Investing In India: The Demographic Bonus Will Play A Big Role

Includes: EPI, PIN
by: Charles Putz

Recently many are suggesting the "I" in BRICS should be replaced by Indonesia. I'm not going to go into that analysis. Instead, I'll focus on India briefly explaining why it is a BRIC, and analyzing whether it can become the next China and if it is time to invest in it.

The BRICS leaders just met in New Delhi for their summit. They have agreed to examine a proposal to create a BRICS development bank, but that is still far from being implemented. Although the BRICS shall represent more than half of the world's growth this year, not much should be expected from this group of countries acting together. Why? Let us first understand what they have in common. If we list the ten largest countries in the world by Population, Land and GDP, only five countries will be in all three lists: USA, Brazil, Russia, India and China. The BRIC are countries which are very large by most standards, however still developing, and therefore expected to grow faster than developed economies and increase their importance on a global basis. The appendix S stands for South Africa, which has similar characteristics but on a more modest scale, since it wouldn't fit any ten largest list based on the mentioned criteria. South Africa's role is more regional and some say it was included in the group for "political correctness."

It would be an overstatement to say that's all in terms of similarities, but let's quickly look at some significant differences. China and India are really huge in terms of population - India is approaching China's population size, which is almost four times the population of Brazil and Russia combined. On the other hand, Brazil and Russia have a per capita GDP (all GDP figures here are dollar equivalent, not PPP) that is more than twice that of China, which itself has a per capita GDP more than three times higher than India's. Brazil was colonized by Europeans, has a western culture, and is more like a less developed US, whereas Russia was until recently a super power leading the Soviet Union, and India and China have their own millenary cultures as well as disputes with each other. China's GDP is greater than that of Brazil, Russia and India combined. I could go on, but the bottom line is that although they may have several interests in common, they might have just as many not in common.

There are several reasons to consider that India could grow faster than China in the next decades. Population wise, yes, it is a matter of time for India to outgrow China. But when that occurs, China's economy will still be growing and its per capita GDP will be much higher than India's. Therefore, if India's economy will ever become greater than that of China, that certainly would still be decades away. I guess the question is not if India's economy will become greater than China's soon, which it won't, but rather if India's economy could grow in absolute terms more than any other country? In other words, could India pick-up China's locomotive role when China slows down?

Although India has grown at very high rates during the last years, China has grown even more. The same is true for India's productivity rates and for its investment level. Some believe that India has a language advantage, but English isn't as widely and fluently spoken in India as some may suppose, and one could also question how substantial would this advantage be, considering that Mandarin is the most spoken language in the world. Others argue that India could be favored by its lower labor cost, but once productivity gets factored in, that advantage doesn't seem to hold so well. The significant difference is demographic.

Although India's population growth is slowing down, according to its 2011 census, it still grew 1.6% p.a. last decade, down from 1.9% p.a. in the 1990s. Population growth has a similar effect on GDP as inflation has on returns, i.e. inflation eats away part of the nominal rates of return once real rates are calculated; the same way that population growth eats away part of GDP growth when GDP per capita is calculated. Population growth also results in a young population, with many people (children) at non-working age, putting a burden on the "few" who can work. However, fertility rate (the expected number of children born per woman in her child-bearing years) is continuously declining in India, from 3.9 in 1990 to currently 2.6 and expected to continue falling. As the fertility rate approaches 2, and children become adults, the proportion of the population in working age increases, which presents many challenges, but is a very powerful ingredient for economic growth. This process is known as demographic bonus or dividend. Among other things, it helps investment rates to go up, since people in productive age are the ones who save, not children. Developed economies went through it when baby boomers became adults and China after the one child policy was implemented. Brazil is currently undergoing this process and India will go through it in the future.

Another important long-term growth factor in India is that it is going through an urbanization process. Urbanization presents many challenges, but is a tremendous growth ingredient, and given that two thirds of the population still lives in rural areas, this process could continue for many years.

On the other hand, India faces huge challenges. One that also applies to China is the imbalance between male and female population. India has 940 females per 1000 males, which results in 37.25 million males without a pair. This situation is even worse in China, but its implications are a matter for a different article.

India has to face the fact that although it is among the countries with the largest number of Engineers, 26% of Indians can't read or write, which leads to estimates that it is home to one third of the world's illiterate population. The 2011 transparency international figures show India among the worst large nations on corruption issues in the world and worsening relative to 2010. Whether corruption is increasing or only becoming more visible with protesters and the press playing their role better is debatable, but nobody questions that it is very high, counter productive for the country's development and one of the reasons for some referring to its democracy as dysfunctional. Likewise India's ranking in the Ease of Doing Business 2012 World Bank report puts it in number 132 among 183 countries, which not only isn't good, but also isn't showing any material progress.

One could go on saying that India is still a very closed economy (in spite of being much more open today than 20 years ago), discussing its infrastructure problems, lack of energy supply and dependence on oil imports, inflation, and extreme poverty. Disputes with neighbor countries, terrorism and internal rebels are also important points of concern. But perhaps for the long term a more important question would be if its culture could curb its economic development. Indians are known for being accommodated and valuing much more enjoying a good life than work. When visiting a factory in India and comparing it with other Asian countries, it's almost as watching a film in slow motion. As Malcolm Gladwell explains in the book Outliers, for thousands of years Chinese, Japanese, Koreans and other Asians who have cultivated rice have worked around 3000 hours a year, while most of the world has worked less than 2000 hours and some as little as 1000 hours per year. Indians don't seem to be at the higher end of working hours. I recall a story I heard decades ago about villages in India where people worked for a daily pay, and everyday on the way back from work setup a net to catch fish. In the next morning, before going to work, they checked the net. If they've caught any fish, that day they wouldn't go to work. I wouldn't be surprised if this still exists in India.

One could argue that with all these problems India isn't prepared for sustained fast growth. I may be naïve, but thinking very long term, I tend to see these problems as a half full glass rather than half empty. In other words, there are lots of opportunities for improvement. And the fact that India is a democracy may slow things down, but makes them more sustainable. Indians are known to be very creative, and a democratic society is normally good soil for creativity. In a matter of time, India can become very successful on a global basis on a lot more than IT services. I believe that with the help of urbanization and its demographic bonus, the Indian people will be able to make things happen, even if at a slower rate and taking longer than several would wish. It is likely that at some point India's growth will be of more relevance to the world's growth than that of any other country.

India's ETFs have had a very bad performance. Wisdom Tree India Earnings (NYSEARCA:EPI) has had a negative return of 25.9% since its inception in Feb 2008, -23.8% in the last 12 months, and -9.6% in the last 30 days. Power Shares India (NYSEARCA:PIN) hasn't done much better, with -23.7% since it started trading in March 2008, -16.8% over the last 12 months and -10% in the last 30 days. These ETFs could be a way of participating in the country's potential growth and given the bad performance so far, now could be the right time to start. Check out the Seeking Alpha Indian Stocks Beginning To Look Cheap article for more on India's ETF performance and time to invest. But I prefer private equity companies that invest in new creative companies. I think it's still early to build a large position, but for those who think long term, my recommendation is to gradually start building a position. If you wait until most problems are solved to start investing, you'll lose out on the best part of the party. The demographic bonus will play a big role, so keep an eye on fertility rates, and when they get close to 2.1, increase your position. Also follow the transparency figures and when corruption levels start approaching the developed economies levels, increase your position.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.