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India has been not left unaffected by the global economic slowdown with the GDP growth expected to come down to ~5.5% from the 8-9% growth rate in the last 5 years. The country's sharp slowdown in growth is not only due to global factors but also due to internal factors. The UPA government is mired in corruption allegations with one scandal after another hitting the media headlines almost every other week. Ballooning food, fuel and fertilizer subsidies have left a gaping hole in the government budget, pushing inflation into double digits and leading to a dizzying decline in the rupee. As the fiscal deficit kept growing, the government was finally forced (in the 2nd half of 2012) to introduce some reforms. However, most of these reforms are half-hearted and are a case of one step forward with one step backwards.

India - Bear Case

  1. Education - India's education standards remain one of the lowest across Asia. Despite government efforts to boost education through a new law - RTE (Right to Education), a new survey indicated that the education standards have fallen instead of rising. Not only is there a large population of illiterate people, but even the literate population has suspect reading and writing skills.
  2. Governance - The less said about governance in India the better. Corruption remains endemic throughout the country and getting any government service without a bribe is a miracle. Singling out one political party for corruption is futile, as the whole political funding system is based on black money. Multiple corruption scandals can be found almost every major industrial sector like telecom, real estate, technology, mining etc.
  3. Gender inequality - Women in India remain suppressed despite women occupying top political and business positions. The recent gang rape and murder in the heart of India's capital sparked country wide outrage against crimes against women. Due to preference for sons, female infanticide remains prevalent across the country. Gender inequality can be seen in both education and healthcare.
  4. 2014 Elections means more government freebies - Federal elections in India are held every 5 years with the next projected to be held in 2014. The central government is expected to introduce policies to give away freebies to the poor. This could potentially exacerbate India's already poor fiscal position.
  5. Middle Class Activism has not resulted in anything concrete - The anti-corruption crusade by Anna Hazare had raised high hopes about a change in existing system. However, the movement has petered out and the leading activists have gone their own separate ways. The anti-corruption ombudsman remains a distant dream for now.
  6. Land Acquisition and Environmental Issues - India remains one of the most densely populated countries in the world. Acquiring land for industries is becoming one of the biggest issues for companies. Environmental approvals are also becoming a major problem which is leading to inordinate delays and even cancellation of projects. Two of India's leading conglomerates recently left their road building contracts citing these delays.
  7. Growing Economic Inequality - Economic Inequality in India has always been present in India but globalization has considerably increased the scale. While hundreds of millions live on less than $2 a day, billionaires are increasing in number. Politicians and bureaucrats have also amassed hundreds of millions through fraud and embezzlement in real estate and mining sectors.
  8. Energy and Power Shortages - India imports a major percentage of its oil needs. The coal mining policy has been a disaster which has led India to become a major importer despite massive reserves. The country made international headlines after experiencing the world's biggest power brownout. Industries are shutting down because of lack of power. Fuel and electricity inflation has become a major headache for the middle class.
  9. Inflation remains stubbornly High - The Indian industry and the government have been clamoring for lower interest rates, but the central bank RBI has not budged in its stance. With inflation refusing to come down from double digits, it's a prudent stance in our view. India's vast majority of poor citizens are already being hurt quite hard by high inflation. They can ill-afford the inflation rate going even higher.

India Bull Case

Strong Foreign Fund Inflows - The Indian stock markets received the highest FII inflows into its equity markets in 2012 after 2010. More than $20 billion was pumped into the Indian stock markets as "risk on" returned with Bernanke's new QE program. There is suspicion that a lot of this FII inflow is Indian black money coming back in disguise. India retail investors have left the Indian stock party long ago leaving the market for the big boys.

Low Base - India's per capita income remains far below other major Asian countries like China, Malaysia etc. This means that India's economy has a lot of room to expand. Despite the dysfunctional political and social system, the economy continues to grow.

Does the Right Thing in the End - Like the US politicians, Indian politicians finally act when the crisis peaks. The 1990 economic reforms were triggered after the economy faced a major foreign exchange crisis. The piecemeal reforms in the 2nd half of 2012 were implemented when major rating agencies threatened a downgrade of India's investment ratings.

Valuation and Market Performance

Using the MSCI India Index as a proxy for the Indian stock market, we can see that the Indian stock market has given a ~29% return in 2012. However the performance has been quite dismal in the last 5-year period with an annualized net loss of ~1% compared to an annualized gain of ~6% for MSCI Emerging Markets. India's current P/E of ~16.2x implies 30% premium over the other emerging markets.

How to invest in the Indian markets

The Indian government has allowed non-Indian citizens to directly purchase stocks in the Indian markets. A number of ETFs focusing on Indian stocks are listed on the US markets as well.

  1. Wisdom Tree India Earnings ETF (NYSEARCA:EPI)
  2. iShares S&P India Nifty Fifty Index Fund (NASDAQ:INDY)
  3. PowerShares India Portfolio (PIN)
  4. EGShares India Infrastructure ETF (INXX)
  5. EGShares India Small Cap ETF (NYSEARCA:SCIN)
  6. EGShares India Consumer ETF (NYSEARCA:INCO)

Besides these ETFs, some of the Indian blue chip stocks like Tata Motors (NYSE:TTM), HDFC Bank (NYSE:HDB) and Infosys (NYSE:INFY) also have ADRs trading in the US markets.

Summary

The India's benchmark BSE Sensex has crossed the crucial 20,000 level after almost 2 years as global markets are touching new highs. There is optimism that India has touched the bottom of the growth cycle and the country will return to higher growth rates in the future. But the government's recent decision to partially deregulate the diesel prices was negated by the increased subsidy for cooking gas (LPG cylinders). It shows how movement in the forward direction is being neutralized by going back on earlier reforms. India's low per capita income base means that the economy will continue to grow in the future but this growth remains far below potential. Also, it is not certain that this growth can be captured by the stock market.

Source: India: One Step Forward, One Step Backwards