Dateline: Bangalore, Silicon Valley of the sub-continent

DRIVE 10 miles out of Bangalore on the road to Madras and provided you survive the stampede of bicycles, scooters, belching trucks, motorised rickshaws and the not-so-occasional bullock that constantly ply this four- lane highway, then you will arrive at Electronic City.

Incongruous as it may seem for a place that is still connected to a mains water supply only on alternate days of the week, Bangalore has become the software capital of India.

And how the area revels in its reputation as the Silicon Valley of the sub-Continent. This year, India's exports of software are expected to reach $2.7bn (pounds 1.7bn). Of that, approaching a third will come from Bangalore. And of Bangalore's share about a third will be generated by the 80-odd companies based in Electronic City.

The shanty dwellings and street beggars - constant reminders of the abject poverty in which so much of India still lives - mean that, however much it tries, Bangalore will never become an exact replica of Silicon Valley. But amid the squalor there is more than enough evidence of the wealth and the conspicuous consumption that the computer revolution has brought.

The local airport sports a brand spanking new terminal, the best hotel in town charges $180 (pounds 112) a night, and Oracle, one of the many US software firms drawn to the region, has discovered that land is more expensive in downtown Bangalore than in its home base of Colorado Springs.

A glass of Kingfisher beer in one of Bangalore's 200 pubs will set you back 90 rupees (pounds 1.30) - the equivalent of a day's wages to many - while the shops along Mahatma Gandhi Road are bursting with designer label goods to tempt its affluent army of software engineers.

In the space of a decade the Bangalore phenomenon has created an estimated 500 dollar millionaires through the stock option programmes that the local software companies have used to attract senior executives.

Even the humblest software engineer in Bangalore draws a salary that many Indians could only dream of. A graduate with two years' experience will typically be earning 20,000 to 24,000 rupees a month (pounds 285 to pounds 340), some 10 times the average income.

But the success of the sector has also brought familiar problems. The population of Bangalore has exploded from 1.5 million to five million people in six years and, not surprisingly, the infrastructure is creaking at the seams. Everywhere you look there is a mangle of half-finished apartments.

Since the software industry employs only 40,000 in Bangalore it is responsible directly for only a fraction of this population growth. But software has put Bangalore on the map. Where the likes of Siemens, Oracle and Microsoft have led, others follow. Every inward investor into India, whatever their business,makes a beeline for Bangalore. In turn, the rising affluence of the city has acted like a magnet for the whole region of Karnataka, fuelling mass rural migration.

The Indian government seems happy to live with such problems of success. Its National Information Technology Taskforce has set some ambitious goals. The Indian IT sector employs some 400,000 in total, of whom about 230,000 work in software. But the target is to create a further 500,000 jobs over the next five years and grow the value of software exports to $50bn in the next 10 years.

So why India? And, more specifically, why Bangalore? Dewang Mehta, president of India's National Association of Software and Service Companies, says mischievously that one of the explanations for the growth of the Indian software industry has nothing to do with cheap labour or the plentiful supply of computer-literate graduates. "The only reason that a lot of Indian banks and financial institutions installed PCs in their offices was so that they had an excuse to fit air-conditioning at the same time."

But it is no accident that India exports twice the amount of software that is sold in the domestic market or that most of the software companies in Bangalore are reliant on overseas customers, many entirely so. Companies which export 100 per cent of their output do not have to pay tax for 10 years. This, coupled with wage rates which are perhaps a sixth of those in the US or UK, has enabled India to become an important offshore centre.

Much of the software written in India is not proprietary and much of the income comes from maintenance work, upgrading the software installed in Western companies while the customer sleeps. The software which enables London Electricity to operate the capital's power grid comes from India. Many of the millennium bug computer upgrades for UK-based banks and financial service companies are being carried out in India.

The structural reforms ushered in during the reign of Rajiv Gandhi and his "computer boys" as Gandhi's inner-circle became known, also helped the software industry. Whereas it used to take nine months to import a computer, the waiting time was cut to weeks. The government also made it possible to hire IT consultants outside India and, crucially, abolished the office of Controller of Capital Issues (a bureaucrat who in effect decided the price at which companies were permitted to issue shares) making equity funding of software companies a viable option.

Mr Mehta identifies another trend. "The brain drain which saw a lot of Indian software engineers migrate to the US has begun to reverse."

Why Bangalore is a more difficult question to answer. Some put it down to the Californian-style climate and stable politics of south India. Others to the proliferation of pubs where the computer nerds can hang out. The seminal event is generally held to have been the arrival of Texas Instruments in Bangalore in 1986. But that is not the whole story. Five years before TI arrived, a group of seven software professionals got together and with $300 of capital formed a company pledged to the ethical creation of wealth. Today that company, Infosys, is valued at $1.9bn, employs 3,600 people and has just become the first Indian company to list on Nasdaq, the New York stock exchange which is home to the world's hi-tech companies.

Although the business was founded on the lofty principles of "fairness, honesty, transparency and courtesy", its employees have been incentivised by something baser. After the business was floated on the Indian stock market in 1992, staff were given stock options at 100 rupees a share. Today, those shares have risen in value 300-fold and some 1,345 eligible employees are sitting on stock worth $52m - an average profit of $39,000 each and considerably more in some cases. Staff are also offered zero per cent mortgages and loans to do everything from buy a car to getting married.

The company, India's sixth biggest software exporter, is still run in the same ethical, paternalistic manner. Its chairman and co-founder, Narayana Murthy, begins his staff memos "Dear Folks", all employees are known as Infoscions (and their children as "Petit Info- scions), lunch in the subsidised canteen costs nine rupees (13p) and every employee receives a birthday present from the company (this year it was a backpack).

But Infosys is facing a challenge on the employee-relations front. The last stock options under the old programme were issued in 1998 and from the end of this month the first options to be granted in 1994 become exercisable. Infosys is working on a new options package - the Nasdaq listing was driven largely by the desire to give its US employees stock options. But any new options will have to be issued at the market price. Mr Murthy recognises the challenge. "We will have to devise new forms of incentives, empower people more and make their work more flexible and interesting," he says. "We want to maintain the philosophy of `emotional ownership'."

Infosys, along with the rest of the Bangalore software community, has its work cut out on other fronts. India needs to maintain its cost advantage over other countries and demonstrate that it is at the cutting edge of software development. Ranjan Chak, Oracle's executive director for India, insists that the calibre of its staff is now as important as the cost advantage, which he warns is being eroded through high capital and infrastructure charges - international telephone charges are $2.50 a minute, for instance. "My reckoning is that although staff costs are only perhaps an eighth of those in the US, the overall costs are nearer 30 per cent. If that figure rises above 50 per cent then some software companies will ask whether it is worth being based in India. There might still be a sale going on but would you want to drive 10,000 miles to get to it?"

Within India, Bangalore is facing increased competition from Hyderabad and Bombay, which is still in absolute terms the biggest software location in India. Externally, the software firms are competing more for projects with offshore centres such as Ireland and Israel. Mr Murthy says Infosys is now considering setting up centres in low-cost economies, including Mexico, Ireland, China and the Philippines.

But perhaps the biggest obstacle to the expansion of India's software industry and at the same time the biggest growth opportunity lies in its own backyard. Only 2 per cent of Indian homes have a telephone and even fewer a PC. The government has set a target of increasing that to 15 homes in every 100 within 10 years. Sudheendra Kalkarni, director of communications and research in the Prime Minister's Office says: "The computer industry here has grown in spite of rather than because of government policy. We now need to bring together the public and private sectors to encourage computer literacy on a mass scale, not something which is confined to an elite class."

Given the extent of basic illiteracy which still exists among India's 900 million people and its miserable experience so far in liberalising its telecoms industry, nobody in Bangalore is holding their breath.