This is a sequel to my earlier article on investing in India, and reading it first will help set the context for this article. In that article, I outlined the number of structural and process issues that make India's capital markets risky for most but the well-informed and well-connected investors. I predicted that the situation would be precarious for India's capital markets and I recommended that investors wait and watch before they invest. An unscientific but important structural criterion that I mentioned is that the time remaining till the next general elections in India (expected in May 2014) is an important factor to consider for those brave enough to invest in a key emerging market. I indicated that if the next elections are less than 12 months away, this could present a good opportunity to invest. The logic for this parameter is that a desperate government willing to hold on to power will spew forth populist policies in such magnitude and urgency that would scare away most investors. Quite predictably, there have been a slew of populist measured announced by the Indian government over the last few months. However, little did I know when I first wrote that article, that India's situation would precipitate to a crisis so quickly as it is going through now. India's currency (rupee) has declined by over 20% since June 2013 to historically unprecedented levels, and the Indian equity index (Sensex) is quite the picture of volatility over the past 8 months, with the mood swings that can unnerve even a seasoned investor.
India's policymaking is probably at its nadir with signals that downright scare investors. With practical moratorium on key resource industries like mining (the 'pendulum extreme' response to corruption in that industry), onerous regulatory and tax burdens (some retroactive) on international companies investing in important sectors like aviation, retail and telecommunications, fuel price regulations that are driving the state oil companies into perennial losses, the recent food security bill that provides food subsidy to 67% of the population), and of course, countless other subsidies to special interest groups and farmers - India has become Dante's Inferno for retail investors, as a fund manager remarked to me recently.
However, as is often repeated in different forms by many SA authors, the best opportunities for investment are to be found when the fear psychosis is high. The uncertainty of looming elections adding to the populism of the current policy environment, with perhaps the only 'positive' news being the appointment of a prominent Chicago economist Raghuram Rajan as the new head of India's central bank, the downbeat Indian scenario bears consideration for serious investors as a potentially attractive entry point. In fact, so enamored were the currency markets with Rajan's appointment that the Indian rupee appreciated by nearly 6% from INR 68 to INR 64 to a US dollar in just the last week. No wonder the Indian financial press is in love with Rajan, and some even adoring him as a sexy poster boy for banking, as an Indian novelist has gushed. From a global investor perspective, especially for those based in North America, the conditions are starting to get attractive for establishing entry into India's capital markets.
By the mere fact of staying away till now compared to even 4 months ago, all of India's equities are now available at attractive 19% discount when priced in US dollars. Combine this with the fact that many large cap Indian companies (that form the bulk of India-oriented ETFs that I outlined in my previous article) have either growing international operations or have made significant acquisitions in Europe or North America, it is not hard to conclude that when the financials are consolidated back into parent operations, the currency boost will make their earnings picture better, and can lead to a 'catch up' rally. The automobile sector demand in India has moderated after a sustained drop in the last 8 months. With the notable exception of the auto industry facing their first significant recession after nearly two decades of strong growth, others are faring better. Many consumer durable companies have been able to pass on commodity cost increases to consumers. Given the reasonable pricing power, and the known track record for Indian companies to achieve sizable cost reductions (including indigenization of imported components and overhead reductions), the margins will be somewhat protected in my view. This is a macro view from a company P&L picture perspective, which will need to be validated for specific companies under the investment screen.
Regardless of recent woes in India, the fundamentals and demographics of the country remain strong. While the GDP growth has slowed to 4.4% in the second quarter of 2013, a far cry from the heady rates of 7-10% in the recent years (see chart below), the signs of improving GDP growth to even the conservative 5.3% forecast for the next financial year (India follows April-March financial year cycle) indicates a potential turning point in the recovery.
Investors interested in a small exposure to India's growth potential should consider establishing a starting position in one of the ETFs mentioned in my previous article. Alternatively, they can consider buying directly into large cap companies in India with global operations, as some of them trading as ADRs on U.S. exchanges. Some of the leading companies in India's banking sector (HDFC Bank (HDB), ICICI Bank (IBN), Axis Bank (OTC:AXBKY) etc) are sporting attractive valuations. IT industry leaders (Infosys (INFY), Wipro (WIT), Tata Consultancy Services (TCS.CO), Cognizant Technology Solutions (CTSH), iGate (IGTE) etc) with substantial back-office and delivery centers in India are uniquely positioned in this environment as significant part of their costs are in incurred in Indian rupees but the bulk of their revenues are in US dollars or Euros. Investing in any emerging market, not just India, involves country risk. However, a prudent and opportunistic approach towards investing in India could yield a significant return when the risk-reward profile is favorable. I believe this is an opportunistic time for starting a position and tactically adding funds over the next 9-12 months depending on market, political and business conditions leading up to the general elections in India. As always, caveat emptor!