India's Economy Hits the Wall

Growth is slipping, stocks are down 40%, and foreign stock market
investors are fleeing. Business blames the ruling coalition for failing
to make reforms

Just six months ago, India was looking good. Annual growth was 9%,
corporate profits were surging 20%, the stock market had risen 50% in
2007, consumer demand was huge, local companies were making ambitious
international acquisitions, and foreign investment was growing.
Nothing, it seemed, could stop the forward march of this Asian nation.

But stop it has. In the past month, India has joined the list of the
wounded. The country is reeling from 11.4% inflation, large government
deficits, and rising interest rates. Foreign investment is fleeing, the
rupee is falling, and the stock market is down over 40% from the year's
highs. Most economic forecasts expect growth to slow to 7%—a big drop
for a country that needs to accelerate growth, not reduce it. "India
has gone from hero to zero in six months," says Andrew Holland, head of
proprietary trading at Merrill Lynch India (MER)
in Mumbai. Many in India worry that the country's hard-earned
investment-grade rating will soon be lost and that the gilded growth
story has come to an end.

Global circumstances—soaring oil prices and the subprime crisis that
dried up the flow of foreign funds—are certainly to blame. But so is
New Delhi. Much of the crisis India faces today could have been avoided
by skillful planning. India imports 75% of its oil to meet demand,
which have grown exponentially as its economy expands. The government
also subsidizes 60% of the price of such fuels as diesel. In 2007, when
inflation was a low 3%, economists such as Standard & Poor's Subir
Gokarn urged New Delhi to start cutting subsidies. Instead, the
populist ruling Congress government spent $25 billion on waiving loans
made to farmers and hiking bureaucrats' salaries.
Botched Opportunities
Now those expenditures, plus an additional $25 billion on upcoming
fertilizer subsidies, is adding $100 billion a year—or 10% of India's
gross domestic product, or equivalent to the country's entire
collection of income taxes—to the national bill. This at a time when
India needs urgently to spend $500 billion on new infrastructure and
more on upgrading education and health-care facilities. The
government's official debt, which dropped below 6% of gross domestic
product last year, will now be closer to 10% this year. "Starting last
year, the government missed key opportunities" to fix the economy, says
Gokarn. In fact, he adds, "there has been no significant reform done at
all in the past four years"—the time the Congress coalition has been in
power.

Even the most bullish on India are hard-pressed to recall any
significant economic reforms made in the recent past. A plan to build
30 Special Economic Zones is virtually suspended because New Delhi has
not sorted out how to acquire the necessary land, a major issue in both
urban and rural India, without a major social and political upheaval.
Agriculture, distorted by fertilizer subsidies and technologically
laggard, is woefully unproductive. Simple and nonpolitical reforms,
like strengthening the legal system and adding more judges to the
courtrooms, have been ignored.

A June 16 report by Goldman Sachs' (GS) Jim O'Neill and Tushar Poddar, Ten Things for India to Achieve Its 2050 Potential,
is a grim reminder that India has fallen to the bottom of the four BRIC
nations (Brazil, Russia, India, and China) in its growth scores, due
largely to government inertia. The report states that India's rice
yields are a third those of China and half of Vietnam's. While 60% of
the country's labor force is employed in agriculture, farming
contributes less than 1% to overall growth. The report urges India to
improve governance, raise educational achievement, and control
inflation. It also advises reining in profligate expenditures,
liberalizing its financial markets, increasing agricultural
productivity, and improving infrastructure, the environment, and energy
use. "The will to implement all these needs leadership," points out
Poddar. "We have a government in New Delhi with the best brains, the
dream team," he says, referring to Oxford-educated Prime Minister
Manmohan Singh and Harvard-educated Finance Minister P. Chidambaram.
"If they don't deliver, then what?"
Disillusioned Business
More worried than most are India's businessmen, who have turned in
stellar performances with their investment and entrepreneurial drive
and begun to look like multinational players. For them, there's plenty
at stake. But lack of infrastructure, from new ports to roads, along
with an undeveloped corporate bond market and high prices for real
estate, commodities, and talent, are causing them to hit "choke points
and structural impediments all over. We will lose years," says Bombay
investor Chetan Parikh of of Jeetay Investments.
Sanjay Kirloskar, chief executive of Kirloskar Brothers (KRBR.BO),
a premier $470 million maker of water pumps, already has $100 million
in overseas contracts. Yet few infrastructure contracts have come from
New Delhi. Kirloskar had hoped to be part of a grand project linking
India's rivers, but those plans have been on hold for four years. "The
infrastructure growth we had hoped for has not come about," he says.
"Instead, we will now expand overseas more than in India."

Such constraints on growth at home will have an impact. Corporate
earnings growth is likely to dip, says Merrill Lynch's Holland, who now
predicts just 10% growth, instead of the previous year's 20%. That
slowdown makes it less attractive for foreigners to invest in India's
stock market. Already this year, foreigners have taken $5.5 billion out
of the market, compared with the $19 billion they invested last year.
Gagan Banga, chief executive of India Bulls Financial Services, an
emerging finance and real estate giant, points admiringly to China's
ability to maintain its growth momentum for a decade, while India's has
not been able to hold up for even three years. "Serious companies are
going to grow at a much slower pace, and some may even de-grow this
year," he says. Unless major policy decisions are made by New Delhi
immediately to keep the economy on the growth path, he says, "India
will slow down even further."
New Delhi defends its four year reign in India. "We've had 9% growth
for four years in a row," says Sanjaya Baru, media adviser to Prime
Minister Singh. "That is unprecedented." He attributes it to the
increasing rate of investment, up from 28% of GDP to 35% currently,
"close to most ASEAN economies," though he admits that a large part is
from the private sector. "Yes, there is a fiscal problem, but there's a
price to be paid for coalition politics," adds Baru. So having growth
drop "from 9% to 7% is not grim."
Social Backlash?
Chetan Modi, head of Moody's India, says the increasingly high cost of doing business in India may
force global investors who had set up base in India—especially
financial-services players—to move to more affordable and efficient
hubs, such as Singapore and Hong Kong. If the economy slows and
inflation continues to accelerate, says Sherman Chan, economist at Moody's Economy.com, "social unrest is possible."

In fact, India is becoming a dangerous social cauldron. The wealth
harvested by the reforms of previous governments has made itself
evident in the luxury cars and apartments in India's big cities,
leaving much of India full of aspirations but few means to achieve
them. There is a severe shortage of colleges, yet a plan to build 1,500
universities gathers dust. The Communists in the ruling coalition are
against both globalization and industrialization, so without new
factories being built, employment growth has been almost stagnant,
rising to just 2%—a disappointing rate in a country where an estimated
14 million youths enter the workforce every year, but just 1 million
get jobs in the regulated, above-ground economy.

Meanwhile, few expect any bold moves New Delhi, especially with
national elections due in 2009 and five important state elections
scheduled before the end of this year. Thus far, the ruling Congress
party's record has been poor; it has lost almost every state election
this year and is likely to lose all five of the upcoming ones.

The big hope for a return to the course of reform in India,
businessmen hope, will be a new government in New Delhi next year. The
gravest danger is that India's messy coalition politics will bring into
power another indecisive alliance that will keep the country in policy
limbo for another five years. If so, says S&P's Gokarn, it's a
meltdown scenario: growth slipping below 6.5%, accelerating the chances
of India reverting to its 1991 status when it was plunged into a
balance-of-payments crisis.

Source: Business week

Volatile market may benefit NRI investors

NRI investors are watching the current bearish days on the Indian stock market with trepidation. From the peak of the bull run at over 20,000 on June 8, the Sensex has plummeted to less than 13,000 now. The rise in crude prices has fuelled inflation at over 11 per cent and the recent monetary policies to curb demand have accelerated the decline of the Sensex.

Considering the current volatility in the equity market, what does an NRI investor do? For some, the knee jerk reaction would be to panic and start selling in anticipation of the market weakening further due to rocketing oil prices and spiralling inflation.

For others, it could be 'Hold on!' The market can go lower and better bargains can be picked up for stocks, including blue chips. It all depends on how much lower will be the market decline and for how long.

And as Indian stocks may get sucked in the global spiral of depression, the third option for some NRIs would be to buy right now, as the market seems to be heading to its bottom.

This opposite view is for the adventurous. Those who look to the silver lining and have an appetite for risk taking think that the market will go up again because of India's overall economic strength.

Inflation in India is expected to come down after six months, according to the finance minister. So these investors are bullish on the long-term prospects of the Indian economy where the Risk-Reward Ratio is in their favour. Thus they can invest now to add low priced stocks to their portfolios for possible high gains later on.

Finally, there are the extra-cautious NRI investors. They do not want to speculate in the market but want to safeguard their hard earned investment funds 100 percent and so go for fixed returns. With real returns from fixed income options turning negative due to spiralling inflation and uncertain equity markets in the medium term, they do not know what to do.

Now with all these conditions, how can you have your cake and also eat it? Since stocks are not the answer for these trepid investors, mutual funds have recently launched innovative structured products for them. Known as Equity-Linked Fixed Maturity Plans, these schemes provide a 100 percent capital safety with returns linked to the equity market albeit with some conditions.

Investment advisor Sanjay Durgan of AbunDanze explains how it works: "There is an Initial Value, Observation Value and the Closing Value of the Reference Index that is NIFTY. The Observation Date for NIFTY is fixed as the last Thursday of every month during the tenure of the plan. Returns are determined based on the difference between the Closing and Initial Value of NIFTY. Depending on the structure of the scheme, the Closing Value could be the average of the last three months NIFTY Observations of the period of the scheme."

Adds Durgan: "Depending on the structure of the scheme, the Initial Value of NIFTY could be the closing date of investment in the plan or some average of the initial few months. Observation dates for NIFTY are fixed as the last Thursday of every month. The catch lies in the Observation Values that are pre-conditions known as 'triggers' that could apply if any Observation Value were to breach them."

For example, if at Closing Level, NIFTY rises by 50 per cent from the initial level, the investor gets 150 per cent participation (i.e. 50 multiplied by 1.5 ensure 75 per cent absolute return on investment).

However, a trigger condition could be if NIFTY were to rise by more than 100 percent or any Observation Date, then the investor gets a flat 65 percent absolute return after 36 months.

If NIFTY falls, the investor still gets the principal amount in full. The minimum amount for investment is Rs.5,000 and the period is fixed for such investments. It can be 21, 36 months or as structured by the fund house.

In this 'heads you win and tails you win' situation, a risk averse investor is protected for the face value of the capital with a potential to generate returns linked to the equity market.

Since these are close-ended schemes, they are ideally suited for those who have the relevant time horizon for investment and are looking for a little more excitement than the plain old vanilla fixed-income options.

"Though the capital is safe, the returns are maximized only if the market moves within a certain range. This is more like the casino that works on probabilities but your money is safe," said Durgan. If you are a conservative investor, this is a 'win-win' situation.

Source: Economic Times