Address @ Luncheon of Main Board & IAB of Rolls-Royce @ Taj Mansingh on 01.04.2008

Good Afternoon Ladies and Gentlemen

I understand this is the first time the Board and Advisory Boards of Rolls Royce are meeting in India. So welcome to India. I trust you will have a good and fruitful visit to my country. You have picked an interesting time to visit – we are at the end of term of our current government and the election season is showing signs of having arrived early!

I’ve been asked to speak on my views and vision on the Indian economy. I have been an entrepreneur who is completely a product of this new India and am also currently a participant in the politics of my country and so I will approach this subject from a perspective of my experiences. I have structured my talk to cover the two very different growth phases of the 90s and now, and the challenges that I see on the road ahead in the Indian investment thesis.

I am sure, you have being subjected to many presentations on India and so I will go a different way. Let’s look at the India growth story. There are really two parts or phases to this growth story. The first was in the early 90s when the current Prime Minister was Finance Minister and of course the current bull run. I believe it’s useful to understand today’s growth phenomenon and equation compared to the earlier 90s where there was similar interest in India. If you take the time to understand the extent and velocity of the transformation of the Indian economy between these two phases, today’s India will appear even more impressive.

I can speak with some authority about the past, because I started my entrepreneurship exactly at the same time as the Indian economy first started opening up.

In the 1990s having inherited a bleak fiscal situation and an even bleaker external payments situation and with our back against the wall and with a national bankruptcy staring us in the face, Prime Minister Shri Rao and the then Finance Minister Dr Singh set aside the socialist playbook and decided to open up the economy. India, in those days, was described in a famous Economist article as an Elephant caged by its politicians.

This opening-up triggered the first phase of the Indian growth story. The growth at this stage was primarily driven by private investment – Public Capital spending was insignificant – The fiscal situation meant that the government did not have too much money to invest and the middle class consumption story remained at that point a story of potential – and whilst we had a few years of giddy excitement – this growth stalled in a few years just as investment flows slowed down, which was in turn because of political changes with a new form of coalition government – so it was really a one dimensional growth story – all on the back of private foreign capital flows.

You must remember that at this stage (just a decade or so ago), the Indian economy and business scene was dominated by just a few names like the Birlas, Tatas, Modis, Singhanias, etc that were more or less the products of a directed planned economy and license raj and a banking and financial sector that was almost completely government dominated. There was just one venture capital company operated under a government owned Development Bank. I know of this because my first meeting with them lasted about 10 minutes and I was shown the door.

India wasn’t a poor country but it was clearly caught in a trap of limited capital availability, along with a stranglehold on the access to this capital to a few, therefore limited competition in the economy and thus ensuring low growth rates - all combined with high WACC and beta, with a resultant low rate of new wealth and capital formation.

This was a model inspired by the Soviets with a bit of Indian old style crony capitalism and unique Indian bureaucracy thrown in. I can’t knock every thing about that model. In many parts of the country, the government’s role did help India create capabilities in heavy industry and some good corporate groups did emerge from this process like the Tatas etc – But in the critical aspect of capital formation and investible equity we lagged. We were literally out there begging for investments – the early investment deals in India like the big Enron Power project were clearly one sided showing and demonstrating the poor negotiating wicket India stood on. But the seeds of entrepreneurship that was going to shake and irreversibly alter India were sown in that period.

This first period of growth ended in a 3 year recession type scenario all the way till the late 90s, caused primarily by the fact that the growth model was single dimensional and private investment led – and as the investment tap dried up in the face of political uncertainities caused by the first National coalition government – so did the economy go into a long stall and then dive.

This current growth phase – which is the second growth phase - has its origins in 2003 the time when the then Prime Minister Vajpayee and Finance Minister Jaswant Singh - on the back of a right of center economic policy that included successful disinvestment of many Public sector companies, growing corporate sector performance and successful and private sector investments in IT and off shoring, airlines, telecom, highways, ports and renewed public spending focussed on infrastructure like the Highway build program, Rural roads program, ended up creating for the first time in many years a growth platform of strong fiscal position at a historic low of 4.5% and strong external reserves situation and most importantly a diversified economy which now consisted of a strong component of services sector and a consumption economy.

This was what Dr Manmohan Singh’s Government started with and has significantly built on. The growth today is far deeper and broad based – the last 5 years or so of growth have created a strong consumption economy, a strong investment-led growth story, a very vibrant services sector and most of all, this has been a mix of both private and public spending – Government as a spender and investor has been a significant player in this equation – made possible by its riches in revenues. So while the usual political risks of any democracy remain – this time the growth is so diverse and broad based that it can weather any political hailstorm and in the words of the RBI Governor “this growth is showing signs of being self-accelerating”. Services sector today accounts for a significant part of the Economy of almost 55%. Investors are making money and a recent poll by FICCI showed that 74% of all foreign companies in India are profitable. 86% of these companies rated India as a positive India destination.

I may be a bit biased but the real story of this phase of growth is the starring role of entrepreneurs in this growth. Most of the growth is being driven by Enterpreneur led companies. The real players in the economy aren’t the old names only any more. They are the new first generation entrepreneurial class, building world-class and scale - companies and ventures. 65% of the companies in the Sensex weren’t around a decade or so ago. Capital, the fuel of enterpreunership which was the preserve of a few names a decade or so ago, is available to almost anyone who pass the simple tests of idea and execution – thanks to a financial sector that has transformed in its ownership and scale!

The availability of capital and the new confidence is also allowing Indian companies to look beyond the Indian market. It is possible that some of these bets will go wrong, but the fact that we have arrived at a stage where companies are making these large cross border bets is, in itself, big news. I have another way of describing where we have reached - In the mid 90s, when we negotiated the Power investment deal with Enron , the government had to agree to a price of Rs 7.50 per unit of power and other onerous terms. Recent power deals executed with Tatas and Reliance with the same government are at less than 1Rs/unit in tenders with interest from all over the world. GDP Growth in the 90s to 2005 averaged at 6%. During the last three years at 8.8%. The last two years its 9.5% - So we have come a long way indeed.

Robyn Meredith, in her book, “The elephant and the dragon” – the rise of India and China, describes India as an elephant that takes one step forward and two steps sideways and despite that little dance, India grows at 9%. Imagine what we could do if that elephant didn’t do that little sidestep!

Just like IT , offshoring and consumer economy were the hot growth buttons so far, I believe the coming years will throw up significant opportunities in high end manufacturing and Engineering services, Media, Aviation, Education and the whole defence and homeland security space, amongst many others.

There are, of-course, areas of concern still in this story – If I have to list out the issues – the top one is that of the nature of our growth. Unfortunately the growth pattern that the country and its entrepreneurship has created has been unequal and large tracts of our country and large numbers of Indians remain destitute and live in abject deprivation with none of this growth seemingly making a difference in their lives.

This large constituency of people is impatient and increasingly so - to see the fruits of these so called reforms and political leadership are no longer able to sell them the story of wait and it will happen to you sometime in the future. In the words of our Central bank governor “Fighting inflation is bigger priority than growth because spiraling prices hammer the poor immediately whilst the benefits of economic expansion took time to trickle down to the poor”.

This is despite the fact that Government spending on programs for the poor have grown annually by almost 45% in gross terms for the last 4 years. This leads to the real issue facing India today. Its not a problem of money – It’s a problem of delivering the money and resources to the targeted. The system being used is the same old historically leaky system that former Prime Minister Rajiv Gandhi famously characterized as delivering only 15 paise for every Rupee pumped in. In this year’s budget debate in the Parliament, I and several others made this centerpoint of my discussion and its good to note that the Finance Minister and the government is responding to this big challenge of taking on the various vested interests that typically dog public spending.

The other challenges are about the basic issue of growth of institutions. For every argument in favor of contract and laws, there is an argument made against, in terms of less than stellar performance of our court and regulatory systems in terms of speed. The whole independent regulatory system and bureaucracy needs a push in terms of capacity and quality. As someone who has dealt with Regulators and bureaucrats many times over the last decade since the institution took root for the first time in India, I will admit that capacity building here has lagged the sectors that they intend to regulate. This is not unusual for growth economies. There’s a similar thing happening in the US where the regulators were lagging the financial players. Problem of regulating the economy is made more complex since Indian economy of today is more globally linked than ever before and so in that sense is vulnerable to any global movements.

Thirdly, there are some pockets of our economy that are still not exposed to competition, partly where there are private oligopolies and/or Government owned companies. A competition law has been introduced in Parliament which should help address this issue of competition in all areas of our economy - This is crucial for us to truly get to becoming a super efficient and competitive economy vis a vis our peers amongst the developed countries.

Lastly, there is the politics of India. We are proud of our democracy and free society but that also throws up divisive polity and opposition for the sake of opposition and in a coalition regime – this is a recipe for gridlock. But there is increasing awareness and maybe even a consensus around a minimum set of economic issues amongst the principle political parties. At FICCI, the Chamber of Commerce of Industry which I chair as well, we are working with Political Parties to get them to agree via manifesto a certain core set of economic principles this election season. We are working to make the Indian elephant walk a straight line and avoid either a side step or step back.

Let me end by saying that the Indian investment thesis is a compelling one – Its never been more compelling than today, far more compelling today than when I first started out. As proof of my confidence - I have very little invested outside India and almost all of my capital is at work in this market. That’s how confident I am from a long term perspective.

I hope I have laid out a clear view of Indian Economy today and where she has come from and where I believe she will go. Thank you for inviting me to speak this afternoon. I wish you a good and successful stay in India.

Thank you and Jai Hind.