India: Fresh Opportunities for Investors

The promise of long-awaited reform and less stringent investment and ownership rules in India will benefit Western companies as well as Indian ones

By David Bogoslaw

Until a game-changing election on May 16, India had been a laggard among Asia's markets, which have been advancing at a fairly strong clip since earlier this year. The victory of a coalition led by a recharged Congress Party, which won 262 of 543 legislative seats, brings the promise of long-awaited economic reforms, reduced corruption, and a younger, more vigorous leadership. The news drove the Indian equity benchmark Sensitive Index, or Sensex, up 17.3% on May 18 and has people taking a closer look at investment opportunities on the subcontinent.

Those opportunities are abundant, ranging from financial services to infrastructure to consumer goods and private education, says William Nobrega, a managing partner at Miami-based Conrad Group, which provides business consulting and investment banking services.

India's economy has had investment pros worried, with recent reports showing the country experiencing its biggest production decline in 16 years, and declines of 33% for both imports and exports, in the first three months of 2009. The International Monetary Fund said it expects the economy to grow by 5.1% in calendar 2009, vs. a rate of nearly 9% between 2003 and 2008. India needs to keep gross domestic product growing at 8% or more in order to continue to eradicate poverty, says Nobrega; he estimates current growth at 4% to 5%.

Business Reforms Expected

Just 10 seats short of a majority of 272 seats, the Congress Party-led United Progressive Alliance doesn't need the support of the Hindu Nationalist or Communist parties, both of which have long blocked the Congress Party's attempts at economic liberalization, says Nobrega. The new government should have the smaller centrist parties clamoring to join and fill the remaining 10 seats needed to form a majority and push through reforms, such as removing caps to foreign investment in and ownership of Indian businesses. "This shows that Indian democracy has finally come of age," says Nobrega. "In the past, it's just been coalition after coalition or radical right or radical left, like the Hindu Nationalists and the Communist Party," whose corruption had become a growing frustration to the electorate.

Another much-needed area of reform will be private education, which has become entrenched as part of Indian society but couldn't expand due to opposition to for-profit alternate providers from outside the Congress Party.

However encouraging the political signs, Nobrega sees the surge in the stock indexes as overdone. "The earnings don't support it. I think there's a little exuberance going on," he says.

A Chance to Catch Up

Over the longer term, however, he expects the more liberal government that was voted in to provide a major push for India's business fundamentals and growth trajectory. After years of frustration among the Indian populace about its progress compared with China, "this will help India begin to achieve the type of gains that China has done in the areas of infrastructure and foreign investment," says Nobrega.

A big driver of that will come from all the new faces coming into government, including some key cabinet posts, he says. He expects to see the first tangible results from this generational shift in the next three to six months, but others are more conservative. "This isn't something that's going to change overnight," says Nick Beecroft, a portfolio specialist at T. Rowe Price International (TROW) in London. But led by a government with a much stronger mandate, "there's a possibility that over the next few months and years we could start to see a real benefit to some sectors" of the economy.

Beecroft expects the banking and insurance industries to be among the first to benefit, as large capital inflows into the country start to reverse the "massive withdrawals of foreign capital in 2008." The return of foreign investments will provide the high liquidity that the financial-services industry needs to flourish, he says. Capital inflows will probably also be a boon to infrastructure and real estate companies. There are many domestic investors who took refuge in cash during the runup to the election and will now be ready to jump back into the stock market, he says.

No Quick Fixes

But Beecroft is prepared for a slight pullback in stocks over the next few weeks as people come to realize there won't be a quick fix for India's economic woes.

Not least of those woes is the country's poor public finances, which RBC Capital Markets (RBC) agrees will be hard to repair. While a greater mandate for the prime minister to pursue economic reforms should boost the economy and the value of the rupee, RBC's Emerging Markets Research Group warned against excessive optimism.

"Its weak fiscal position not only constrains the government from providing significant fiscal stimulus in a period of slower growth, but also represents the chief risk that India's sovereign debt may be downgraded into subinvestment-grade status," RBC said in a May 18 note. "For these reasons we think that the upside for the [rupee] coming from the election results will be limited."

Government Has Limited Options

India's current account deficit is expected to shrink from 3.5% of GDP in fiscal 2008-2009 to about 1.3% in the current fiscal year, a Goldman Sachs (GS) economist said in April. Official estimates of the total fiscal deficit, for the federal government plus the individual states, range between 9.8% and 11%, London-based Lombard Street Research said in a May 14 note. But Lombard puts the total deficit closer to 13%, since it adds in off-balance-sheet subsidies such as oil bonds.

With its finances so thinly stretched, the government has little flexibility to fund initiatives needed to fuel economic growth, such as expanded education for a growing middle class. One of the reforms people are expecting is the privatization of some of India's state-owned and operated companies, says Beecroft.

With change on the horizon, where should India-focused investors be looking now?

Underrepresented in Indices

T. Rowe Price has broad exposure to Indian stocks, from infrastructure and real estate development names to television broadcasting companies, alcoholic beverage makers, and personal product manufacturers.

T. Rowe's $2.0 billion New Asia Fund (PRASX), a dedicated Asian strategy that excludes Japan, held 36% of its assets in Indian stocks at the end of March, compared with a typical 9% weight in Indian stocks, says Beecroft. He expects that fund to benefit directly from the 17% bounce on May 18. The more geographically diverse Global Emerging Market Stock Fund (PRMSX) was 1% to 1.5% overweight in India in March.

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