Intellectual Thoughts by Sanjay Panda: January 2007

Finance- Economy vs Real exchange rate

The Chinese experience shows the costs of under-valuation are a lot less than the benefits in terms of jobs. In recent years, as China’s exports have grown rapidly, and the country is registering increasingly larger surpluses on the current account (an estimated $140 billion this year), it has faced a lot of pressure for a “more flexible” exchange rate regime. Instead of openly calling for an upvaluation of the currency, the politically correct euphemism is to use the term “more flexible exchange rate”.
After holding on to a steady yuan-dollar exchange rate for more than a decade, China has engineered a modest appreciation (5.4 per cent) over the last year and a half. China’s exchange rate policy is clearly rooted in the need to create manufacturing employment. China needs to create at least 25 million non-agricultural jobs a year, considering the number of new entrants in the job market, as also the vast immigration from rural to urban areas. Most of these would have to be in the manufacturing industry, and its global competitiveness is, therefore, of crucial importance. Hence, the undervalued yuan. Indeed, for many years, the yuan’s fall in real effective terms was even more than in nominal effective terms, because China has had lower inflation than the US for nine years! This is remarkable at a time of surpluses on current account and huge capital inflows (in theory, both generate inflation pressures), resulting into reserves accumulation of a trillion dollars. One advantage China has in sterilising the excess money supply is that domestic interest rates are lower than the dollar or euro interest rates: this means that there are financial gains to the central bank in sterilising the growth in money supply. China is not only keeping domestic inflation low but, as a low-cost manufacturer, is a major contributor to keeping global inflation low despite the very high commodity prices of recent years.
But there is also a major risk in the reserve accumulation. As argued earlier also earlier, given the huge deficit on current account in the US, the possibility of a sharp fall of the dollar can hardly be ruled out. Indeed, diversification of Chinese reserves into other currencies (as Russia, Switzerland, Italy and the UAE are already doing) could itself trigger such a fall: it is Chinese investments in the US treasury market that keep the dollar from falling and the yield curve flat to negative. On the other hand, should the yuan appreciate against the dollar, there would be huge paper losses for the central bank as dollar assets become worth less in yuan terms. Assuming that, currently, 70 per cent of the reserves are in dollar assets, even a 5 per cent yuan appreciation against the dollar would lead to a translation loss of something like 250 billion yuan! Clearly, the authorities are treading on delicate ground trying to balance the needs of the real economy with the possibility of large paper/financial losses if and when the yuan is forced to appreciate in dollar terms.
Arguably, the root cause of the large and increasing surpluses China is registering on the current account, is the savings-investment imbalance. Despite huge investments, the savings rate is so high, above 50 per cent of GDP, that the excess savings result into a surplus on the current account. Interestingly, the household sector savings in China as a percentage of GDP are actually less than in India — this, despite the fact that personal consumption in China per capita is only about 70 per cent higher than in India, while per capita incomes are 2.5 times as large. The real cause of excess savings is the corporate sector: the corporate sector’s savings amount to as much as 30 per cent of GDP, with retained earnings alone contributing two-thirds of that. One reason, it seems, is that Chinese companies do not distribute dividends. At the macro level, one way of reducing the excess savings and the politically sensitive surplus on current account, is to get the public sector companies to distribute dividends, and spend the money on needed social services like health care, higher old age pensions, and so on. Sooner or later, we should see some movement in this direction even as the yuan gradually appreciates. Incidentally, the non-deliverable forwards market is factoring a yuan rise of just about 3 per cent over the next 12 months.
One point on which we need to learn from China is the focus on the real, job-creating economy rather than philosophical arguments about market versus managed exchange rate, the cost of sterilisation, and so on. On the second issue, what we often seem to overlook is that the cost to the real economy of an appreciating currency (jobs uncreated or lost, business profitability, forgone GDP growth, and so on) can be far, far bigger than the financial cost of sterilisation. To be sure, these costs are not as easy to calculate as the cost of sterilisation — but are, nevertheless, as concrete and perhaps even more important.

The research Gap

India’s R&D appears to be going somewhere finally. R&D expenditure, in absolute terms, is up three-fold over the last decade. While 70 per cent of R&D in India is still government-funded, and 60 per cent of this goes towards defence—with very few commercial spin-offs—this picture is changing as private investment in R&D is now rising faster than government spending. Apart from the pharmaceuticals sector’s R&D outlay, which has risen rapidly for understandable reasons, India is now host to 150 R&D centres set up by international companies—or so, says a report from Demos, one of the UK’s influential think tanks. More than 100 of these were opened in the last four years. Another figure, to buttress the same claim, is that foreign firms invested over a billion dollars in Indian R&D centres between 1998 and 2003.

The question then is, why does India continue to lag behind other countries in the World Bank’s Knowledge Index? Worse, why has it even slipped vis-à-vis itself? On the World Bank’s latest Knowledge Economy Index, which takes into account not just R&D but the entire ecosystem that allows R&D efforts to blossom into something meaningful, India scored 2.8 in 1995 and a marginally lower 2.71 in the most recent score card.
China, by way of comparison, has raised its score from 2.83 in 1995 to 4.26 in the most recent score card, and Brazil from 4.73 to 5.1, while Russia has remained more or less at the same score of 5.9. India’s numbers are slightly higher if you do not weight the index by population, but then so are those of other countries and the net impact is the same—India has lost ground. The standard argument given for this has been the low level of R&D spending in the country, the small number of papers by Indians that get cited in respected scientific journals (between 1997 and 2001, India had 77,201 citations, versus China’s 115,339), the low levels of literacy and the limited number of college graduates. If weight them by GDP per capita, India tops the global charts with 32 scientific publications in the Scientific Citation Index; China is at 23 and the US is only seven. All that may well be true, but many will question this as a basis for judgment. In any case, it does not allow the country to get away from the fact that India’s R&D output lags behind that of competitors like China. Its 229 universities are manifestly unequal to the task of rapidly ramping up the number of PhDs, critical for any R&D expansion programme. The issue here is not just R&D spending, which is important, but also the environment for such activity. Universities continue to be tightly controlled by the government and are mired in red tape and bureaucratic procedures—not to mention virtually frozen pay scales at a time when salaries in the private sector are rising rapidly. And when it comes to industries such as pharmaceuticals, which drive R&D to a large extent, the government’s policy has been to control prices and profits, thus taking away the ability to spend on research. In short, while foreign companies may set up research centres in India to make use of the country’s low-cost technical manpower, that should not be taken to mean that things are going well on the research front. A great deal of action is required on multiple fronts before that claim can be made.


Out-licensing, Is it growth or survival strategy

Indian majors are exploring out-licensing deals for lower risks and bigger profits. The strategy of the fittest is finally coming into play in the Indian pharma market. Some of the strongest pharma companies are flexing their muscles across Europe and announcing their arrival on the global platform in the process.

As in-licensing deals become a norm, out-licensing deals are the latest to catch the fancy of Indian pharma majors. Out-licensing deals are deals wherein an Indian pharma company licences a foreign pharma company for the development of a particular molecule into a drug. Dr Reddy’s Laboratories, for instance, entered into an agreement with ClinTec International in 2006 for the development of an anti-cancer compound. Having completed the first phase of clinical trials for the compound, Dr Reddy’s has allowed ClinTec to carry out phase II and III of the trials. Once the product is commercialised, Dr Reddy’s will receive royalty on sales by ClinTec International in its designated territories and ClinTec International will receive royalty on sales by Dr Reddy’s in the US. The trend of out-licensing deals has recently picked up in India because Indians have now started working on basic research and discovery of molecules. If the international companies see value in the molecule, they pick it up. But what is really taking Indian companies to foreign shores is the unavailability of expertise or resources to take a molecule through its various stages in the drug development cycle. Such deals usually spell a win-win situation for an Indian company, which is investing only half the capital, bringing down cost and risk factors. The royalty acquired from the deal is often much more than the investment.
By out-licensing, the new innovator, with a high potential molecule in early stages of development, has an opportunity to take it through the expensive stages of development and a share in the risk and reward. Glenmark Pharma was an early bird to join the out-licensing bandwagon. In 2004, the company entered into a collaboration agreement with Forest Laboratories for the development, registration and commercialisation of a compound for North America. Experts, however, don’t see the trend trickling down to smaller pharma companies in the country any time soon. “Even though this would be an ideal route for any new entrant in the field. Out-licensing requires a lot of investment, and for a small company, this might not be possible. Breaking even also takes a long time, and smaller companies may not have the staying power to wait that long. Big and small pharma companies can, however, look forward to more and more in-licensing deals, raking in more investment than ever before. And the benefits are passed on to the consumer, who get new products at lower costs. In-licensing in the post-patents regime has enabled us to have a stronger product pipeline and provided Indian physicians and patients with novel products meeting their unmet needs.
But despite the piling up of in-licensing deals, the involvement of the Indian pharma in the deal is still restricted only to the packaging and marketing of the drug and not its manufacture. Foreign companies don’t want to out-licence to India for manufacture because the market here is still very small, thus increasing the risk factor.


Tamiflu Vs Bird Flu, who cld be the major threat

The cure may, at times, be worse than the disease. That would now seem to be the case with tamiflu, the drug used more than any other for treating and preventing the dreaded bird flu — caused by the pathogenic H5N1 virus. Going by the findings of a study by researchers of the Oxford-based Centre for Ecology and Hydrology, the consequences of large-scale consumption of tamiflu can be scarier than even those of a bird flu outbreak. The main fear is that the many tonnes of this drug that are in stock in various countries for combating a possible pandemic would, on consumption, play havoc with wildlife besides increasing human health hazards. Specifically, the scientists have warned that the bulk of this drug would get excreted through urine and flushed down sewers into natural water bodies and rivers, devastating aquatic bio-life. The worst hit would most likely be micro-organisms, including all manner of useful bacteria, present in these waters. This is because oseltamivir carboxylate, the active anti-viral ingredient of tamiflu that also kills bacteria, is resistant to bio-degradation and cannot be eliminated through normal sewer water treatment. Its toxicity can, therefore, persist in water bodies for weeks, even if only treated water is released in them. As a result, fish, birds and other creatures that dwell in these tanks and rivers or feed on them could face ruin. Man, too, needs certain kinds of bacteria in the gut for the digestion of food. All these systems could go haywire if the need should arise to use tamiflu on a mass scale. As if this scenario were not alarming enough, the scientists have also pointed out that widespread consumption of this drug can create conditions in which the H5N1 virus, which normally infects only birds and some animals and does not get transmitted to humans, can mutate into forms capable of being passed on to humans. Another likely fall-out could be the development of immunity against oseltamivir carboxylate in H5N1 virus itself, rendering tamiflu ineffective. This would further heighten the risk of a flu pandemic. And, what is worse, should this happen, mankind would find itself fighting a losing battle till an alternative vaccine targeted specifically at the new form of virus is developed, which might take months. Of course, it can be argued that these dreadful implications are hypothetical even though they emanate from a scientific study carried out on rivers in the US and UK. In any case, the possible hazards are far too serious and indeed unnerving to be disregarded. The bird flu has not yet been eradicated and its incidence continues to be reported from the south-east Asian region. What needs to be remembered is that the flu outbreak of 1918, albeit of a different virus strain, had killed nearly 50 million people. Equally essential to bear in mind is the alarming decline in the population of vultures, which are nature’s scavengers, owing to the indiscriminate use of diclofenac, an anti-inflammatory drug, for the treatment of animals. Its residual toxicity in animal carcasses is killing the vultures who feed on them. It is, therefore, imperative to revisit the strategies devised to cope with the bird flu menace and to look for safer drugs. An anti-influenza vaccine developed at the Bhopal-based high security laboratory of the Indian Council of Agricultural Research is believed to be a less harmful alternative to tamiflu. If that is indeed the case, enough stocks of this vaccine, as also adequate production capacity, need to be built up. Simultaneously, research needs to be initiated to evolve suitable biological and chemical treatments for sewer water to minimise its residual toxicity before the discharge is put out into natural water bodies.