THE
INDIAN
TIFFIN
INDIAN
TIFFIN
EDITION LIX
Amidst the global economic downturn precipitated by ongoing geopolitical disturbances in Europe and the Middle East, India continues to retain the title of the fastest-growing economy among the larger economies in the world. However, for once, the stress lines are showing in the Indian economy.
The Gross Domestic Product (GDP), the most closely watched economic indicator, slumped to 5.4% for the September 2024 quarter, ostensibly dragged down by weak manufacturing and tepid demand amid high inflation, exacerbated by elevated interest rates. The promise of an acceleration in momentum in the second half (October ’24 – March ‘25) of the financial year is based on the likely improvement in rural demand and a pickup in the Government capex. The forecast for the year now stands at 6.6% to 6.8%; the growth projections are lower than the 7% projection that India’s central bank, the Reserve Bank of India (RBI), continues to maintain. While pressure is being felt on the key vitals, this is hopefully a temporary blip rather than the beginning of a downward trend.
Mirroring the declining GDP trend, the outflow of foreign exchange, led by the unwinding of foreign portfolio investment (FPI) in Indian stocks and the unrelenting dollar surge after the US presidential polls, has dented India’s storied foreign exchange reserve. By November end, forex reserves shrank to a four-month low of USD 658bn for seven consecutive weeks, with a cumulative contraction of USD 47bn.
While India can be proud of its ‘talent-surplus nation’ status, it needs to create approximately 10 million jobs annually between 2024-25 and 2029-30. In comparison, an average of 8.5 million jobs were generated each year from 1999-00 to 2022-23. In the Union Budget announced in the first week of August this year, Finance Minister Nirmala Sitharaman announced the Prime Minister Internship Scheme, which aims to provide internship opportunities to 10 million youth in the country. The Scheme was launched in October and aims to connect a large workforce with the most prominent Indian businesses. At last count, the leading companies have listed over 125,000 internship opportunities in the dedicated portal for the scheme set up by the Ministry of Corporate Affairs. The Scheme will benefit 3 million youth in the first two years and another 7 million in the next three years.
Complementing the goal of job creation, India’s expectations from the manufacturing sector remain high, as it currently contributes only 17% to the GDP. To reach the coveted goal of becoming a developed society by 2047 (the centenary year of India’s independence), this sector must grow to nearly 16 times its current size. Additionally, India must achieve self-reliance in 80% of its strategic sub-sectors while also expanding the global manufacturing share to 5% from the current 1%.
In her Budget speech, the Finance Minister emphasised that the key reason for underperformance in manufacturing is the inverted duty structure that increases the domestic cost of production. Another critical step that needs to be taken is to indigenise the production of certain imported materials. The increased input costs faced by Indian manufacturers due to expensive imports leave them hard-pressed to compete effectively with cheap imported finished products. To unlock India’s manufacturing sector’s full potential, manufacturing must expand much faster, with systematic tariff reforms keeping pace!
India is now the third-most improving country in business environment. This is marked by strides in the foreign direct investment policy, foreign trade, exchange controls, and the tax regime. However, much more needs to be done. For example, it still takes an immense amount of time to set up a manufacturing plant. Ideally, the country needs to move into a plug-and-play mode.
On the brighter side, one of the significant policy successes the manufacturing sector is witnessing is that of Production Linked Incentive (PLI) schemes introduced in 2020. The smartphone PLI scheme has become a revenue bonanza for the Government, generating 19 times the value of its incentive disbursements in the last four years. The industry contributed USD 13bn to the Government exchequer and produced goods worth USD 150bn between FY21 and FY24, during which the Government disbursed USD0.70bn in incentives.
As winter has set in, India will need to work hard to clear the smog screen (also witnessed in much of North of India at this time of the year) of slowing growth and regain momentum. However, the biggest blessings that India has delivered in the past 10+ years are political stability and a progressive policy framework, that have shaped the Indian economy.
M&A Tax and Regulatory
Deal Advisory Services
Between 01 October 2024 and 30 November 2024, around 165 M&A deals were announced, of which 78 deals were closed. The aggregate value of deals announced was USD 7,413.18mn; dominated by 125 domestic deals (USD 5,517.13mn) and 40 cross-border deals (USD 1,896.05mn).
In terms of sectors (considering only closed deals), Consumer Discretionary sector saw deals worth USD 671.10mn, followed by Industrials sector with deals worth USD 150.51mn and Materials sector with deals worth USD 132.10mn.
When determining the worth of a company, the valuation process analyses financial performance and market conditions like supply-demand scenario, competition landscape, economic conditions, and prevailing regulations, considering both qualitative and quantitative aspects. This helps investors and stakeholders make an informed decision.
The valuer needs to assess the systematic and unsystematic risks for the subject company to be valued. Systematic risk refers to the risk inherent to the entire market, reflecting the impact of economic, geopolitical, and financial factors, also known as undiversifiable risk. Unsystematic risk is the risk that is unique to a specific company or industry, and can be described as the uncertainty inherent in a company also known as nonsystematic risk, specific risk, diversifiable risk, or residual risk.
Today, the world is facing systematic risk i.e. geopolitical uncertainty, significantly impacting the amount and timing of cash flows. The risk could be adjusted either in the discounting factor or in the cash flows. However, incorporating the risk factor into discount is often subject to exercise of professional judgement and experience of the valuer.
It is difficult to forecast, to factor all these uncertainties into a single set of cash flows and provide a single estimate of value. Hence, to appropriately factor these uncertainties in the valuation process, the valuer relies on sensitivity analysis, scenario analysis, and probability distributions (weighting scenarios) to assess different potential outcomes for change in key input variables.
From January 2025, the International Valuation Standards Council (IVSC) requires valuers globally to integrate Environmental, Social, and Governance (ESG), an unsystematic risk, in the valuation approach. Under the market approach, the valuer needs to assess the ESG practices followed by comparable companies/ industry and performance of the subject company to be valued for the same criteria.
The valuers are then required to calibrate the ESG observations from comparable companies with the subject company, which could be by way of adjusting the multiple adopted for the valuation. However, currently, the valuer faces challenges pertaining to availability of ESG data and standardised disclosures by organisations. Hence, no consistent rating measurement for ESG is available to the valuer. There is an element of judgement for assigning scores to different ESG factors and different valuers may assign different weights to each factor.
In India, ESG rating is at a very nascent stage, although the Securities and Exchange Board of India (SEBI) has mandated the top 1,000 listed companies by market capitalisation to make ESG disclosures as per the Business Responsibility and Sustainability Reporting (BRSR) on a mandatory basis from FY 2022-23. Further, it is planning to include mandatory ESG metrics disclosure for only those value chain partners who individually comprise 2% or more of a company’s purchase or sales by value.
Morgan Stanley Capital International (MSCI) and Sustainalytics also provide ESG rating for Indian companies, measuring businesses against various ESG criteria to promote environmental accountability and encourage the development of sustainable business practices and technologies. Big credit rating agencies such as Moody’s, Fitch, Standard & Poor’s, Bloomberg, etc. have incorporated ESG into their credit rating methodologies, signifying its importance in valuations. However, at present these parameters would be available primarily for large or listed companies.
Under the income approach, there are two ways to factor ESG impact - either in the cash flow or in the form of additional risk in the discounting factor. While assessing the ESG factors affecting operations and future cash flows, it is recommended to undertake sensitivity analysis to assess the impact of each ESG factor on the valuation of the company.
Another way to factor ESG in valuation is by adding ESG risk premium in the discount rate in addition to size, volatility of revenue and earnings of the company. The IVSC has emphasised on prevention of double-counting of certain ESG factors that are implicitly incorporated into the valuation. For example, criteria cited as rationale for incorporation of size premium in discount rate derivation overlaps with what many would consider ‘ESG’ factors (e.g. smaller, private companies are typically associated with relatively weaker governance, concentrated shareholding, non-existence of independent oversight from board of directors etc., which can be viewed as ESG factors).
The regulatory framework in India requires independent valuation reports for transactions like Mergers & Acquisitions (M&As), Infrastructure Investment Trusts (InviTs), Real Estate Investment Trusts, minimum pricing for open offer, portfolio valuation for InviTs and Alternate Investment Funds (AIFs), private companies for issue and transfer of shares, etc. In the current regulatory regime, a transaction may need valuation under Companies Act 2013, Foreign Exchange Management Act (FEMA), Income Tax Act, 1961 such as fresh issue of securities to non-resident investors. The independent valuation reports are scrutinised by the Regulators and the valuers need to provide explanations/ clarifications. The mandatory ESG assessment in valuation may add complexities and increase responsibilities of the valuer, given the challenges around the availability of standardised ESG data.
A famous quote by Peter Bernstein goes: “Volatility is often a symptom of risk but is not a risk in and of itself. Volatility obscures the future but does not necessarily determine the future.” Valuations are tricky; they rely as much on the valuer as the source data. The same set of numbers and past performance may result in vastly different valuations between different valuers. After all, the true determinant of value is the buyer.
In an increasingly complex world, valuation inputs, determined by the valuer, have transcended quantitative elements, with diverse factors that make translation of numbers as important as the numbers themselves. Regulations around factors such as Environmental, Social and Governance (ESG), corporate governance, compliance discipline, etc. have become traditional. In emerging areas - the domain of startups, the lack of regulation, which would lend organisations an edge, has now become a significant detriment to valuation. One need only examine the myriad FinTech companies that have played in the interstices between regulated and unregulated services suffering immense value erosion the moment the regulator wakes up.
Geopolitics and online dynamics
Geopolitics is also becoming a significant factor as globalisation comes under threat from increasing protectionist tendencies around the world. The year 2024 saw 74 global elections, with more than half of the global population’s leaders being elected. This election supercycle has massively increased risk as many billions of dollars under incumbent programmes have come under threat. Asset allocators had to study the probabilities of success and policy planks of all candidates to assess capital allocation.
Market movements caused by X (erstwhile Twitter) have become the norm, not the exception. The M&A of Twitter by Elon Musk began as a joke on the platform and culminated in its sale. CEOs’ utterances on social media now make or break deals more than boardroom discussions. The world has grown ever closer online as geographies try to decouple and grow apart.
The rise of India in global markets
2024 saw India undertake more tech IPOs than the US - a true inflection point in the startup ecosystem of the country. Many assets that were years away from listing due to high burn models shed expenses and became lean before listing. Listed market comparables for unlisted assets have seen the greatest change in the last four years, with many companies exceeding their private market valuations in a few quarters.
The trend of ‘Ghar Wapsi’ (returning home) among startups headquartered in the US and Singapore is at a lifetime high as many crave the Indian investor’s attention for their sector. This is also attributable to the US markets becoming more demanding of their listings, causing many to rethink their IPO plans. The dearth of listed software product companies is a wide whitespace in the Indian bourses, which should soon be filled in the next 18-24 months.
Even Foreign Portfolio Investment outflows due to profit booking and the growing US market were defanged by mutual funds, which boast an impressive USD 4bn of monthly SIP flows. USD 10bn pulled out of the market in the first half of November saw a 6% decline, compared to around 25-30% in March 2020 and during the Global Financial Crisis.
The role of regulation
Regulatory streamlining is coming to the forefront, as the Department of Government Efficiency (DOGE) in the US will set the template for government rationalisations around the world. Although India reduced various regulations over time, it added many more in the interim. Domestic streamlining is necessary for progressing towards the envisioned ‘ease of doing business’ within the country.
The future of valuation
The future of valuation will move from a periodic function to a continuous one. The factors stated here change every minute, let alone monthly or quarterly. This demands a change in the valuation approach and requires the valuers to adapt or be replaced by AI agents who can manage it better. Volatility and complexities are now features of the modern business landscape, not a bug.
As the valuation and M&A landscape navigates global economic and geopolitical uncertainties, the ripple effects can be witnessed in the Indian market. However, foreign strategic interest in India is intact as reflected in the healthy FDI inflows recorded for the April-September period.
In this video, Anu Aiyengar, Global Head of Advisory & M&A, JP Morgan, sits with NDTV Profit’s Tamanna Inamdar to talk about the economic and M&A trends prevalent in the Indian market. She delves into the market outlook and encouraging inbound investments. She also shares important insights on the fundamentals of checking valuation risks, highlighting how geopolitical, electoral and performance factors impact contemporary valuations.
Indian Tiffin’s Editorial team also refers BDO in India and its associates, partners, employees, advisors and assigns
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