to 7 trillion rupees by 2020.

Progress, finally

The Delhi-Mumbai Industrial Corridor, a joint project between Japan and India, is designed to help the South Asian nation improve its rail transportation efficiency.

     The project, which involves building a 1,500km cargo rail link between capital New Delhi and Mumbai with industrial parks and distribution centers set up along its length, has been significantly delayed from its originally scheduled launch date of 2006. In that time, demand for rail cargo transport continued to grow at around 15% every year.

     But Japanese trading house Sojitz began laying rails and building a cargo terminal and other facilities in a section of the proposed rail link late last autumn after winning a 110 billion yen ($1.08 billion) contract for the work.

     India must also upgrade its road infrastructure, for example by adding more lanes. But to ensure further economic growth, the vital task will be to increase the proportion of goods transported by rail. This means introducing high-speed cargo rail services and reducing the delivery time.

     For that to happen, the government must reform Indian Railways from the ground up. Since better transportation infrastructure is one of the keys to attracting consistent foreign investment, such reform will serve as an important test for incoming Prime Minister Modi and his government.

 

Learning from Toyota's union woes

Two assembly plants operated by Toyota Kirloskar Motor, an Indian subsidiary of Toyota Motor in the southern state of Karnataka, are returning to normal operations after a monthlong standoff between labor unions and management this spring. The factories have a combined annual capacity of 310,000 units, including the Etios subcompact.

     The dispute is the result of stalled wage negotiations. Although pay is reviewed annually at the Toyota subsidiary, this year's negotiations lasted 10 months and came to a standstill when the employer and its workers union failed to agree on pay rises. According to Toyota Kirloskar, some union members stopped production lines to express their frustration, and in response the company temporarily shut down the factories and declared a lockout on March 16.

Common struggle

The union did not back down from its demands. They also revealed details of the pay negotiations to local newspapers and other media. "Toyota's proposed wage increase was limited to three-quarters of what we requested," said one union official. When the company lifted the weeklong lockout, some union members refused to return to work. As an early resolution seemed unlikely, the Karnataka state government ordered Toyota Kirloskar and the union to resume normal operations, which encouraged union members to return to work in late April. But as negotiations remain unresolved, the labor dispute has not been put to rest yet.

     Conflicts over labor conditions are quite common in India. Since last year, a number of India-based domestic and foreign manufacturers in auto-related industries have faced intractable conflicts with their employees. Aside from Toyota, they include Bajaj Auto, an Indian producer of two- and three-wheeled motor vehicles, German autoparts giant Bosch, and U.S. automaker General Motors.

     Indian workers tend to take an aggressive stance when it comes to labor disputes. This is partly because regulations in the country ensure a high degree of worker protection. Anyone employed to do factory work or simple clerical work is categorized as a "workman" under the country's labor laws and it is difficult to fire such workers. The law does not specify what constitutes an illegal dismissal, so when employees feel wrongfully terminated, they bring labor lawsuits against the employer. In most cases, courts issue rulings in favor of employees. As litigation is a lengthy process, it is normal for such lawsuits to last five years. Regulations even make it difficult to fire employees that violate work rules. "It is virtually impossible for a company to dismiss full-time workers," said a senior executive at a major Japanese automaker with operations in India.

Governing labor

In its 2014 election manifesto, the BJP, led by Modi, said that it would review the country's "outdated, complicated and even contradictory" labor laws. The party has also pledged to promote their concept of an "industry family" to mitigate labor-management conflicts, which often escalate due to a strong awareness among workers of their rights nurtured under a socialist economic system maintained until 1991. The industry family idea calls for businesses and employees to build cooperative systems to boost productivity while enhancing quality of life through the improvement of skills and higher wages.

     Over 40 laws govern different aspects of labor, including regulations implemented before India gained its independence from Britain in 1947. The Industrial Disputes Act that came into force in the same year as independence requires companies with 100 employees or more to obtain government approval for withdrawing from local operations and closing down offices. The purpose of the legislation is to ensure continuity of employment, but it is very difficult to be granted permission to close such a business. This law often works to dissuade companies from entering the Indian market.

     Modi has identified the development of manufacturing industries as the core of his growth strategy. However, the country's labor regulations and practices may become the biggest obstacle for the new Modi government in pushing through much-needed economic reform.

 

Powering up with CLP

Traffic jams are not the only source of headaches in India. An overtaxed power supply is also creating major bottlenecks, inconveniencing people and hampering business.

     Increasing generation capacity of electricity has been one of the government's top policy priorities since it kicked off its economic liberalization drive in 1991, but supply is still chronically below demand. Experts calculate the gap to be about 10%.

A difficult relationship

Foreign-owned independent power producers have been allowed in India for more than 20 years, but shortages remain and frustration is growing.

     Andrew Brandler, former CEO of Hong Kong's largest electricity company, CLP Holdings, does not mince words when describing the power business in India: "Frankly, the country is in a mess when it comes to fuel supply, not only coal but gas."

     CLP is one of the few foreign power generators left in India. Since the late 1990s, it has gradually expanded its portfolio to include coal, gas and wind. Its major cause of irritation at the moment is the low utilization rate of its state-of-the-art Jhajjar Power Station, a 1,320-megawatt coal-fired power plant commissioned in 2012 in the northern state of Haryana. Under-capacity has already cost CLP 350 million Hong Kong dollars ($45 million) in impairment charges in the first year and put its Indian operations in the red. It recorded another loss, this time of HK$109 million, in 2013, while CLP as a whole secured a HK$6.06 billion profit.

     Brandler, who now is a nonexecutive director, lashed out at the Indian energy industry at press conferences in Hong Kong, blaming the underutilization on the "total inability of Coal India and the Indian government on full allocation of coal." His criticism places the blame directly on the state-owned coal giant and the government for failing to live up to its promise of providing the right amount and quality of coal. Things are starting to improve now that CLP has been given permission to use imported coal to offset Coal India's late deliveries, but the plant is still not at full capacity.

     India is actually a coal-rich country.  It boasts the fifth-largest reserves in the world. But according to BP, only 76% of its consumption is met by domestic production in 2012. While consumption has soared 42% since 2007, production has risen only 26%.

     The rise in coal imports, along with an increasing reliance on imported oil, are adding to the current-account deficit, which is widening at an alarming pace. The biggest one-day drop of the rupee against the dollar in 15 years occurred last August. Efficiency in the energy market is a long-term remedy that could prevent a similar crisis.

Monumental tasks

Operational inefficiency is not the only problem plaguing the energy sector. Another is the rampant theft of electricity.

     Dharavi, the largest slum in Mumbai, is crisscrossed by a seemingly endless web of cables hung between one shanty and the next. Electricity is needed to light these shelters, but it is an open secret that most are connected to the grid illegally. "We all know it's illegal, but there's so many that we can't do anything about it," one resident said. Including theft, market watchers estimate the distribution loss of electricity to be around 20-30% of the total supply.

     The BJP emphasizes the importance of a coordinated energy policy and recognizes power generation and distribution as a "national security issue." Included in its manifesto is the promise to "come out with a responsible and comprehensive National Energy Policy." Creating a stable electricity supply is just one more challenge facing the new prime minister.

 

Unshackling Citi and other foreign banks

Citibank is the largest foreign bank in India, but even after 112 years, its presence in the world's second most populous country is small.

     Citibank India had 42 branch offices spread across 30 cities and total assets of 1.28 trillion rupees as of March 2013. By comparison, State Bank of India, the country's largest lender, had 14,800 branches and 15.7 trillion rupees in assets.

     Keeping its ambitions realistic, Citibank India would like to at least double its network. But the bank has struggled to get approval to add even three offices in recent years, ostensibly because the U.S., where Citi is based, has limited the growth of Indian banks there. Despite India's historically better ties with the U.K., HSBC and Standard Chartered have been similarly constrained, with 50 and 101 branches, respectively.

     Citi has tried to grow in India by acquisition, but found that path no easier. It bought a stake of just under 10% in Housing Development Finance, a mortgage company with a banking subsidiary, in 2006. It would have been limited to a 5% stake in HDFC Bank itself but hoped the rule would be relaxed and it could swap its shareholding in the parent. That didn't happen, and Citi sold its stake for $1.9 billion in 2012.

     StanChart and HSBC encountered more direct obstacles. The Reserve Bank of India barred StanChart from raising its stake in Tamilnad Mercantile Bank and blocked HSBC from acquiring branches from Royal Bank of Scotland.

     Squeezed by the global financial crisis and subsequent tightening of rules on bank capital, several foreign players are looking to exit India. Deutsche Bank and Barclays have withdrawn from retail banking, and ING has put its 44% interest in ING Vysya Bank up for sale. HSBC sold off minority stakes in two local banks last year.

     The RBI said last year that foreign banks that transfer their operations to local subsidiaries would be allowed to open more branches and buy control of private local banks. Neither Citi nor its peers have accepted the offer, as it would require them to ring-fence capital within new local units and adhere to more stringent lending requirements.

     The BJP has been hostile toward the Reserve Bank's reforms, especially the idea of allowing foreign banks to buy local ones. Once in power, however, the new government will face harsh realities.

     India's state banks dominate the industry, but many need recapitalization because of troubled loan books. A Reserve Bank panel on May 14 recommended that the government yield control of state banks and allow them to raise new capital. This could create an opening for Citi and its peers, but only if the BJP embraces reform.

Nikkei staff writers Takafumi Hotta (Mumbai), Satoshi Iwaki (New Delhi); Kenji Kawase, Nikkei deputy editor (Bangkok); Shinya Sawai, Nikkei staff photographer; and Ryan Maxim Rodrigues, contributing writer (Mumbai), contributed to this story.