After years of subdued ties following India’s nuclear tests in 1998, two large deals last year appear to have set the stage for a renewed wave of Japanese investment in India.

Japanese pharmaceutical major Daiichi Sankyo bought a 34.8% controlling stake in India’s largest pharmaceutical firm, Ranbaxy Laboratories. The deal, announced in June, valued Ranbaxy at US$8.5 billion. A few months later, Japanese telecom giant NTT DoCoMo bought a 26% stake in Tata Teleservices Ltd. (TTSL).

Japan had taken a “cautious attitude toward India,” says Rajesh Chakrabarti, assistant professor of finance at the Hyderabad-based Indian School of Business (ISB). “But now they seem to have decided that it is time to move in.”

The bilateral relationship is indeed picking up fast. Japan was the partner country at the Vibrant Gujarat Global Investors’ Summit this month. According to Japanese ambassador Hideaki Domichi, who visited Gujarat for the jamboree: “Relations between India and Japan have grown, but there is still more that we can look forward to.”

A total of 8,500 memoranda of understanding signaling US$240 billion of planned investments were signed at the summit, more than the total US$185 billion of the last three summits, according to Gujarat chief minister Narendra Modi. Japan was but one of 30 participating nations, and a breakdown of the numbers hasn’t been announced. But Japan could end up with a pivotal chunk because it is a key funder of two projects that run through the state: the Delhi-Mumbai Industrial Corridor and the Dedicated Freight Corridor.

Some observers are quick to point out that Japan, which has trailed the United States and the United Kingdom in India investments, has overpaid for foreign investments in its not-too-distant past. “In the late 1980s, Japanese firms raced after foreign real estate, and in the late 1990s they piled into technology companies,” the U.K.-based weekly newsmagazine The Economist noted in an October 2008 article. “Both binges ended badly, as companies sold their stakes at a loss and bolted for home.” The article points out, however, that things could be different this time. “Instead of trophy assets such as Rockefeller Center or Pebble Beach golf course, the targets are companies that fit strategically with their acquirers, providing new technology or access to new markets.”

However, the Ranbaxy investors have taken some large early losses. Ranbaxy shares have traded far below the Rs 737 (US$15.11) that Daiichi Sankyo paid to Ranbaxy’s promoters, the Singh family, closing last week at Rs 217.6 (US$4.46). Daiichi Sankyo said this month that it expects to take a US$3.84 billion charge to earnings to reflect the reduced value of its 64% holding in Ranbaxy. (Daiichi Sankyo acquired the rest of the stake in late summer through a statutory open offer.) Similar comparisons aren’t possible for TTSL, which is privately held.

The Big Picture

How the Japanese value their investments in India may have more to do with the big picture. The Financial Times of London said this month that “analysts have been puzzled as to why [Daiichi Sankyo] did not seek to renegotiate the purchase in light of the share [price] drop. Some have speculated that the investment forms part of a broader Japanese engagement with India and that the financial difficulties surrounding the purchase would be made up for at another level in the bilateral relationship.”

As Chakrabarti of ISB notes: “The India deals may look overvalued now, because with the current crisis everything looks overvalued. Pre-crisis, I am not sure if we can say that they were vastly overvalued. The Japanese did a lot of soul searching after their investments in the U.S. didn’t work out that well and they are unlikely to repeat that mistake.”

“India-Japan economic relations are definitely on an upward trajectory,” says Sanjana Joshi, a consultant with the Delhi-based Indian Council for Research on International Economic Relations (ICRIER). Joshi has a key role with the ICRIER-SPF (Sasakawa Peace Foundation) Japan Studies Project and wrote the book, Changing Japan: Opportunities and Challenges for India.

“Total trade between the two countries crossed US$10 billion in 2007-2008,” Joshi says, adding that foreign direct investment from Japan to India from April 2000 to July 2008 was US$2.2 billion. She also points out that Japan ranks third in foreign technology transfer approvals, trailing only the United States and Germany. A total of 871 such technology collaborations between India and Japan were approved from August 1991 to June 2008. “These figures are not very impressive when seen in terms of India’s share in Japan’s total global trade and investment,” Joshi says. “On the other hand, there has been a notable increase in Japan’s official development assistance (ODA) to India. India has been the largest recipient of Japan’s yen loans since 2003. In August 2008, Japan pledged to extend Japanese ODA loans to five projects. Given that the issue of ‘underdeveloped infrastructure’ comes up repeatedly in Japanese perspectives on the business environment in India, the recent ODA disbursements are a strong signal of growing Japanese economic focus on India.”

Joshi further notes that Japan has agreed to provide US$4.5 billion for the first phase of the Delhi-Mumbai Industrial Corridor, and that five Japanese companies already have decided to set up industrial bases along the corridor. Japan is also committed to supporting the rest of the corridor which, at an estimated cost of US$90 billion, would span six states and bring a major expansion of infrastructure and industry, Joshi says.

She points out that according to the latest survey of overseas business operations by Japanese manufacturing companies, released in November by the Japan Bank of International Cooperation, the number of Japanese companies that view India as promising has increased to a level on par with those that view China as promising. “India and Japan are also in the midst of negotiations for a comprehensive economic partnership agreement,” Joshi says.

The Big Players

The flagship Japanese investment in India is car manufacturer Maruti Suzuki India. “The company still sells one in every two cars sold in the country,” says managing director Shinzo Nakanishi. The economic slowdown has hit sales, but Nakanishi is unfazed. Maruti Suzuki, now majority-owned by its Japanese parent, will remain market leader, he predicts.

Maruti is celebrating its 25th year in India. The bigger players among other Japanese companies in India are Honda (both in a joint venture with the Hero Group and independently), Toyota, Asahi Glass, Mitsubishi, Marubeni, Panasonic and Sony. According to Japanese embassy figures, the number of Japanese companies operating in India has increased from 260 to 560 in the last two years.

“Over 80% of Japanese companies in India are profitable, and more than 90% have expansion plans,” says business weekly BusinessWorld, quoting Japan External Trade Organization chairman Yasuo Hayashi. “Japanese investment in India tripled in 2006 and doubled again in 2007.”

The 1,483-kilometer (921-mile) Dedicated Freight Corridor is sure to keep the investments flowing. Japan is helping to fund the railway project that will provide high-speed connectivity for high-axle-load wagons. The industrial corridor will be on both sides of the freight corridor; dozens of Japanese companies are expected to set up shop.

Traffic also flows in the other direction — from India to Japan. Several Indian information technology companies have started operations in Japan. Some textile majors are headed there, lured by the prospects of an attractive export market. Even the Tokyo Stock Exchange (TSE) is wooing Indian companies to raise funds and list there. Says TSE board chairman Taizo Nishimuro, who was in India recently: “Indian companies have vigorous fund-raising needs and Japanese investors have abundant financial assets. The TSE will act as a bridge between the two.”

A ‘Radical Reappraisal’

When money moves, bankers follow. Last year, in the first such deal, Mizuho Financial Group of Japan announced a tie-up with the State Bank of India. India’s UTI Asset Management Company has inked a deal with Japan’s Shinsei Bank. And Nomura, which handled the Ranbaxy deal, has acquired a significant additional presence in India through its takeover of Lehman Brothers worldwide.

Why is India becoming a hot destination for Japanese money? “A radical reappraisal of India’s economy has taken place in Japan in view of the high economic growth led by the service industry and the accompanying rapid expansion of consumption,” says Joshi of ICRIER. “They have noted the development of the IT, pharma and biotech technologies in India on the strength of a large, highly educated workforce and the fact that the proportion of India’s working population aged 15 to 64 will expand over the long term. There is also an element of not wanting to be left out as India strengthens ties with other East Asian countries, particularly Singapore, Thailand, South Korea and China.”

Japan’s interest in India is “really not very surprising,” says Chakrabarti of ISB. “If you look at the profile of investors in India over the past few years, ever since the India story caught on, Japan has not been as participative as the U.S. and the UK. The delay in looking at India could probably be related to the Japanese attitude toward foreign investments. Compared to other developed countries, Japan has shown reluctance in foreign investments, and the extent of home bias in Japan has always been much higher than that in other developed countries.”

But Chakrabarti feels that Japan may shine simply because the West is mired in the global meltdown. This is particularly true of foreign institutional investor (FII) funds. “In the short to medium run, it is possible that one may see more investments in India from Japan than from the U.S. or the UK, and this is because of the current crisis,” he says. “The FIIs need to honor their commitments in their home countries and so are rolling back from India and going for a safe portfolio. It is possible that in a few months, once things get back to normal, they may return to India.”

“In the past year and a half there has certainly been a renewed interest from Japan,” says Alok Shende, principal analyst at Ascendia Consulting. “This has happened in two phases. In the first phase, a lot of Japanese money went into the Indian stock market as part of emerging market investments. The second phase that we are seeing now is the serious money that has come in with the two big deals — Daiichi-Ranbaxy and DoCoMo-TTSL. But instead of looking at Japan as a monolith, we need to realize that the Japanese have always looked at emerging markets. We have seen Japanese investments coming to India earlier also, like in the case of automobiles. Now, with India showing high growth potential, we are going to see more of these deals. Earlier, because interest rates in Japan were low, a lot of U.S. banks borrowed from Japan and invested in India. As part of the deleverage, that is now coming down. But money has started coming to India directly. We are likely to see some significant Japanese investments.”

Regional Concerns

Regional concerns also play a role in Japan’s newfound interest in India. “There is a China-India-Japan story,” says Arvind Mahajan, executive director, advisory services, of global auditing major KPMG. “With Europe and the U.S. in recession, at least for some time, the safeguard for Asia is intra-Asia trade. In that context it makes good sense for Japan, which is under-invested from an India perspective, to diversify its portfolio and invest in India.”

“Over the past few years, this region — India and China together with Japan — has certainly experienced economic prominence,” says Chakrabarti of ISB. “China and India having risen so fast and, being so large, much of the action in the world economy is here. After the Asian crisis, Japan was seriously considering an Asian Monetary Fund. But the international community — especially outside Asia — was not particularly impressed with the idea and it did not take off.”

Joshi, of ICRIER, notes that “the idea of trilateral cooperation between India, Japan and China was first [proposed] by the then-Japanese ambassador to India, Yasukuni Enoki, in 2004. But it did not find many takers. In the context of the current global economic downturn, cooperation between these three major Asian economies will be certainly required, particularly for the effective utilization of Asian savings.” Joshi says, however, that, given the importance India and Japan attach to relations with the United States, “any proposition to form a counterbalancing axis is not likely to find favor.”

Adds Mahajan of KPMG: “Japanese investments are not a knee-jerk reaction. They take a long time to consider and think through. Over the past 10 years, the Japanese market has grown very slowly, so they are certainly looking at newer markets. In the past, they have made significant investments in China; now they are looking at India.”

Joshi uses a broad brush to paint her view of the future: “The road ahead for India-Japan relations is economic and this is the arena in which India should continue to direct its energies. This will not be easy. But enhanced economic cooperation between the two countries will develop interdependencies that will be harder to ignore for Japan. There are three reasons for proposing this: First, Japan continues to be firmly committed to the alliance with the U.S. as the primary vehicle to advance its security in the international arena; second, Japan is no longer complacent about the economic rise of China; and, third, there may be some slowdowns, but the Indian economic growth story is now irreversible.”