Is India a Benchmark Bet on the Global Economy?

Includes: EPI, ICN, IFN, INP
by: Rakesh Saxena

“Despite significant hurdles, GDP growth for 2009 will exceed 7%,” India’s chief economic planner Montek Ahluwalia has been repeating in recent media interviews. And, with the Sensex rising above 17,000 points yesterday on steady buying, few analysts are prepared to make a short call on the Indian stock market.

Fewer still are bothering to look closer at the “significant hurdles” which plague the Indian economy. Though the Indian government claims that, with ample food in storage, there is no threat of widespread hunger, the weakest monsoon season since 1972 has wreaked havoc on millions of farmers, many of whom have already defaulted on loans to banks and private money lenders. During the height of last year’s downturn, more than 10 million workers in the “unorganized” sector, India’s largest labour pool, either lost their jobs or were forced to accept drastic reductions in wages and working hours. And, with the prices of basic foodstuffs like lentils, sugar and vegetables at historic peaks, it is not difficult to visualize the fate of the 500 million-plus Indians living below the poverty line.

Yet, corporate profits are expected to rise and government spending will inevitability boost core industrial segments. On the one hand, levels of impoverishment clearly suggest that the Indian Shining story has failed to touch the lives of a majority of Indians and, in fact, the already-disturbing rich-poor gap continues to widen. On the other hand, as evidenced by valuations attributed to recent listings, investor sentiment is gearing up for another 15-20% surge in stocks before Christmas. “We see the Sensex at 20,000, as a first target,” a Mumbai stockbroker declared over the weekend. “We are not worried about drought, unemployment or food inflation.”

In other words, the “significant hurdles” Mr. Ahluwalia mentioned belong to another India altogether, an India which lives in the villages and the urban shanty towns. The India asset managers and business leaders speak about is confined to the 200-million-strong middle class, the super rich and those loaded with cash which has escaped the scrutiny of tax authorities. But is this “disconnect” sustainable? Specifically, is the Indian stock market capable of breaching one resistance point after another in an environment where the deep-rooted structural problems within the national economy still need to be addressed?

The answers must shape a strategy to trade India-specific ETFs or ETNs (EPI, ICN, INP and PIN). In this writer’s view, any surge in Indian equities from this juncture must bring with it attractive short opportunities, for three good reasons.

Firstly, widespread economic hardship is imposing severe constraints on the consumer demand matrix. Secondly, the optimism generated amongst local and international investors by a stimulus-loaded GDP is no substitute for comprehensive and realistic asset valuations; the painful lessons of heavily-leveraged balance sheets have been easily forgotten. Thirdly, a Maoist movement, rooted in marginalized tribals and landless peasants, now holds sway in 180 districts across 10 states, accounting for almost 42% of India’s geographical area. Armed confrontations between paramilitary forces and communist guerrillas will dominate the headlines in forthcoming months; New Delhi rates the Maoists as the biggest threat to national security, ahead of the terrorism promoted by Islamic militants.

Too often in the past, fund managers in the West have applied flawed valuation methodologies to India by ignoring the political, social and economic risks the “other” India brings to the asset equation. “The disconnect between deprivation and abundance works to a degree but, at the end of the day, nothing works if the disgruntled are prepared to pick up the gun and fight for social justice,” an opposition politician in the Maoist-infested state of Andhra Pradesh conceded at a news conference last week.

An informal survey revealed that the overwhelming majority of Mumbai brokers are convinced that global growth through 2010 will create the foundations for another impressive bull run. But the lack of clarity on what global growth means in this era of unprecedented deficits was striking indeed.