India's Economy Standing Firm Amid the Growing Global Financial Crisis

[Editor's Note: This is the eleventh installment of our "Outlook 2009" series, which looks at the global investing outlook for the New Year.]

By Mike Caggeso
Associate Editor
Money Morning

In a surprise to many, India’s central bank has cut its base-lending rate four times since October, going from 9% to its current rate of 5.5%. After all, isn’t India’s economy growing nearly as fast as China’s? And isn’t that growth already being fueled by an unprecedented level of middle-class spending?

The answer to both questions is a resounding “yes.”

But there’s a pesky asterisk here – and that’s the global financial crisis, the cash drought that has sapped nearly every country directly through their banking systems, or indirectly through fluctuations in exchange rates and gyrations in revenue received from key trading partners.

And the Reserve Bank of India’s rate cut proved two things:

First, its new governor, Duvvuri Subbarao, is less afraid of inflation than he is a global slowdown.

“A 100-basis-point cut is an indirect admission that not all is ‘hunky dory’ with the India growth story,” Nandkumar Surti, chief financial officer at JPMorgan Asset Management India Pvt. Bank in Mumbai (JPM), told Bloomberg News.  “One way to look at it is that the global problem has begun to affect us.”

For years, India doggedly raised rates to keep widespread inflation in check. It even went as far as subsidizing food and forcing the state-owned oil companies to sell gasoline to domestic consumers below cost.

And second, Subbarao believes India should taper its economic growth outlook for 2009.

This installment of “Outlook 2009,” report will chart India’s growth next year – its headwinds, tailwinds and possible factors that could turn the direction of either. 

It will also reveal the two best ways investors can ride along with India’s economic growth, and take home profits from India’s bullet-proof industries – and in the process, perhaps even offset some of the losses they’ve incurred here in the U.S. market.

India’s Headwinds  

India’s economy logged an annual growth rate of 7.6% for the quarter ended Sept. 30 – its slowest rate of growth in nearly four years.

India’s farm sector employs about 60% of India’s 1.14 billion people. That was great during last year’s run-up in commodity prices, but those prices have subsequently fallen, and so has the ag sector’s rate of growth – 2.7% in the quarter ended Sept. 30, which is well below the 4.7% pace of a year ago, according to The Wall Street Journal.

Manufacturing – also a powerful economic engine – has also stopped chugging as hard. That sector advanced 5.0% in the last year, a significant drop from the 9.2% growth from the same period the year before.

The global deceleration bears much of the blame for those drop-offs, as the United States far and away, remains India’s top trading partner.

But India is now dealing with a major share of homegrown problems – issues that have become ever more glaring as India’s economy grows in size.

The biggest problem of all: India’s domestic infrastructure is sorely deficient.

The country’s roads and highway systems are a mess, and its power grid is grossly insufficient for an economy of India’s size and rate of growth. That’s an observation that Money Morning guest columnist and well-known India-investment expert Karim Rahemtulla observed firsthand in India last year, when he lead an investor’s field trip around the country. 

And while India has a prosperous and growing middle class, more than 200 million people living there are living in poverty. The government has taken many measures in the past decade to reduce poverty, but Rahemtulla says that the nation’s poor are “mostly against reform because they see little benefit from it.”

In a way, that, too, is an infrastructure issue. India’s poor don’t feel any kind of real connection to the country’s financial system. Indeed, many work day-by-day in the thousands of farming villages. A wave of government reform won’t affect them because they are living at such a far distance – physically, socially and culturally – from the parts of India that would benefit from any changes, new programs, or financial-stimulus efforts.

Even with those obstacles, the World Economic Forum (WEF) and Confederation of Indian Industry predict India will grow 7.4% to 7.8% in the 2008-2009 fiscal year.

But not everyone agrees with that assessment.

Not going to happen,” Rahemtulla said. “There will be positive growth because India will reduce rates and devalue the rupee in order to stave off economic contraction which it can ill afford.”

But Rahemtulla was just as quick to credit the Reserve Bank of India for taking action as the global financial crisis spread across the world.

“They have explicitly stated they will aggressively promote fiscal and monetary stimulus to promote growth,” Rahemtulla said.

India’s Tailwinds

No question, the global financial crisis has crippled economic growth around the world. But the malaise – combined with the significantly reduced inflation that’s resulted from the downturn – has opened up a straightaway into which India can shift its cautionary policies, refuel its economic engine, and ultimately re-accelerate growth.

“Taking note of the downturn in the inflation rate, RBI has lowered the policy rate as well as the reserve requirements. RBI's policy is now biased towards stimulating growth,” India’s former finance minister, Palaniappan Chidambaram, said in reference to the steps taken by the Reserve Bank of India.

“If the rate of inflation continues to decline, the policy rates may also moderate and the bias in favor of growth may deepen,” he told economic editors during a meeting late last year, Reuters reported.

India’s annual inflation fell near a 10-year low of 6.38% in December, a dramatic drop from the 13% growth rate in August. The trend is expected to continue, with inflation slowing to 5% or less by March, Pronab Sen, secretary at the ministry of statistics and program implementation, told Reuters

That could open a door for the Reserve Bank of India to cut interest rates further, encouraging banks to lend money. And though lower rates may weaken the rupee, Rahemtulla says that will make India’s exports more appealing – especially as countries around the world tighten their belts amid the global financial crisis.

Low inflation isn’t the only tailwind that’ll rebound India’s economy back to its high speed.

India’s overall economy sputtered, but a pair of critical sectors posted promising numbers: Construction is up 9.7% from a year earlier, while India’s service sector has advanced at a robust 10.8% in that same span.

Credit goes to India’s middle class, which, like China’s, is growing in both numbers and overall strength.

Also very promising: Only $1 billion of the Reserve Bank of India’s $510 billion loan portfolio is in toxic Western assets.

That explains why – at a time when the global turmoil has claimed several major U.S. banks – none of India’s banks have gone bust.

India is unmistakably frugal. And its monetary policy proves that it is willing to accept a reputation for being a stifler of growth – instead of being known as being clumsy, overzealous and even reckless, as many U.S. banks are now accused of being.

Two Ways to Play India… for Cheap

Like every major economy, India is falling short of previous economic forecasts in large part because of the global financial crisis.

But make no mistake: Next to China, India’s economy will grow four-to-five times faster than most of the world’s other major economies – many of which are stuck in recession.

For now, investors should target the companies in India that are internationally competitive and are active exporters. That’s because any budget or inflationary difficulties will probably be reflected in a weakening of the rupee, which will help countries exporting from India.

Infosys Technologies Ltd. (ADR: INFY) is India’s premier exporter of software. The company carries almost no debt, and its shares are trading at a current Price/Earnings (P/E) ratio of 12.6, with a dividend yield of 1.48%. That P/E is quite low for a company in a high-growth market such as software.

Dr. Reddy’s Laboratories Ltd. (ADR: RDY) is India’s premier manufacturer of generic pharmaceuticals, and is positioned to benefit in the 2008-2012 period as many popular drugs lose their patent protection and are opened to international competition. In the near term, too, as household and corporate budgets tighten around the world, people will more likely opt for generic prescription drugs, instead of high-price name brands.

Dr. Reddy’s has moderate debt (about 50% of equity), and is trading at 19 times forward earnings – not at all pricey, given the high promise of the generic-drug sector. The stock also features a modest dividend yield of right around 1.0%.

Both stocks are down nearly 50% from their 52-week highs, suggesting value.

[Editor's Note: As the whipsaw trading patterns energy investors have endured this year have shown, the ongoing financial crisis has changed the investment game forever. Uncertainty is now the norm and that new reality alone has created a whole set of new rules that will help determine who profits and who loses. Investors who ignore this "New Reality" will struggle, and will find their financial forays to be frustrating and unrewarding. But investors who embrace this change will not only survive - they will thrive.

Money Morning Investment Director Keith Fitz-Gerald has already isolated these new rules and has unlocked the key to what he refers to as "The Golden Age of Wealth Creation." But Fitz-Gerald brings more than a realization - and an understanding - to the table, here. After a decade of work, he's also developed a new computerized trading model based on a mathematical concept known as "fractals." This system allows him to predict price movements of broad indexes, or individual stocks, with a high degree of certainty. And it's particularly well suited to the kind of market we're all facing right now. Check out our latest report on these new rules, and this new market environment.]

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