Pinakin Patel, manager in JP Morgan’s Japanese and Pacific region equity group, talks to Neal Underwood.
Q. What has driven India’s economic growth to date? A.
A.There are multiple factors, and the key for India is that these multiple drivers are all working at the same time. Consumption has grown dramatically. Its demographics have meant that a high savings rate is having a trickle-down effect. There are a lot of employees in the IT and financial services sectors, and a lot of higher wage growth has come through.
Another driver is rural areas. India is 20% urban and 80% rural, and the rural areas are farmer orientated. The government has increased spending in rural areas by 25 to 40%; there has been a lot of investment into agriculture, which has a high return on investment.
The third important driver is infrastructure spend. India spent little from about 1950 to 2000; it is only since then that it has been adding infrastructure. It previously added 11,000km of roads a year – since 2000 it has added 11,000km a day. Infrastructure spending is expected to double in the next five years, and investment in infrastructure as a percentage of GDP is still only roughly 5%. Another key catalyst is that since 2000 India has seen the growth of China and its investment in infrastructure, and this was its wake-up call.
Q. How big a role have IT exports played? A.
A.IT amounts to about $32 billion (£16 billion) in terms of value. It is increasing at a 25% compound annual growth rate, so it will probably take another three years to double. It employs about 3.5m people and accounts for about 20 to 25% of GDP. India is conscious of its dependency on IT and is looking to establish new industries. It is dependent on an American client base as an end provider so will go through periods, particularly in American election years, where it is front loaded or back loaded, but it is here for the long term and will grow.
Q. Do problems with red tape hold back Indian corporations? A.
A.Yes. The scores for India in the World Bank Doing Business survey, which includes how long it takes to open and close a business, are indicative of the red tape. If a foreign investor needs a Foreign Institutional Investor (FII) licence it takes a long time. India is aware that foreigners are using P-Notes [as a way round this] and is starting to try to convert these into ordinary investors. A lot of foreign investors have stated that red tape is a problem. There is a need to create greater transparency over the FII process.
Q. Can the country’s infrastructure keep pace with the rate of growth? A.
A.The economy is running at 8 to 9% GDP growth and the infrastructure is creaking at best. Capacity utilisation in India is currently at 84 or 85%. The government needs to invest in infrastructure and is making efforts – it has put out tenders for airports, and continues to build roads – but GDP growth is running ahead. We are seeing a lot of foreigners making investments in infrastructure and via property funds.
Q. How much effect is foreign investment having on the stockmarket? A.
A.Foreign investors account for about 20% of the Indian market including ADRs [American Depositary Receipts] and GDRs [Global Depositary Receipts]. This has not really risen since 2004. It is worth pointing out that many shares are owned by company owners, known as promoters. India still has strong owners of these corporations, but foreigners are substantial players. In direct investment, the figure for foreign direct investment rose from $5.5 billion in 2006 to $15.7 billion this year, which includes Vodafone’s acquisition of Hutchison India.
We will see more M&A. A lot of foreign investors are looking at whether to acquire a company or build their own. Cement firm Holcim, for example, preferred to take stakes in two or three Indian stocks. But given the rise in the Indian stockmarket in the past two or three years, the cost of such acquisitions is not as cheap. Many foreign multinationals are looking at setting up production facilities in India. They are talking about using the India facilities to export and want to move production away from China. India has a ready supply of consumers on the doorstep.
Q. The India country report from the Organisation for Economic Cooperation and Development (OECD) says that India’s annual economic growth could reach a sustainable 10%. Is this realistic? A.
A.The June quarter GDP growth came in at 9.3%, while the consensus was at the 9% level. To get up to a sustainable 10% the infrastructure needs to be improved. In the labour market there is a shortage of middle management and skilled labour, so labour is being bid up and the cost of labour is affecting margins. There are some structural impediments to getting to 10%. It seems bullish; the maximum is probably about 9.5%.
Q. What are the long-term prospects for the Indian economy? A.
A.We remain positive on the economy and the market over the long term. We upgraded India in early September from neutral to overweight – we believe investors will look to India for growth. The story of India is still strong. There is a strong macro environment, and on corporate earnings India will grow by about 30%. It has seen growth in each of the past 16 quarters. This gets more difficult as time goes by but it continues to beat expectations. It is coming off quite a high base, but we see more than 500 companies a year and our feedback from corporations is that they are positive about the outlook.
It is a domestically orientated economy, which is why we saw money coming back in in August. India is less dependent on America and the quality of earnings is extremely strong. It will work alongside China, although we believe India is several years away from China. Asia is seeing strong growth as a region, but India and China are the drivers.
Q. What impact does politics have? A.
A.When there is a change, which we last saw in 2004 when Congress won, it brings about a bit of instability, a bit of a dampening. There are effects from a micro perspective but this tends to be fairly short-lived. Markets in India have faced several political issues over the years but the fundamentals and the liquidity story remain strong.
Q. The country’s finance minister has said surges in the Sensex worry him. Are the recent stockmarket rises unsustainable? A.
A.Our view is that markets have taken a breather. The fundamentals are still strong. We have proven the case for India – it is hard to see how that level of growth will completely fall off. We will get volatility along the road but those periods are where you take money off the table or put more in. The long-term structural story is still there. By 2010 the global population will see a 314m increase; 71m of those will be in India. You have a young population, so the demographics are strong.
PINAKIN PATEL is a client portfolio manager in JP Morgan Asset Management’s Japanese and Pacific region equity group in London. He has more than 11 years’ experience covering Asian and specifically Indian markets