Did Tata Bite Off More Than It Could Chew?

Indians are flushed with pride at Tata’s acquisition of the iconic British auto brand names Jaguar and Land Rover. As with the conglomerate’s purchase of the steel group Corus, a successor to British Steel, it seemed to represent a tasty but polite piece of revenge on the old colonizer and also the coming triumph of the developing world of Asia over the over-developed west.

But these purchases, together costing almost $10 billion, seem not so much the work of India’s entrepreneurs eager to create new industries, whether in media, mangoes or medicines or simply to take advantage of the needs of a billion Indians. More at work were the emotions of business leaders born when India was under British rule – Family patriarch Ratan Tata was born in 1937. They appear to be looking backward to prove a point.

Younger Indians in newer industries may reasonably question the benefit of investing huge sums in foreign brands in mature industries at a time when India is crying out for investment of all sorts – starting with primary education, public health and agricultural productivity before going on to more publicized issues such as roads and ports, not to forget steel and cars.

There is a whole host of reasons why these deals are unsound from the point of view of both India as a whole, and Tata.

Opportunity cost. This may seem the most nebulous but is actually the most important. Tata, India’s best known group with the possible exception of flashy upstart Reliance, has been taking advantage, until quite recently, of surging stock prices and the unparalleled liquidity prevailing in international debt markets to make its foreign purchases.

This is not only soaking up capital that could be invested in India itself, where returns are generally high. It will in the not too distant future crowd out other Indian borrowers, perhaps with worthier projects, from international markets just at the time when access to those markets, equity or debt, is becoming more difficult.

Jaguar may be an iconic name but it hasn’t built an iconic car since the E-type launched in 1961 – and still one of the sexiest cars ever built. But finding out when it last made a profit is rather difficult. Ford for sure never did.

Land Rover has a fine track record and in some ways almost invented the sports utility vehicle when it transformed its military type original Land Rover into the luxury brand Range Rover in the 1980s mostly beloved of rich urbanites who like to imagine they are touring their ranches. But it is small scale, at best, and has had a multiplicity of owners who like the brand but not the bottom line.

Even if both brands could be made profitable, neither vehicle company fits naturally into Tata’s product range nor offers technology particularly relevant to developing its home market to the point where it can export profitably in volume. They are also at the other end of the spectrum from Tata’s ultra-cheap Nano. Whether or not it is a success, the Nano is an imaginative effort to create a new income level of demand within the giant untapped market which is India.

Corus is quite a good company –after the once state-owned British Steel was subjected to the Thatcherite blow-torch and an injection of some Dutch realism. But it is hard to see why this should be such an attractive investment for a developing country given the levels of competitiveness in global steel markets, and Corus’ focus on a static Europe and high-grade steel.

Tata enthusiasts may reasonably be asked why, after an existence of 100 years, the conglomerate is still a small steel producer compared with the likes of Korea’s Posco, less than 40 years old and already a global leader in steel technology as well as scale of output.

Of course it is not Tata’s fault that for four decades the Indian steel industry was hamstrung by the Licence Raj, lack of access to capital and foreign technology, and the favors given to state-owned steel companies. But the reality today is that China produces nine times more steel than India. It is India that needs the billions being spent by Tata to acquire the foreign companies to create new industries at home.

Meanwhile, for several reasons India is continuing to give high levels of protection to its domestic steel companies. Like much Indian manufacturing, it is unable to compete globally. Nothing illustrates this better than trade with China. Despite tariffs, almost all of China’s exports are of manufactured goods while India mainly sells iron ore and other minerals to China.

Protection has fallen but it is still high. That is more often than not a reflection of failings not attributable to Tata competence – transport costs, labor laws etc. But if India continues to keep demand growth high by reducing obstacles, it will need more capital. If it does not, today’s euphoria will sour quickly. Indeed, some skeptics wonder whether the Tata buys in Europe are less a vote of confidence in India than a diversification away from it while the going is good.

In reality, it is India where demand can grow fastest (even compared to China). The quicker the various obstacles to growth are removed the more the demand for steel, cars etc will grow and with it the demand for capital. But India needs its capital at home, and it needs its big groups like Tata to retain their foreign money-raising ability, not to saddle themselves with low yielding (at best) foreign companies bought near the top of the market.

Yes, India is boasting record foreign capital inflow and record reserves, but it prefers to forget that much of that capital is footloose portfolio investment, not permanent foreign direct investment in new businesses and equipment to drive exports as in China.

India’s vulnerability is not just to short-term capital flows. It is also exposure to an old enemy – its current account deficit. This is now almost the only such deficit in a significant Asian country and it is likely to deteriorate given oil prices, a strong rupee, and weakening demand in the west.

The Tata acquisitions may be viewed as representing the pinnacle of Indian euphoria at its newfound success. Like grand Mumbai weddings, they make a fine spectacle. But in the final analysis they could well prove to be bad not just for Tata shareholders but, more importantly, for India.