Indian Hubris Creates a Mountain of Debt
|Our Correspondent||Feb 2, 2007|
It may have been a coincidence that the Shanghai stock market tumbled 5 percent on the day that India's Tata group won a $12-billion battle for the Anglo-Dutch steel company Corus. But maybe not. Easy money and reckless purchases are a global phenomenon fuelled by a surfeit of cheap money.
Chances are the neophyte investors in Shanghai stocks will suffer severe burns in the short run. But longer term they may come out ahead of the 100-year-old Tata group. Its bid for Corus has been described in the kind of overwrought verbiage of national pride that once accompanied the Japanese purchase of New York's Rockefeller Center for a sky-high price at the height of Japanese hubris in the late 1980s.
Ratan Tata has congratulated himself for what he says will be judged a "visionary move" and "a moment of fulfillment for India". Well, if this is the way a capital-short India spends its resources, no wonder one third of the population is still illiterate.
The Tata burst of India Rising extravagance was only possible because it could borrow two thirds of the money from a global financial system with no concept of discipline. Tata is buying a company several times bigger than its own steel operation and paying nine times Corus's 2006 earnings before interest, tax, depreciation and amortization (EBITDA).
This is justified, at least in public, by the supposed synergies that can be created between an Indian company making cheap low-grade steel and plants in Europe turning out expensive high grades. That remains to be seen. Meanwhile Tata will be hostage to interest rates as well as steel prices.
It is perhaps typical of India's current self-congratulatory mood that the Tata deal is being compared with the Mittal takeover of Arcelor, creating the world's largest steel company by tonnage. It seems the Tatas did not want to be outdone by the Mittals while at the same time adding to national pride at India’s arrival on the global scene.
But at least the Areclor-Mittal deal appeared to contain rather more logic – and less debt finance than this one. Indians and others might also pause to consider how the Tata ascent compares with that of the Korean giant, Posco, or indeed of Japanese firms in the 1970s. They did not need to go and buy companies to get bigger. They relied on a mix of rising domestic – and later foreign – demand and on constantly raising the quality of their output and the sophistication of their processes.
Posco became a global giant because Korea had steel-based export industries – ships, cars etc – that demanded reliable, quality steel. Thus today Posco is not just the world's third largest steel producer; it is a leader in steel production technology. It is quite a commentary on Tata that with the vast potential of India's market, it has to spend its cash on buying into high-grade but ex-growth markets in Europe. Meanwhile India itself exports iron ore but little in the way of steel products.
Yet such is the hype generated in India by the deal that it is described as reflecting India's galloping, 9 percent-growth economy. Reflecting self-confidence perhaps. But having the capital to sustain 9 percent growth looks to be increasingly in doubt now that the private savings surplus has fallen sharply, the government deficit remains huge and the trade gap is widening rapidly.
The argument that Tata brings iron ore resources and hence stable supplies to the party holds little water. Iron ore is a readily traded product. If the world price – largely set in negotiations between Brazilian and Australian producers and East Asian users – goes up, there is no good reason why Tata should rob one part of its group to support another. And if the price goes down, owning iron ore supplies will be a disadvantage.
If iron ore was a clincher, the Brazilians should have won the battle hands down. Or BHP might have decided to use their mining muscle to get back into the big leagues of steelmaking. They wisely did not.
The idea that producers need to own their own sources of readily available commodities never was much of a winner whether in steel-making or newspaper production there was a time when Dow Jones bought into forestry and pulp-making supposedly to protect itself against newsprint prices hikes. It learned a lesson. Newsprint prices could go down as well as up. And there were better ways of stabilizing newsprint costs than buying trees.
Of course, Tata has been in steelmaking and ore mining for 100 years. But it is also into so many other things in India and elsewhere that it could end up being mismanaged like the pre-crisis Korean chaebol, with their cross subsidies and jobs for everybody in the family, rather than focused, like Posco, on its area of expertise.
Looking at the Mumbai and Shanghai markets today, one would also have to say that the former is even more overbought than the latter – thanks in part to the "India rising" hype which has infected foreigners and locals alike. On a one year basis, Shanghai looks to be the bigger bubble, having risen almost 135 percent before its correction this week.
But Mumbai has risen by almost the same amount over two years. With its gigantic external surplus, China's domestic liquidity is also likely to remain high and may defeat the administrative efforts of the government to cool the market. It may also cushion any major fall by clamping down on IPOs.
The Indian market, meanwhile, remains much more sensitive to pure market forces. Inflation at over 5 percent and a rising current account deficit suggest that further interest rate increases may be on the cards which will at some point – probably sooner rather than later – crimp credit growth, which has been running at an unsustainable 20 percent and cause investors to focus less on GDP numbers and more on the structural weaknesses of the economy, and PE ratios which are about the same as Shanghai and higher than anywhere in Asia except Japan.
There are reasons to prefer Mumbai – corporate governance, market sophistication, the smaller role of government etc. But those are longer term considerations. Short-term even a bloated Shanghai looks less vulnerable than a Mumbai bourse which will, among other burdens, now have to bear some of the cost of Tata’s hubris.
The rest will in due course be absorbed by the usual banks and private equity funds that make their money from deals today and leave the consequences to their successors.