Outlook 2008: Five Ways to Profit Even If India's Growth Slows in the New Year

Editor's Note: This is the Ninth Installment of an Ongoing Series Highlighting the Global Investing Outlook for 2008.

By Martin Hutchinson
Contributing Editor

Over the past five years, India has demonstrated it is a growth economy rivaling that of China. But, unlike China, India is a democracy, so it's far less likely the economy will suddenly be derailed by a coup or distorted by some crazy government policy.

Without a doubt, every serious investor should have a portion of his or her portfolio positioned to take advantage of India's extraordinary long-term growth. Nevertheless, even the fastest growth rate can slow down, or even pause for a breather, and it looks as though India may experience such a growth pause in 2008. Investors should remain positive, but must also be selective. [For a related story on India's economic growth in today's issue of Money Morning, please click here].

Three Obstacles to Accelerating Growth

India's economic growth has been spectacular in the last few years, and was expected to hit 9% in 2007. However, most forecasters, including Standard and Poor's Inc., for example, expect it to slow a bit this year, perhaps down to around 8%. And that may be a little optimistic, for there are likely to be three factors working against India in the New Year. Let's look at all three:

  • First, there is the likelihood of a recession or a prolonged period of slow growth in the United States, which is India's largest trading partner. Such a slowdown could induce such countries as China, Japan and Korea - those with balance-of-payment surpluses - to put more of a focus on domestic demand and growth, which would enable them to continue their rapid growth. India, however, runs a modest current-accounts deficit. So any rapid run-up in domestic demand - combined with a decline in exports - would leave it with an exacerbated balance-of-payments problem. Thus, an export decline is likely to translate into an economic slowdown, as the Reserve Bank of India would be forced to follow more-cautious policies with respect to its monetary and foreign-exchange policies.
  • Second, India's inflation rate is heading higher. As an importer of oil and most other key commodities, India is highly subject to the vagaries of global commodities prices and has little control over domestic price levels other than through direct subsidies. And while the Indian government did not allow the price of domestic gasoline to rise last year - despite a 60% increase in petroleum prices - consumer-price inflation remained close to 6% in the year through October. With the huge jump in oil prices, and given the Reserve Bank's target for inflation of only 5% -- it seems likely that budgetary constraints will force the Indian government to reduce its subsidies of domestic petroleum and heating oil prices, which could force India's inflation rate up to around 10%. That would force the Reserve Bank of India to raise interest rates from their current level of 7.75%, further cooling growth.
  • Third, India's public sector is in a chronic and increasing deficit-spending situation, a position that has only been exacerbated by the current center-left government.  Even though India's recent prosperity has caused government revenue to soar, year-over-year expenditures have risen even faster, up 28% in the seven months through to November. As long as global interest rates remain low, India can finance such a deficit. However, rates are rising, particularly in India's domestic market. Couple that fact with the potential for slowing output, and India will face a situation in which the government must exercise much greater restraint in its spending for its new fiscal year, which starts in April. By removing that spending stimulus, growth would slow.

Looking a bit further ahead, we see that early in 2009 there is the possibility of favorable political change. The current Congress Party-led coalition government has been in power since May 2004. While theoretically committed to the free market, in practice it has been forced by its Communist allies to abandon economic reforms and increase public spending faster than it should.

However, the BJP party [Bharatiya Janata Party] party, architect of India's economic revival that began in 2001, is doing well in the polls and has just won an important state election in Gujarat. Should the BJP do well enough in the spring 2009 election to form a stable government, economic management should improve and public spending will be better restrained.

There is no doubt about India's long-term growth potential; even the Congress Party has come to accept that its old socialist methods don't work, and that free-market strategies provide India with the surest route to prosperity. Thus, investors should position some of their non-U.S. investments in Indian stocks, and should seek to "buy on dips" in years when growth slows and the India stock market [The National Stock Exchange of India Ltd.] backtracks.

For sound exposure to India, the simplest method is by an Exchange Traded Note, or ETN - in this case, the Barclays IPath India Index ETN (INP), whose returns are linked to the Morgan Stanley Capital International India Index [unlike a conventional ETF, an ETN is technically a 30-year note, meaning it distributes assets to holders at the end of 30 years]. However, that has the disadvantage that it is tied to the Indian stock market as a whole, which currently looks high, given its Price/Earnings ratio of about 25. It is also trading at about a 15% premium to its net asset value (NAV) - very high by ETF standards. So, as an alternative, you might consider the Morgan Stanley India Investment Fund Inc. (IIF), or the India Fund Inc. (IFN), both actively managed funds investing in India, and which currently trade at discounts to NAV of 3% and 2%, respectively.

Individual shares to look at would include Infosys Technologies Ltd. (INFY), a software giant that currently trades at a high multiple of 26 times trailing earnings [although its P/E of 19 times projected earnings is a bit more palatable].

My particular favorite is the pharmaceutical company Dr. Reddy's Laboratories Ltd. (RDY), which as a major generic drugs manufacturer can expect to benefit from the expiration of many U.S. pharmaceutical patents in the next five years, and is trading at a forward P/E ratio of only 15.

Editor's Note: Money Morning's "Outlook 2008" series last covered Bond Investing. Next up: Latin America.

News and Related Story Links: