India: Going for jumbo gains

By Vikram Barhat | February 4, 2011 | Last updated on February 4, 2011
5 min read

The Indian economy is an elephant growing at 9%, making it a formidable beast in the global financial jungle, a financial expert from India recently said.

An amusing parallel, but the pachydermal analogy actually makes a strong case for the world’s fourth largest economy as an investment destination of choice.

“India is the country of investment opportunity and high potential returns,” says Bhim D. Asdhir, president and CEO of Mississauga, Ontario-based Excel Funds Management. “Investors should be allocating at least half of the equities component of their investment portfolios to emerging markets.”

Asdhir puts his money where his mouth is. “About 80% of my money and my kids’ money is in emerging markets; a substantial part of that in India,” he said. “This is how confident I am.”

Asdhir’s assertions are backed up by Mumbai-based Ajay Argal, portfolio manager for Excel India Funds, who also heads offshore equities of Birla Sun Life AMC, a joint venture between the Birla group in India and Sun Life Financial of Canada.

“The interesting thing to note is that over the next five years India is actually going to outpace China in growth, and this growth is going to be of better quality, because there is going to be lower cyclicality due to the domestic oriented nature of consumption, which is two thirds of GDP,” says Argal who is currently in Canada as part of an India-themed road show organized by Excel Funds.

This constant comparison may project India as the next China, but Argal says the two economies are very different. “Interesting thing to note about India and China is that they’re complimentary in nature,” says Argal. “For any global investor, it’s a case of India and China, and not either/or.”

The Indian story, he said, is about consumption, a young population, rising income levels and aspirations. In addition to being hi-tech and capital intensive, it is largely domestic oriented, with exports representing less than 35% of GDP.

China, on the other hand, is low-tech and labour intensive. “If you look at China it’s the other way around, because there are a lot of fixed asset investments, which are going to support manufacturing capacities, primarily for the export market,” says Argal.

The world is familiar with China’s impact on global economy, and Argal believes India will have a somewhat similar impact in the time to come. “It is estimated that in the incremental global GDP, 10% will be contributed by India’s growth; it is a meaningful and a significant chunk and it is very important for any global investor to note this.”

Demographics and domestic consumption form the bedrock of Indian economy, but it’s the numbers, not the narrative, that tell the real story:

  • India’s GDP stands at a whopping $4 trillion in purchasing power parity (PPP) terms
  • 10% of its growth driven by domestic consumption, a middle class of 350 million people
  • 180 million people are about to join its workforce
  • 8.4% is the expected GDP growth over the next five years
  • 50% of India’s 1.2 billion population is under the age of 25
  • 610 million of those are future car buyers, twice the size of the entire U.S. population.

Translation: vast investment opportunities in India.

“We think that the coming two or three decades are going to be very good for the Indian economic growth as well as the returns in the stock market,” says Argal.

Yet, India’s per capita consumption is a fraction that of China. Poor penetration levels of consumer goods – mobile phones, televisions, vehicle, for instance – is said to be the culprit.

India wants to get closer to the per capita consumption of China. But it’s unlikely for the next 15 years, says Argal.

“If you look at a parameter like power consumption, India’s current demand is about 165 gigawatts, whereas China’s current demand is 800 gigawatts; as for the estimates by various analysts, even by 2025 India’s power demand is going to be just 540 gigawatts, far short of where China is today.”

Even on those assumptions the growth rates in India look very attractive. Rising per capita income and urbanization are driving demand for infrastructure. Infrastructure investments in the next decade are expected to reach about $1.4 trillion, the equivalent of India’s current GDP.

“The objective is to get the infrastructure to GDP ratio up to 10%, which is what is the ratio in China at the moment,” says Argal. Currently it is at about 5%. Other growth areas with investment potential include the banking sector, pharmaceuticals, gas, auto ancillaries, software and industrials.

“Market valuations in relation to 20% earnings growth are very reasonable and sustainable,” says Argal. “We are overweight pharmaceuticals, gas, and automotive and underweight banking, petroleum products and metals.”

Suffice it to say that this equation changes with every market correction when valuations alter, creating either entry points or exit cues.

Of course, there are some risks involved, as is the case with any equity investment. Most of these risks are rooted in global events – sovereign default risks, or global recovery, or how the U.S. credit is going to exit. Argal dismisses these as short-lived tremors that only have a limited impact on India’s largely inward-looking economy.

He is, therefore, more concerned about internal worries such as inflation and valuations.

“At the moment core inflation is 7%, and it is falling; so we think that inflation is a bit of a worry, but it is not anything which is going to derail the India story, especially from the long-term perspective,” says Argal.

The other worry is valuations. But they must be looked in the context of growth and of return ratios, urges Argal. “If you look at the valuations after the correction [in January], we are now trading at 15 times forward multiple, which we think is quite reasonable, because our average since 2000 has been around 14 times.”

The 10% correction in January could be a good entry point for investors who want enter the Indian market, says Argal, or an opportunity to increase holdings for those invested in India.

India is at the centre of what’s happening in emerging markets. The infrastructure needs are building up, the consumption story is just starting and there are still a lot of poor people in India going through the cycle of becoming middle class.

“The biggest reason why India,” says Asdhir, “is because India is driven from bottom up; it’s needs-driven. People need something, they’ll build it.”

And an elephantine economy is just an inevitable by-product, as India has displayed.

Vikram Barhat