With India, Long-Term Profit Potential Trumps Near-Term Concerns

By Martin Hutchinson
Contributing Editor
Money Morning

India remains a great long-term profit play. But global investors should beware of the near-term exuberance that followed that nation's weekend elections.

The Indian market zoomed 17% on Monday on the news that the Congress Party had been re-elected with an increased majority. It's certainly true that some of the other alternatives - for example a weak leftist Third Force coalition including the spectacularly corrupt Mayawati Kumari (India's richest politician, a keenly fought title) - would have been worse.

Nevertheless, you have to remember that the Congress Party (also known as the India National Congress, and referred to by its initials, INC) is responsible for most of India's woes, both recently and in the 60 years since independence, and that putting it back into power is unlikely to bring much of a step forward - economically speaking.

Condemned to Slow Growth

For more than 40 years after independence - albeit with one short exception - India was ruled by the Congress party and condemned to slow economic growth. Then, after 1991, then finance minister Manmohan Singh began opening up the economy. However, growth had already slowed again in the mid 1990s and it was only under the Bharatiya Janata Party (BJP) government of Atal Bihari Vajpayee in 1998-2004 that India removed many of its longstanding statist obstacles to growth, and began to enjoy economic growth rates comparable to those of China.

The Vajpayee government was rejected by the Indian electorate in 2004, in a stunning act of electoral ingratitude second only to Britain's shocking 1945 rejection of Winston Churchill, who had helped engineer the Allied victory in World War II.

Since 2004, India's Congress Party has been back in power under Singh - this time as prime minister - in a coalition with the left. The nation's leadership has made endless promises of reform, but has really accomplished very little. Economic growth has continued to be rapid, largely because of the Vajpayee government's reforms, which were particularly extensive during that administration's last two years in power in 2002-2004. The Congress Party's main achievements were run-ups in both public spending and the fiscal deficit, the latter of which seems likely to run at a rate of about 12% of gross domestic product (GDP) for the 2009-2010 period - if state deficits are included.

By the 2009 election, Vajpayee had retired, and his successor as BJP leader - L.K. Advani - was both old and associated with the party's Hindu nationalist wing, so it's not surprising that the BJP failed to make progress. The collapse of support in the election for the mostly leftist third parties is itself a good sign, making a swing back to the BJP under new leadership more likely whenever the next election occurs, probably in 2014.

In the five intervening years until that happens, India will have to endure a Congress Party government, either under current Prime Minister Singh, or possibly under newcomer Rahul Gandhi - grandson of former Prime Minister Indira Gandhi, which would make him the latest member of the Nehru/Gandhi dynasty to hold that office.

Don't Expect Reforms

Congress' claim to reformism becomes especially thin when you look at the party's allies. For example, West Bengal's Trinamool Congress led the violent opposition to Tata Motors Ltd.'s (NYSE ADR: TTM) "Nano" automobile plant in that state. Tata had managed to do a deal with Bengal's Communist state government to produce the revolutionary $2,000 car, but the Trinamool Congress was able to force Tata to relocate the plant to Gujarat at a cost of more than $500 million, delaying the full production of the Nano by more than a year. In the recent elections, Trinamool, in alliance with the national Congress Party, was rewarded with 26 of West Bengal's 42 parliamentary seats, and its leadership will doubtless be part of the new government.

The new government's policy is thus unlikely to be very reformist, especially as it rejoices in the support of the egregious Mayawati. In welcoming the election win, Prime Minister Singh indicated further areas where India's public spending and transfer payments needed to be increased, with no suggestion that privatization or reining back the immense public-sector deficit were a priority. It's thus likely that the Indian government will continue as an ever-increasing drag on the economy, with a funding crisis possible if public spending increases too much.

In such an environment, it is unlikely that India's 8% average growth rate of the last five years can continue; the average of the next five years is much more likely to be in the 4% to 5% range, possibly with an acute foreign exchange crisis at some point. There's no question that India's stock market - trading at a Price/Earnings (P/E) ratio of roughly 20 - is expecting much better than this. That means it's time to step back.

When - and How - to Make Your Play

Once the euphoria has dissipated, and the Indian market has dropped at least 30% from its current level, to below 10,000 on the Bombay Stock Exchange's Sensex Index, Indian shares will once again be worth looking at, if only because of the country's immense long-term-growth potential - an upside great enough to overcome even the immense drag of most of its governmental shortcomings.

At that point, the heavy capital investors such as Tata Motors should be avoided, because of the unpredictability of capital availability in a capital market whose savings can be sucked into the government's immense maw. Look instead at such non-capital-intensive exporters (the exchange rate is likely to remain relatively weak) as the software company Infosys Technologies Ltd. (Nasdaq ADR: INFY), or global pharmaceuticals producer Dr. Reddy's Laboratories Ltd. (NYSE ADR: RDY).

Both stocks are currently somewhat expensive, with Infosys trading at about 18 times the consensus analyst estimate for forward earnings, and Dr. Reddy's roughly 14 times. But both stocks should be purchased for long-term growth during periods when investor enthusiasm for the Indian market has had a chance to cool down.

[Editor's Note: When Slate magazine recently set out to identify the stock-market guru who most correctly predicted the stock-market decline that accompanied the current financial crisis, the respected online publication concluded it was Martin Hutchinson, a veteran international investment banker who is one of Money Morning's top forecasters.

It was no surprise to our readers: After all, Hutchinson warned investors about the evils of credit default swaps six months before the complex derivatives did in insurer American International Group Inc. Then, last fall, Hutchinson "called" the market bottom.

Now Hutchinson has developed a strategy for investors to invest their way to "Permanent Wealth" using high-yielding dividend stocks. This strategy is tailor-made for an unpredictable stock market that's backdropped by an uncertain economy. Just click here to find out about this strategy - or Hutchinson's new service, The Permanent Wealth Investor.]

 

News and Related Story Links: