Asia Inc Jan 94

BUSINESS: India's middle class boom

January 1994

Upsurge In India

Some 300 million newly affluent consumers make this the most promising market in Asia. So where are the East Asian Investors?

Beneath the early morning Indian sun, a fleet of six-ton delivery trucks filled with large, round signs bearing a familiar red-and-white logo sets out from a bottling plant in Hathras, a town in west-central Uttar Pradesh state. Their mission: to reclaim territory for the Coca-Cola Co. after a 16-year absence by planting the company's colors throughout this land of 853 million people.

Coca-Cola and many other multinational companies left India after 1977, rejecting the government's effort to enforce a law that required them to dilute their equity in their Indian operations to 40 percent. But since the liberalization of India's economy that began almost three years ago, Coca-Cola and others are coming back for the real thing: a market of 300 million middle-class consumers.

While many investors in Asia are mesmerized by the vision of a billion-strong market in China, few have paid much attention to India. But since July 1991, when Prime Minister P.V. Narasimha Rao took measures to open up the economy, India has become a hot market for foreign consumer goods.

Investment in India may even produce bigger rewards faster than in China. "Both India and China have half a billion very poor people," explains Timothy J. Malloy, Visa International's general manager for South and Southeast Asia. "The crucial difference is that India has at least 100 million not-so-poor people; China does not have that yet." Markets in both countries are expected to grow 30 to 40 percent in the next few years. However, he notes, "India has a head start: For 30 years it has created a professional middle class without social upheaval. It is going to take China longer to reach there. "

India has long been viewed as only a market for Oxfam and Mother Teresa. On the surface, it may seem foolish to invest there: Per-capita income is a paltry $ 310, the number of destitute could be as high as 300 million, and the country is prone to violent social upheavals like the riots following the demolition of the ancient Ayodhya mosque by Hindu zealots in December 1992.

But then there is that enticing 300-million number. Although estimates of the size of the middle class vary, India's National Council of Applied Economic Research (NCAER) found in a 1989 survey that 200 million Indians earn between $ 700 and $ 1,400 annually, and another 100 million earn even more. At least 40 million Indians have annual incomes of more than $ 30,000, Visa International estimates. They have the disposable income to afford $ 15 Van Heusen shirts and $ 5,500 Indian-made Suzuki cars.

This burgeoning middle-class market rivals the population of the entire U.S. or that of the European Community and is more than 10 times Australia's total population. "It would be a very foolish marketing man who'd say 'who cares?' when shown such numbers," says Alyque Padamsee, advertising agency Lintas's regional coordinator for South Asia.

Moreover, per-capita income statistics fail to reflect the real purchasing power of Indians. According to the now-fashionable purchasing-power-parity (PPP) model, which some economists believe more accurately measures consumer buying power, India is the fifth-largest economy in the world, with a PPP-adjusted per-capita income of $ 1,255. States in western India, such as Gujarat and Maharashtra, and in the north, such as the Punjab and Haryana, have incomes comparable with newly industrialized nations like Malaysia and Indonesia.

Historically, India and East Asia have ignored each other when it comes to doing business. India looked west for the technology and products it needed; East Asia looked elsewhere for its markets because India discouraged imports for so long, and because East Asian businesspeople had no guanxi (connections) there anyway. But considering the success that newly arriving Western companies are enjoying in India and the enormous purchasing power of the country's middle class, it's time for East Asia to take a closer look.

Until a few years ago, modern India shunned private foreign investment and products. After its independence from Britain in 1947, India tried to follow the Gandhian principles of self-reliance and self-sufficiency under the leadership of Jawaharlal Nehru, its first prime minister. It pursued this course through democratic socialism. But the Indian economy became mired in a complex system of protectionism, permits and licenses. Companies had to seek permission for everything from opening and closing plants to expanding their operations, or as the acerbic former managing director of Tata Iron and Steel Co., Russi Mody, put it, even to go to the bathroom.

Still, the socialist approach worked -- for a while. By the 1960s, India had an impressive industrial base. "Thou shalt not consume foreign products" was an unwritten mantra that the bureaucratic babus (low-level clerks) parroted as they made business decisions for Indian companies. But the push for self-sufficiency became twisted into a paranoia of foreign things, which was exploited by politicians, says John Patterson, an international business consultant who lived in India for 11 years. In 1977, the ruling Janata Party, with its fervent commitment to socialism and nationalization, began kicking out multinationals with glee. Not surprisingly, foreign investment plunged.

The economy continued to function because of large domestic demand and barter trade with the former Soviet Union: India bought guns and sold butter. Exports were soon nonexistent, and imports were prohibitively expensive. So when East Asia underwent its exceptional economic transformation in the 1970s and 1980s, India was just a passive spectator.

It's easy to see why. Just look at the experience of PepsiCo. Inc. The U.S.-based soft drink giant applied to set up a plant in 1983. But it had to wait five years, face 200 critical questions in the parliament, 5,000 negative press articles and 14 inter-ministerial committees before getting government approval. It even agreed to unheard-of conditions, such as promising that half of its sales would be from exports and only 25 percent of its revenues would come from the sale of soft-drink concentrates.

While politicians were making life difficult for business, consumerism was growing. It came to the fore in 1985 under Rajiv Gandhi, India's first designer prime minister, who did not mind being seen wearing Cartier glasses and Gucci shoes. Indian companies vied for consumers' attention and their crisp 100-rupee notes, bombarding them with commercials in India's 15 official languages. As a result, Indian consumer brands proliferated. The number of popular soaps, for example, increased from 34 to 56, and the number of packaged teas jumped from 31 to 80.

Still, official figures showed India mired in what economists derisively referred to as the "Hindu growth rate," which was about 2 percent annually. Meanwhile, a huge parallel economy was growing faster than the legitimate one. Street-smart Indians stopped paying taxes when a 93.5 percent income tax was slapped on the highest tax bracket in 1970. To avoid getting caught, they had to spend their cash. Many bought gold. In 1992, India was the world's largest buyer of gold. Anil Ambani, joint managing director of Reliance Industries Ltd., India's largest private company, says estimates show Indians are hoarding possibly as much as 8,000 tons.

Also fueling the spending boom were increases in salaries and wages. Since 1990, monthly salaries of people with master's of business administration (M.B.A.) degrees from top Indian institutes have doubled in rupee terms to more than $ 330. Wage increases pushed up organized labor's income levels to the top 10 percent in the country. India's governments -- traditionally the country's great job machine -- gave wage hikes far in excess of the consumer price index.

The economy also got a boost from the "green revolution," an emerald wave of agricultural prosperity that swept first across Punjab and Haryana, and later to Uttar Pradesh and other parts of India. Thanks to government subsidies, farmers grew relatively wealthy, and India became self-reliant in food. The fruits of the green revolution started to be harvested in the 1980s when tax-exempt farmers saw their incomes jump tremendously, creating a vast rural market and an Indian development success story (see box, page 29).

Overseas Indians also contributed to economic growth. They began placing large amounts of funds in India in the mid-1970s when banks there offered them lucrative, double-digit interest rates as well as the right to take their tax-free earnings out of the country. Indian manual laborers in the Middle East also began remitting millions of dollars home to their families, transforming the lives of people all over India, from big cities to rural villages.

But the 300 million Indians who today gulp down Thums Up soft drinks, ride in Maruti cars, watch programs on BPL-Sanyo videocassette recorders and wear Flying Machines-brand jeans were impatient for change. This generation -- born after India's independence on midnight, August 15, 1947, and labeled "midnight's children" by author Salman Rushdie -- form an assertive and pragmatic generation that wants instant gratification. They do not relate to Mahatma Gandhi's bold declaration when he launched the swadeshi (indigenous) movement in the 1930s: "By taking off this foreign shirt I shed myself of foreign rule." That foreign shirt has once again become a status symbol.

"The middle class is free from inhibitions which shackled the older bourgeoise," explains Gurcharan Das, Procter & Gamble's vice-president of worldwide strategic planning who headed the company's Indian operations. "The new class is non-ideological, pragmatic, result-oriented."

The status quo in India might have continued if not for the collapse of the Soviet Union in 1991. India by then had a severe balance-of-payment crisis with only enough reserves to pay for three weeks of imports, and it no longer had a trading partner that would accept payment in rupees. Inflation was running at 16 percent, and the country had a huge budget deficit.

Not until July 1991, under the leadership of reformist Prime Minister Rao, did India begin to transform the red tape that ensnared businesses into a red carpet. It relaxed restrictions on foreign ownership of companies, granting automatic approval for 51 percent ownership in 36 sectors and allowing 100 percent ownership on a case-by-case basis (see box, right).

To further encourage foreign investment, the government reduced the capital gains tax to 10 percent less than what domestic companies paid. And income earned from investments in companies that exported their total output was exempt from taxes. Those same companies were allowed to import machinery and raw materials duty-free.

In addition, the government freed Indian companies to expand production without checking with the babus in Delhi and allowed its protected businesses to expand overseas. The rupee also was made fully convertible on trade accounts, and Indians were allowed more latitude to use foreign exchange for business purposes.

The results of this new direction are already apparent. Foreign direct investment in India in the 1980s averaged a puny $ 100 million a year. In 1992, it shot up to $ 1.4 billion. "What's happening here is unparalleled," says Vimal Bhandari, senior vice-president at Infrastructure Leasing & Financial Services Ltd. (IL&FS), a Bombay-based finance company. "We are unshackling the past with promise and hope despite the most serious religious controversy since the 1947 partition." India's government doesn't have a single-party majority, he notes. "Yet we are relentlessly reforming.".

As liberalization takes hold, India is beginning to reveal a new personality. To understand the change, walk through Big KidsKemp, a huge children's clothing store on Bangalore's busy Mahatma Gandhi Road. The loud pink interior, a waterfall, flashing neon lights and a toy train giving free rides make you feel as if you are in an amusement park. Clowns dressed as Laurel and Hardy entertain the crowds while your children eat free cotton candy and ice cream. Before buying those $ 15 jeans for your three-year-old, he can try them on in a changing room that is designed to look like the front half of a car.

The father-and-son team of Vashi and Ravi Melwani -- cousins of Singapore's leading retailers by the same name -- own the store, which is part of their chain of children's clothing outlets. They set up the mega-store in 1990, seeing it as an opportune time given the city's rising incomes, yuppie population and cheap real estate. Big KidsKemp was an instant success. Annual sales now are estimated to be close to $ 2 million.

The Melwanis could have had people like Rashmi and Vivek Gour and their baby in mind when they planned their store. The suburban Bombay couple together bring home some $ 500 a month after taxes, which places them in the top echelon of India's middle class.

Rashmi works as a human resources consultant for international pharmaceutical companies like Pfizer Ltd. and Hoechst Ltd. Vivek holds an M.B.A. from the University of Delhi and works for finance company IL&FS. They just moved from a company apartment in the western suburb of Andheri to one in the upmarket Pali Hill area of suburban Khar, home to many of India's movie stars.

Their home is a picture of newly acquired, middle-class wealth. They drive a Premier Padmini, a locally made car based on a Fiat model, and have filled their home with Indian-made goods: a Sumeet washing machine, Godrej refrigerator and BPL-Sanyo television and videocassette recorder. They listen to the latest Indian pop music on a Philips cassette-player made in India. The Gours prefer Indian goods. "Most of the Indian products are tailor-made to Indian conditions, " says Vivek. But they choose foreign brands for some products such as cameras, cosmetics and some of their clothes.

After working for eight years, the Gours have saved enough money to buy a $ 21,000 apartment in New Delhi. (NCAER estimates Indians on average save about 23 percent of their incomes.) "Life is good," Vivek says. "We do feel a bit of a pinch because of the house we have bought in Delhi, and taxes in India are killing (us)." Even so, they are able to maintain a standard of living that a middle-class couple anywhere would find comfortable.

The rising affluence of Indians is apparent in many areas. According to the Center for Monitoring the Indian Economy in Bombay, spending on household appliances, consumer goods and services rose 14 percent annually through the 1980s, while consumer electronics spending increased 30 percent per year.

Last year, some 3 million Indians traveled abroad. The tourism ministry estimates 62 million Indians travel within the country for pleasure annually. The number of Indians investing in the country's 22 stock exchanges has soared from 2 million in 1980 to more than 20 million last year. And despite the great number of tax evaders who don't want to leave a paper trail of their spending, 900,000 hold credit and charge cards; credit card companies expect this number to increase 30 percent to 40 percent annually for the next five years.

Not everyone supports India's steps toward a more liberal economy. George Fernandes, the opposition politician who as industries minister proudly chased Coca-Cola and IBM Corp. out of India in 1977, swears he will launch a Gandhi-like movement against multinationals that are re-entering the country. And followers of a factional leader of farmers in Bangalore, M. Nanjudaswamy, have ransacked the offices of Cargill Seeds ostensibly to protest a draft trade agreement proposed under the General Agreement on Tariffs and Trades. Nanjudaswamy claims it would force farmers to pay higher prices for seed.

Meanwhile, Indian companies are beginning to voice concerns that they will be unable to survive the onslaught of foreign competition. A number of buyouts and management takeovers by multinationals also makes them nervous.

Despite India's more liberal economic policies, the experience of Pepsi lingers in the minds of some investors. But that hasn't daunted Pepsi, which is increasing its investment in India by buying into an agricultural joint venture with the Indian government. Other foreign companies, too, are enhancing their presence by upping their equity stake in existing operations. New entrants, primarily Westerners, have been quickly teaming up with Indian partners to tap into the enormous middle-class market.

The biggest bull in the India bazaar so far is U.S.-based multinational General Electric Co., which has tie-ups in medical electronics with Wipro Systems Ltd., a Bangalore-based high-tech firm; in housing finance with Housing Development Finance Corp.; and for refrigerators, washing machines and dryers with the Godrej group. The plethora of Western products that are now or soon will be available in India include Levi's jeans, McDonald's hamburgers, Arrow shirts, Hush Puppies shoes, Ray-Ban sunglasses, Whirlpool appliances and Kellogg's cereals.

Not all foreign brands have succeeded. The Indian marketplace is littered with famous names gasping for breath: English Leather cologne, Palmolive soap, Tang powdered orange drink and even Pepsi, which despite its massive advertising budgets could capture only a 20 percent market share in its first three years, reporting losses of $ 17 million last year.

Despite the huge sales potential, East Asian companies remain noticeably absent from India. Observing that Western firms have been burned in the past, many Asian companies are questioning the sustainability of India's reforms. They wonder whether the government might go on a mad drive of nationalization, again.

Given the size and power of India's new middle class and the thriving private sector, such a reversal is unlikely. As midnight's children become midnight's adults, they are realizing their potential to earn and seek gratification for their desires. Armed with cash and credit cards, they stalk the markets of Bangalore, Bombay and Delhi, and even smaller cities such as Hisar, Pune and Cochin, improving their quality of life and creating a powerful constituency for change that can only help India realize its dream of becoming a real economic power. "People are realizing that letting in foreigners and self-sufficiency are not two radically different ideas and that they can live with it and progress," says business consultant Patterson.

As India sheds its socialist wrappings and further liberalizes its economy, the rest of Asia may find it worthwhile to consider the Indian market. Observers say even if the leading opposition party, the Bharatiya Janata Party (BJP), were to come to power -- now a distant likelihood given its poor showing in November's critical state elections -- economic liberalization would continue. "There is no difference in the economic policies of the Congress and the BJP; it is like Coke and Pepsi," says one leading Indian businessman.

By 1997, India will remove all quantitative restrictions on consumer goods imports, vows Finance Minister Manmohan Singh. This is expected to further increase consumer spending. "As tariffs come down, demand for all kinds of goods in India is going to be enormous," says Uday Kotak, vice chairman of Kotak Mahindra Finance, India's largest consumer finance company. "That's why India must be seen as part of Asia. It will be its largest market."

 Box


Investing in India

Despite India's moves toward a more liberal economy, foreign investors still must get government approval before setting up a business. However, such approval -- from the Reserve Bank of India -- is virtually guaranteed for investments in any of 36 "high-priority" sectors as long as foreign ownership does not exceed 51 percent. Those high-priority businesses include pharmaceuticals, computer software, soya products, food processing, hotels and tourism.

To own more than 51 percent of a company or to invest in businesses not included on the high-priority list, investors must get the approval of the Foreign Investment Promotion Board (FIPB) in New Delhi, which reports directly to the prime minister.

For new Asian investors, joint ventures generally remain the best route. The local partner's connections and knowledge of this huge and diverse market are often key to marketing and distribution success.

Foreign investors also can acquire existing companies in India but only by negotiating directly with the company. To prevent hostile takeovers, India sets a 5 percent limit on the shares of one company that an individual foreign entity can acquire through the stock market, with a limit of 24 percent of a company's equity bought by all foreign investors through the stock market. Overseas Indians (called nonresident Indians, or NRIs), overseas corporations at least 60 percent owned by an NRI and foreign institutional investors can trade directly on the stock exchange.

Contacts:

The Controller, Exchange Control Department
Reserve Bank of India, Shaheed Bhagat Singh Road
Bombay, India 400 023
Tel: (91) 22-286-1602, Fax: (91) 22-261-9330

The Secretary, Foreign Investment Promotion Board
Prime Minister's Office
South Block, New Delhi, India
Tel: (91) 11-301-7839, Fax: (91) 11-301-6857

Applications to the FIPB also can be made through Indian missions abroad. Typically, the FIPB decides on a case within 45 days.