Will opening up this sector improve India's fortunes? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Will opening up this sector improve India's fortunes? 

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In this issue:
» Insurance premiums grow well in BRICs
» Is Russia the best investment choice?
» Hotel industry is catering to India's middle class
» SMEs in China are under financial strain
» ...and more!

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The last time that India made some bold and important reforms was way back in 1991. At that time, because of the precarious state of affairs with respect to India's forex kitty, the then Finance Minister Mr Manmohan Singh decided to liberalise and open up India's economy. This move proved to be highly successful and set the tone for future growth in the Indian economy. Sadly since then, the reform process has hardly been much to talk about.

Given that India in recent times has grappling with problems of high inflation, poor infrastructure and corporate governance issues, the time now is riper than ever to once again introduce some bold reforms. And one such reform could be opening up India's vast retail sector. At present, India permits only up to 51% foreign direct investment in single brand retail stores and 100% FDI (Foreign Direct Investment) in cash-and-carry stores that can engage in wholesale trading. FDI in multi-brand retail stores is not permitted.

One major deterrent to the opening up of the sector has been the argument that local kirana shops will become extinct once the competition from big retail stores intensified. There might be some grain of truth in it but the problem may not be as big as envisaged. For instance, one of the advantages of kirana shops for any household is the convenience of location, quickness of delivery among others. Given the expensiveness of India's real estate, poor infrastructure and cultural issues, it seems quite unlikely that kirana stores will completely lose their clout.

At the same time, multi-brand retail has its own set of advantages. These would be elimination of layers of middlemen, cash transactions entering a formal economy, more investments in retail supply chain and storage and employment to India's burgeoning working class population.

Ultimately what will matter is whether these retailers have long term interests in mind while investing in India and whether they are committed to developing the requisite infrastructure in the country. If yes, then opening up the retail sector may not be such a bad idea as it is being made out to be at present. And competition for India Inc. will certainly act as a catalyst to improve business operations and take it to the next level.

Speaking of India Inc., which Indian company do you think is the most trustworthy when it comes to financial reporting? Please take our poll to cast your vote if you haven't already done so. But hurry as this poll closes today at 2 pm.

01:26  Chart of the day
Just as the economies of the BRIC nations are growing at a fast pace, so seems to be the growth of insurance. As today's chart of the day shows, insurance premiums have seen a healthy growth in China, Brazil and India in 2010. Of course, these countries lag way behind the rich countries by volumes (especially the US which accounts for more than quarter of the market). But, when it comes to growth potential, emerging economies certainly take the cake.

Data Source: The Economist

Oil and energy companies appear to be determining future growth for investors. At least for legendary investor Mark Mobius. Mobius opines that thanks to the healthy oil and energy companies, Russia would be the best investment choice for emerging market investors. In fact, Russia tops his own investment list at the moment. This is despite corporate governance issues that surround Russian companies. He feels that the returns justify the risks on account of the governance. This is where we differ from Mr Mobius. Returns are always a focus for investing. However, one cannot overlook the importance of sound corporate governance. In the long run, stock markets also reward companies with better governance standards. On the other hand, we do agree with Mr Mobius on the fact that oil and energy companies are bound to be good investment opportunities in the light of higher crude oil prices. But in a country like ours, where higher crude prices translate to larger losses for our oil companies due to the habit of subsidizing product prices, it is better to evaluate them more closely before investing in them.

The middle class in India has come up in a huge way and is hard to ignore. This time, it is the hotel industry where it is making its presence felt. The hotels were once built for foreign travelers leading to concentration of high end properties. However, that hardly serves the mass segment in India and the hotel sector has begun to realise the need for a change. As per the latest industry data, one in five rooms under construction will be budget rooms catering to the rising middle class. So, the focal point will be neither the top nor the bottom but the middle of the pyramid.

While the shift in the strategy seems easy on the surface, there are quite a few challenges to overcome. These range from the country's poor infrastructure to lengthy approval processes for plans and permits. Further, high cost of land and infrastructure development along with limited returns will make ideal returns on capital a tough goal as far as this strategy is concerned. To compound their problems, unlike previous real estate cycles, it will be tough this time to mop up funds from bank or private equity funds. The recent debacle of real estate in India and painfully long investment horizon periods has made the hotel industry more cautious than ever. While 19 new projects were announced in the first quarter and 21 more were under construction, 52 projects were put on hold or canceled.

Even if the initial glitches are overcome, it is doubtful if the Indian consumer will like a no frills approach. That said, it's a new trend and the industry should be prepared to test waters and learn our lessons if this concept fails.

Amidst all the tension surrounding Greece and the US debt markets, investors seem to be turning a blind eye towards another factor that is equally crucial for the fate of global economy. We are referring to crude oil. The latest development in this commodity concerns none other but India. It may be recalled that few months back, the RBI had halted a clearing mechanism of making payments to Iranian oil imports. This was apparently done at the behest of the Americans. Months of non-payment has led the money owed to Iran snowball to US$ 5 bn. With the Middle Eastern nation struggling for cash flows, it has decided to stop shipping oil to India next month onwards. This is certainly likely to make India look elsewhere for the 4 lakh barrels per day that it imports for Iran. As of now, Saudi Arabia can certainly pick up the slack. But should other nations too follow in on India's footsteps, Iran would have a hard time selling its oil. Furthermore, the incremental demand from India could create upward pressure on crude prices should global economy improve further.

For an economy that has been growing at a break neck, speed slowing down at regular intervals is a must. This is if it wishes to avert a runaway hyper inflationary trend or an asset bubble. China has been attempting to do the same for several quarters now. At 22% the reserve ratio that the Chinese banks have been mandated to keep aside is one of the highest in its history. But the sudden bout of conservativeness seems to be taking a toll on the small enterprises. Especially since the credit squeeze is at a time when the small entities have got used to large doses of cheap funding. The prohibitive interest rates have therefore come as a huge shock to the highly leveraged Chinese SMEs; even driving some to bankruptcy. Although the Chinese government is not known to reveal such facts, the policymakers this time are worried about the SMEs. And why not? After all, these troubled entities account for almost 90% of China's exporters. As per the data cited by the Economic Times, 88% of SMEs in China are under a financial strain! This is certainly not good news for an economy that relies heavily on its industries and exports.

It was a stellar week for the world markets with all countries expect China closing the week in the green. A new deal worked out to resolve the Greek sovereign debt crisis resulted in gains across the world markets. The biggest gainer of the week was Singapore up 3.2% while China closed the week down 0.9%. Among the other Asian markets, Hong Kong was up by 2.6% while Japan was up by 1.6%.

Indian stock market was up by 0.9%. While the country faces medium term headwinds due to inflation, higher interest rates and policy paralysis, the new Europe debt deal resulted in FII inflows. This helped push the markets into the green. In Europe, the biggest gainer was France up 3.1%. UK closed the week up 1.6% followed closely by Germany up 1.5%. In the Americas, US was up by 1.6% while Brazil was up by 1.3%.

Source: Yahoo Finance, Kitco

04:56  Weekend investing mantra
"It is absurd to think that the general public can ever make money out of market forecasts." - Benjamin Graham
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3 Responses to "Will opening up this sector improve India's fortunes?"

R Shankar

Jul 24, 2011

Insightful and compact.. !!
Keep up the good work !



Jul 23, 2011

The opening of the Retail sector is not going to be good for India. As rightly pointed out by Fmr FM Yashwant Sinha in a TV interview, this will have a huze impact on the neighbourhood kirana stores. Even in a tier III city where just one Big bazaar is having a huze impact on the small stores. At first the customer visits this stores on a Sat / Sunday and than after comparing the prices, he makes one visit every month to buy his requirements. The middle class which is the biggest source for the small kirana stores shifts immediately. Now the only thing in favour of kirana stores would be the credit he allows. Again, the middle class person is able to calculate the price difference and he is ready to shift and buy in Cash. Already the mini super bazaars in every tier II and III cities are already filling the heat of the competetion and have started coming out with scheme and discount to retain their fickle "loyal" and regular customer. So the effect once the giants like Walmart / Target and the likes are allowed,will be felt all over India.
One important aspect we forget while comparing ourselves to western world and more particularly to US is our huze densly populated cities to their 1/3 of our population and three times the huze size of land they have. One cannot compare everything which is good for US ?w,world would be good for us. Zamin Assman ka farak hai or Zammen aasman kabhi mill nahi sakte.
Our huze pop and densely populated cities JUST cannot be compared to teh US / W. World.
Feed back requested.


Raj Dhillon

Jul 23, 2011

If we take U.K. as an example, inspite of large supermarkets, small kirana type stores started flourishing with the displacement of Indians from East Africa. In due course, as the next generation of displaced Indians moved up in life, their place was taken up by the displaced Sri Lankan Tamils who are now ruling the roost. The U.S. of A. has it's own brand of Kirana type stores. With so many towns and cities dotting our country, does one think that the Kirana stores will be affected? Absolutely not. This is just a canard being put up by obvious parties.

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