The rupee bull: Late Diwali or early Christmas?

Diwali marks the holiday shopping season in India, much like the Christmas holiday in the United States.

This year, however, Diwali has come late (or Christmas has come early) as the ever strengthening rupee presents challenges and opportunities for US and Indian companies.

The US dollar has shrunk to its lowest value in the last 15 years against a basket of currencies. So far this year the dollar is down 12% against the rupee. In contrast, the euro is only down 1.2%. There appears to be no short term end to the dollar fall as Lehman Brothers has predicted that the rupee may appreciate to Rs33 per US$ within the next five years.

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Foreign reserves in India are surging. Dollar reserves in India 16 years ago were in the order of US$975 million. Today reserves stand at about US$250 billion and are predicted to surge to US$900 billion by 2017.

What does this mean for the Indian economy and for India-US trade?

One might think that direct investment in the Indian stock market would slow, as US dollar investors buy less with their dollars. The Indian stock market, however, has surged with over US$17 billion coming into the market, over half since 18 September. Investors, seeing the dollar decline, have moved to look for the higher returns in riskier overseas assets. Inside India changes are subtle and not so subtle. Visiting the Taj Mahal was formerly denominated as US$5 (to non-Indians) when the rupee was 50 to the dollar and foreign currency was at a premium. It has now shifted to 250 rupees. Companies such as Infosys, with a large amount of dollar off-shoring, have seen profits drop in rupee terms.

For non-resident Indians (NRIs) located in the US, a move home may look attractive. With labour costs in India rising 15% in the last year, coupled with the 12% currency jump, the salary gaps between higher level employees in the US and India are closing. Wipro, due to the soaring cost of doing business in Bangalore (both in human and physical terms), recently announced the establishment of 500 to 1,000 jobs in Atlanta.

Indian firms are not sitting idly by. Many firms are taking proactive measures like hedging currency and improving productivity. But the rising costs of services are beginning to cut into growth rates. Many are seeing that it may be cheaper to buy US firms than expand at home. Further, Indian firms are finding it necessary to climb higher up the value chain.

Indian firms are seeing global markets as a pathway to sustained growth. Early movement was in the basic industries such as chemicals, IT, steel and pharmaceuticals. Today, all areas are a target. Auto parts manufacturers and textile giants such as Dan River are recent scores. The newspapers only report the big deals but many small and mid-size transactions are also being completed. Goldman Sachs believes that the fallout from the sub-prime mortgage crisis in the US will create further opportunities. Indian banks, with an overall lower cost structure, may find trouble getting a licence in the US, and will see an acquisition as the better path. Indian firms will compete with western firms in all sectors around the world.

India will not be alone in the global competition for US mergers and acquisitions. A new survey conducted by the Johns Hopkins Center for Transatlantic Relations shows that for the first time since 2002 takeovers in the US from the EU exceed that of takeovers from the US. The year 2006 saw an EU to US inflow of US$114 billion, a doubling of EU merger/acquisition flows into the United States since 2005.

For the first eight and a half months of 2007, EU to US inflows increased to US$171 billion. Looking at EU investment in 2005, for every euro invested in India, three went to China and 15 went to the United States.

Further, a new competitor is arising: sovereign wealth funds. Many countries are utilizing their new-found wealth (whether from oil, like Arab states and Norway, or from exports, like China) to acquire large stakes in US firms. The sale of a 4.9% stake in Citigroup to the Abu Dhabi Investment Authority is the latest headline and a precursor of things to come.

For the Indian business on the M&A trail, a word of advice. Pay proper attention to post merger integration (PMI) plans. Many firms look at business, strategic and market considerations but do not place sufficient emphasis on PMI. The different culture, compensation structures, managerial practices, legal and regulatory environment can lead to serious problems. Many transactions ultimately fail due to the acquirer’s inability to properly deal with the various constituencies within the company and the alignment of objectives. Corporate politics and cultures are real.

Perhaps the mood of the times was succinctly stated in a press report concerning Wipro’s Atlanta plans: Wipro appears prepared to risk alienating its Indian customers by forcing them to deal with quaint American dialects.

How the world turns.

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Wayne Rogers is a senior adviser in the international law firm of Sonnenschein Nath & Rosenthal, where he specializes in international trade and cross-border transactions. He may be reached at +1-202-408-6478 or wrogers@sonnenschein.com.