Equitymaster.com :

BSE Sensex

Price on reco. date (Rs)	10,201
52-week High/Low	10,305 / 6,118
Free float (%)	59.8
Market cap (Rs bn)	12,922

Share price chart

Rs 100 invested is now worth...

India: Buy or sell?

"If India were a stock, would you buy?" This is what we’d asked our readers two years back. In the past two years, much has changed in the country’s economy, politics and stock markets. While the economy continues to show strong momentum on the back of robust growth in industrial and services sectors, the stockmarkets (as barometer of economic progress) have rewarded holders of the India story. However, the country’s political character, led by the Left’s bickering, has continued to deteriorate.

In this article, thus, we provide you with an update on India as an investment option - an asset class. Kindly note that some of the points from the previous report have been carried forward along with the adequate additions/deletions to/from the investment rationale and concerns.

Note: Hereunder, ‘India’ is used to refer to as a diversified company and a listed stock

Investment Rationale

The essence of democracy: One of the foremost reasons to buy India is its democratic setup, which allows everyone to have a voice. The management (government) is the elected representative of shareholders (general public) and is put to test every five years by way of general elections. If a government fails to address the broader needs of the populace, they are punished. This is what allows the nation to introspect and to grow as per its aspirations.
The ‘internal’ India story: As per the NCAER, on the back of the economic transformation that India has witnessed since the opening up of the economy in the early 1990s, the middle-class has blossomed in the country, growing by around 10% to 12% per annum. This transformation has been fed partly by the explosion of new jobs for the young populace, primarily in the software and other services sectors. This newfound prosperity has further fed consumerism in the country, which has benefited the industrial and services sectors alike.

If one were to take a look at the above graph, there emerges a clear picture why we are positive on the continuance and regaining in strength of the Indian consumerism story. The graph indicates the respective savings levels (as % of GDP) of Indian households, private corporate sector and the government. While the private corporate sector and government have seen stagnant savings and dis-savings respectively, Indian households' saving has risen consistently as a percentage of GDP. Further more, the rise has gained steam beginning the early 1990s, the period when the economy was opened up to market forces. Going forward, we believe that accretion to income levels of the rising Indian middle class (represented by the financially independent young population) and the consequent rise in disposable incomes will fuel a faster growth of the ‘internal’ Indian economy.

Improving entrepreneurial culture: A vibrant and strong entrepreneurial culture seems to be emerging in India. As the younger lot is exposed towards international best practices, entrepreneurship is likely to emerge as a source of competitive advantage for the country. We believe that the seeds of entrepreneurship i.e., less government interference and its increased role as a facilitator, fewer bureaucratic hurdles and easy access to capital are being sown already. Though India is rated amongst the most corrupt countries globally (ranks 90th in Transparency International’s global corruption index), the fact that de-regulation is happening in various aspects removes grey areas, which feed corruption.

The setting up of independent regulators in sectors like insurance, telecom, capital markets and improving regulations in infrastructure sectors like power is a key positive. Historically, though the population was entrepreneurial, constraints on these fronts had resulted in ‘brain drain’. However, we have witnessed a number of such people coming back to the country (reverse brain drain) to enable entrepreneurs in India to fulfill their objectives. Of course, they bring along with them international best practices, know-how and, more importantly, capital. As we move forward, all these factors are likely to keep the spirit of ‘entrepreneurship’ alive in the country.

Robust financial backbone: The financial sector is the backbone of India. The strength of the country’s financial sector can be gauged from the fact that it shelved us from the crisis that had engulfed almost all Asian economies during 1997. This is because we have a central bank - the Reserve Bank of India (RBI) - that is independent in its true sense. The RBI strictly adheres to the international and national rules and regulations. This strong financial backbone, as a whole, has set a platform to support India’s long-term objectives of growth with price stability.

Investment Concerns

Lack of vision among policy makers: When was the last time you heard the ruling government discuss about the long-term growth and development of the economy without being shown a ‘red’ flag by the Left? We have had some policy makers who have taken bold decisions. But one or two people from a large government cannot shape the country’s destiny. Short-term political compulsions have overshadowed the long-term economic progress and this shall continue till coalition politics exist.
Bureaucratic hurdles & corruption: Someone had once said, "...you cannot fool a large number of people all the time. But you can fool enough of them to rule a large country." Bureaucratic hurdles and corruption are probably the biggest factors that might deter serious investors from investing into India’s growth story. While the country has bred a class of active entrepreneurs, burdensome internal regulations and bureaucracy has impeded such efforts. This very bureaucratic nature has led to rampant corruption. If everything is black and white, there will not be any grey areas!
Low on human development: While factors like acquaintance with the English language and high levels of technology skills play a very vital role, sustenance in growth over the long term can only be brought about by addressing basic needs of the populace. As is evident from the table below, India has been a laggard on some of these human development factors. Also, due to a huge workforce and inability in proper distribution of wealth, a large proportion (around 35%) of India’s population is poor. These factors, if not taken proper care of, are likely to ruin India’s chances of building up a solid and sustainable growth model for the future. Policy makers also have to balance decisions between rural and urban development.

India: Laggard in improving standard of living...

India China Norway

HDI Rank 127 85 1

Population (m, 2003) 1,070.8 1,300.0 4.6

Annual population growth (1975-2003) 1.9 1.2 0.5

Population under age 15 (% of total), 2003 32.9 22.7 19.9

Population living below US$ 1 a day (1990-2003) 34.7 16.6 NA

Adult literacy rate (% age 15 and above, 2003) 61.0 90.9 NA

Female adult literacy rate (% age 15 and above, 2003) 47.8 86.5 NA

Life expectancy (years, 2003) 63.3 71.6 79.4

Infant mortality rate (per 1,000 live births, 2003) 63.0 30.0 3.0

Public expenditure on health (% of GDP, 2003) 1.3 2.0 8.0

Public expenditure on education (% of GDP, 2003) 4.1 4.5 7.6

Source: UNDP Human Development Report
People problem: The way the Indian economy is growing, and the way competition is getting hotter, India Inc. is facing a crisis of sorts - something that was never a point of consideration for Indian companies in the past. The crisis relates to 'people' and despite boasting of the second largest population in the world, India Inc is facing 'people problem'. We know of companies that have large war chests (cash), having the ability of paying world-class salaries and still not being able to find good project managers to take over the growth mantle. And we know of other companies that are leaders in their respective sectors and are still not able to retain key personnel being carried away by the lures of foreign shores and dollar dreams! As a top official in India Inc puts it, "The problem earlier was retrograde government policies, the problem now is talent shortage. The future war will be fought based on who's got the best talent. Our biggest challenge is to attract talent laterally and to retain our talent pool."
Labour (mis) reforms: Apart from the dearth of quality manpower in most of the industries, redundant labour policies have also proved to be the bane on the entrepreneurial spirit in the country. For long, the policymakers in India believed that this country would grow into a dominant economic and political powerhouse on the back of its vast natural resources. However, for the right, there seems to be a growing belief now that India needs reformed labour policies to achieve the politico-economic status it deserves. Without labour reforms, sustainable growth and development and prosperity would elude India. We believe that reforming labour policies will not just facilitate closure of sick industrial units, but will also address some core issues like wage policy, employment security, labour redundancy, industrial relations, human resources development, and good and clean corporate governance.
Concerning fiscal situation: If one were to list factors that have impeded India’s progress towards a higher growth path in the past, the government’s fiscal imprudence (excessive borrowings to finance spending) would appear at the top. While high levels of deficits are not necessarily bad, more so for an emerging country, if unchecked, they have the capability to ruin its finances, thus having an ultimate impact on all its stakeholders (the populace).
Valuations ahead of real growth: Given the past two years of bull-run, the valuations of Indian equities has touched historically high levels, which renders them expensive, at least from the medium term perspective. The Sensex P/E is at 16.4 times 1-year forward earnings. A flush of liquidity in the global marketplace has led to this rise of Indian equities. While we do not deny the long-term India growth story, we are concerned of the fact that stock prices have moved far ahead of the growth in real economy. As such, we fear that the markets might have to undergo a vicious correction or a protracted phase of low growth to allow the real economy to catch up. Investors should thus be cautious. However, while there are some solid growth stories that can still be lapped up for strong long-term returns, buying into any and all kind of paper is fraught with high levels of risk.

Recommendation

Considering all the above arguments in balance, we recommend a ‘Hold’ on India. While investors can expect a 15% CAGR growth in earnings for Sensex companies, liquidity and foreign inflows are technical factors that need to be considered before making an investment decision. We are particularly positive on the rising global ambitions of Indian companies, improving entrepreneurial culture and the country’s democratic set-up.

Financials at a glance

(Rs bn) FY02 FY03 FY04 FY05RE FY06BE

Revenue

Tax revenue 1,335 1,585 1,870 2,258 2,735

Direct tax revenue 484 616 766 973 1,298

Indirect tax revenue 851 970 1,104 1,285 1,437

Non-tax revenue 678 723 769 751 777

Revenue reciepts 2,013 2,308 2,639 3,009 3,512

Capital reciepts 1,625 1,805 2,075 2,049 1,631

Total receipts 3,638 4,114 4,714 5,058 5,143

Expenditure

Revenue expenditure 3,015 3,387 3,621 3,861 4,465

Defence 381 407 432 435 486

Interest payments 1,075 1,178 1,241 1,259 1,339

Subsidies 312 435 443 465 474

Others 1,247 1,367 1,506 1,701 2,165

Capital expenditure ** 608 745 1,092 1,197 678

Loans & advances 343 317 288 304 57

Capital outlay 266 291 342 566 622

Others - 138 462 327 -

Total expenditure 3,623 4,132 4,714 5,058 5,143

** Figures for FY03, FY04 and FY05 includes National Small Savings Fund repayments
RE-Revised estimates; BE-Budget estimates; Source: RBI, Equitymaster Research