India, Still a Golden BRIC?   Leave a comment


Investors have been pinning their hopes on the world’s emergent economies to help drive global growth. A recent and marked slowdown inChina has generated a great deal of concern among investors, and only Beijing’s swift response was able to assuage some of that worry. But others among the BRICs (Brazil,Russia,India and China) are also in economic peril, and you can now add India to the growing list of developing economies which are recording sharp slowdowns in growth. That news has caused investors to question whether or not India could still be considered a growth market.

In fact, even as a bull on India one cannot ignore the data itself which is far from encouraging; statistics show that first quarter growth in India expanded at 5.3% on an annualized basis, well off the 9.2% growth over the same period in 2011. Historically, that is the slowest rate of expansion in nearly ten years, slower even than after the 2008 financial crisis when growth decelerated to 5.8% annualized.

Economists say that the blame is in large part due to the country’s political paralysis and say that unless changes are made soon, it could result in a far larger crisis. According to one member of the Indian Economic Advisory Council which advises the Prime Minister, Manmohan Singh, the GDP data should trigger alarms within the government’s leadership. One ex-IMF economist expressed a similar sentiment, and worries that if the data doesn’t merit a sharp and swift policy response, there’s likely little that will.

The Reserve Bank of India (RBI) finds itself in a Catch-22 position, with low growth rates on the one hand and surging inflation on the other. The RBI had lowered benchmark rates by 50 basis points in April, only to leave it unchanged at 8% in May. The accelerating inflation and a greatly depreciated Indian Rupee make rates cuts difficult if not almost impossible. Indeed,India’s central bank resisted the pressure and last month again left that 8% interest rate unchanged, citing rising inflation as India’s key constraint.

India-timizzer

To illustrate just how severe the inflation problem is data showed that India’s Wholesale Price Index climbed to 7.55% in May on an annualized basis, up from April’s 7.23% and food and fuel prices surged 10.74% and 11.53%, respectively. The RBI said that they believe that a rate cut at this point would only worsen inflationary pressures. One JP Morgan economist says that even if the RBI had bowed to pressure, the expected 25 basis points rate cut would likely have been insufficient to stimulate demand.

I must admit, as a die-hard believer in the potential of India, I find myself on the defensive more often than not when debating India’s future with my colleagues. Nevertheless, I continue to see a huge potential in India, because unlike places such as China or Brazil, growth in India paints a much more sustainable picture.

To be sure, China has done an amazing job and has been able to develop its infrastructure while establishing itself as a modern economy, and has climbed all the way up to become the second largest economy in the world. Brazil and Russia, the other two BRICs, have generated tremendous growth, as well. But there is a big cloud of uncertainty weighing on the BRICs that can make long term investment far more risky; all rely on pillars for growth which will probably break at some time in the future. China leverages its low cost work force and its centralized undemocratic political decision making, while Russia and Brazil count on natural resources, even as they neglect nearly everything else.

It is in this context that India shines, as it has been able to establish itself as one of the world’s largest hubs for the knowledge industry. India’s rise is mainly attributed to its dominance in the hi-tech industry; from programmers to engineers to mathematicians India has been able to establish a class of hi-tech workers that are unparalleled and unavailable in other emerging economies. In fact, other BRICs are facing a brick wall that India has been able to avoid.

For example, Chinese policy makers are making an enormous effort to gradually diversify into internal consumption, which is the only way to maintain a growing middle class. But it is practically impossible to generate a growing middle class counting on only cheap manufacturing because once average wages rise, the manufacturing sector becomes less competitive and growth slows. Due to this dynamic, China has been attempting to diversify into the hi-tech industry, a move that will take more than a decade to establish. The hi-tech industry requires a long buildup of knowledge and experience, and it in this area that India has nearly leveled the playing field with advanced knowledge economies such as the U.S., Israel, Sweden and Australia.

India, although growing more moderately, has essentially already created a middle class that has the same qualifications as its peers in the west, thus conquering the most elusive challenge that most of the other BRICs have yet to pass.

It is true that India’s growth rate has fallen off rather sharply; it is equally true that India’s growth has lagged that of China; however the comparison to China is not entirely accurate. One could say that India moves more like a giant elephant, lumbering ahead slowly but confidently; therefore, a comparison to western economies is much more appropriate when it comes to growth and stock performance.

For example, when comparing the performance of India to the world’s largest economy, the U.S., it becomes clear that India is catching up with western economies. While the U.S. grew year-over-year in the first quarter at a pace of only 1.9%, India grew at a pace of 5.3% over the same period.

And while most investors were disappointed with India’s growth consider that it was still more than twice that of the U.S., even in spite ofIndia’s high inflation, bad infrastructure, and overall paralyzed economic policy.

india-money

Moreover, most investors argue that any returns in investments inIndiahave been diminished by the falling Indian Rupee, but a quick check on the performance ofIndia’s major stock exchange, the Nifty, in Dollar terms paints an entirely different picture. The Nifty lost around 5% in real Dollar terms over the last five years; comparatively, the S&P500 lost 11.78% in Dollar terms and the German DAX lost more than 25% in real Dollar terms, even the Shanghai index fell around 15% in Dollar terms – and this is just from investing in indices. The results are even more interesting when comparing outsourcing hi-tech Indian giants such as Tata Consultancy, which returned more than 90% in the last five years in Dollar terms.

True, India is lagging in many aspects, especially in terms of infrastructure and development and as a result a two-pronged economy has emerged. On the one hand, you have an economy related to infrastructure and development, which is sluggish, but this simply means that India is a stock picking play, not an economy to buy as a whole, as is China or Brazil.

On the other hand, everything that is related to the growth of the middle class inIndiaseems to have all the conditions for durable growth in place. While the Chinese dragon is a play of volatile and dynamic investments,Indiais a strategic chess game with careful stock picking and long term values.   India has a middle class of more than 100 million people and an economy nearly as large as Germany’s, thus markets cannot afford to underestimate  India’s potential value over the other BRICs.  

So is India a Golden BRIC?  

Indeed there are many headwinds for India; the two major ones are a current account deficit which is expected to reach $70 billion this year and the government budget deficit with the Indian government spending more than 20% of GDP. Those two deficits have created significant pressure on the Rupee, which fell to a record low of more than 57 Rupee per U.S. Dollar recently.

The Rupee has seen a more than 20% devaluation since 2004, which has caused stubbornly high inflation and left the Indian central bank incapable of stimulating the economy with lower rates, something they are desperate to do now that growth has fallen all the way from the 8% territory to 5.3%. Nonetheless, Indian growth was far better than BRIC counterpart Brazil’s, which grew at only 0.8% in the same period and was substantially better than India’s peers in the west.

In the short term, tackling the twin deficits and the Rupee’s weakness is crucial to restoring investor confidence. This can be done with some rather technical measures; initially by easing foreign funding to corporate India and then allowing foreign funds to participate in higher percentages, and finally providing deposit guarantees for foreign investment in Indian banks which will provide reassurance so that investors will continue to provide fresh liquidity.

In the bigger picture, India stores a much larger potential for future growth than other BRICs. Urbanization, the major reasons for Brazilian and Chinese growth, has already reached advanced stages, while in India it is still in the very early stages, with as much as 70% of the population still considered rural.  This means that, alongside India’s great technology market, their urbanization process has enormous growth potential. Many believe that India will be the next frontier after China for massive scale urbanization. Not only that, but the mega-urbanizing process is expected to come alongside some 200 million new jobs according to Humayun Shahryar, a well known analyst in the emerging market space.

And this massive process, combining with India’s tech industry, is why India is in my opinion the Golden BRIC among the BRICs, with most of its growth potential still to come.

To conclude, I would like to quote Muhtar Kent, the CEO of Coca Cola. In a visit to Delhi, the Indian capital, Mr. Kent announced a $5 billion investment in India after pointing out the country’s fast growing market, its young population and rapid urbanization and predicting that India would soon be among Coke’s five largest global markets by volume. Mr. Kent said, “India’s demographic, economic and social trends are all huge drivers of growth. Six years ago, we were not strong here, not at all… but India has been a remarkable turnaround story.”

 

 

 

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Posted July 17, 2012 by avinash2060 in Uncategorized

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