March 6, 2006 issue - The buzz in the financial circles a few months ago was that every man and his dog could raise money to invest in India. Now the thinking is that a man is no longer required.
India lies at the heart of a boom. Of the $150 billion that has flowed into the stock markets of developing nations since 2002, nearly a fifth has gone to India. It is now one of the most expensive emerging markets in the world, with an average price-to-earnings ratio of 15. India is thus the hottest of the hot markets.
For sure, it has critical mass. India ranks as one of the three largest emerging markets in terms of economic size and stock-market capitalization, with both breadth and depth on offer. There are about 100 companies in India with a market value of more than $1 billion. Foreigners have invested in more than 1,000 Indian companiesâa record for any country outside the United States. These investors think the opportunities presented in South Asia's biggest economy are unlimited, given its potent mix of brainpower and large scale.
The working assumption among many foreign investors is that India will continue to crank out growth rates of 7 to 8 percent, which the very efficient corporate sector will translate into earnings growth of 15 percent a year for eternity. Analysts vie to predict how fast India will rise as an economic power, and how soon it will regain the might it wielded two centuries ago, when it accounted for 20 percent of world economic output.
The only problem is that the future rarely plays out as predicted, particularly in the developing world, where countries have systematically overpromised and underdelivered. These societies tend to push reform in hard times and fritter away gains when the pressure abates. This cycle has played out repeatedly in commodity-dependent countries, and helps explain why per capita income in many Latin American and African countries has not risen for decades.
India is unlikely to suffer any such fate. It has unleashed enough entrepreneurial energy to ensure that even in the worst-case scenario, economic expansion will slip back only to its past 25-year average of 5.5 percent. However, given the expectations, that growth trajectory would feel like a recession to many investors.
The question, then, is whether current growth rates are sustainable. The profile of the Indian economy and equity market suggests that the current boom is born of global trends. The acceleration in the growth rate has been accompanied by a decline in inflation and a rally in the equity market that mirror the experience of the average emerging market in recent years. When the class of emerging markets fades, India, too, is likely to lose some of its sparkle.
Even more troubling, Indian policymakers are showing the same symptoms of cyclical dithering that have stopped many emerging markets from realizing their potential. With blockbuster economic growth not leading to political victories for the last ruling coalition, led by the Bharatiya Janata Party, or the present Congress-led regime, the political class seems to have lost all faith in economic reforms. Instead, populism is on the ascendant.
The Indian government has adopted a tax-and-spend bias, hoping this will help Congress regain the political ground it has been losing at the national and state levels, despite the economic boom. Its showcase policy guarantees one hundred days of employment a year to one person in every rural household. The government would be better off redirecting these wasteful subsidies, worth billions of dollars a year, to build the roads and bridges required to spread real growth to the hinterland.
Whereas the fortunes of one part of India continue to rise at a frenetic pace, many Indians are still reeling under water crises, power shortages, bureaucratic harassment and utter lawlessness. Some estimates suggest that the government has effectively lost control in nearly 20 percent of the country's 584 districts. Those districts are instead dominated by ultraleft militant groups known as Naxals. Most large cities face regular power cuts, many villages have no electricity and business surveys show that lack of power is likely to become an even bigger infrastructure bottleneck. Logically, the power sector would be an urgent target for reform. Well, not in India. There is little political willpower to crack down on power theft, and politicians still think doling out free power to farmers is a vote winner.
It's always easiest to grow quickly from a low starting point, and given the depth of India's poverty, it should be able to at least match China as the world's fastest growing economy. But to hit that paceâabout 10 percentâIndia needs to shed the cyclical habits of other emerging markets. It needs to reform even in good times, rather than falling prey to populism.
Sharma is the co-head of global emerging markets at Morgan Stanley Investment Management.
India lies at the heart of a boom. Of the $150 billion that has flowed into the stock markets of developing nations since 2002, nearly a fifth has gone to India. It is now one of the most expensive emerging markets in the world, with an average price-to-earnings ratio of 15. India is thus the hottest of the hot markets.
For sure, it has critical mass. India ranks as one of the three largest emerging markets in terms of economic size and stock-market capitalization, with both breadth and depth on offer. There are about 100 companies in India with a market value of more than $1 billion. Foreigners have invested in more than 1,000 Indian companiesâa record for any country outside the United States. These investors think the opportunities presented in South Asia's biggest economy are unlimited, given its potent mix of brainpower and large scale.
The working assumption among many foreign investors is that India will continue to crank out growth rates of 7 to 8 percent, which the very efficient corporate sector will translate into earnings growth of 15 percent a year for eternity. Analysts vie to predict how fast India will rise as an economic power, and how soon it will regain the might it wielded two centuries ago, when it accounted for 20 percent of world economic output.
The only problem is that the future rarely plays out as predicted, particularly in the developing world, where countries have systematically overpromised and underdelivered. These societies tend to push reform in hard times and fritter away gains when the pressure abates. This cycle has played out repeatedly in commodity-dependent countries, and helps explain why per capita income in many Latin American and African countries has not risen for decades.
India is unlikely to suffer any such fate. It has unleashed enough entrepreneurial energy to ensure that even in the worst-case scenario, economic expansion will slip back only to its past 25-year average of 5.5 percent. However, given the expectations, that growth trajectory would feel like a recession to many investors.
The question, then, is whether current growth rates are sustainable. The profile of the Indian economy and equity market suggests that the current boom is born of global trends. The acceleration in the growth rate has been accompanied by a decline in inflation and a rally in the equity market that mirror the experience of the average emerging market in recent years. When the class of emerging markets fades, India, too, is likely to lose some of its sparkle.
Even more troubling, Indian policymakers are showing the same symptoms of cyclical dithering that have stopped many emerging markets from realizing their potential. With blockbuster economic growth not leading to political victories for the last ruling coalition, led by the Bharatiya Janata Party, or the present Congress-led regime, the political class seems to have lost all faith in economic reforms. Instead, populism is on the ascendant.
The Indian government has adopted a tax-and-spend bias, hoping this will help Congress regain the political ground it has been losing at the national and state levels, despite the economic boom. Its showcase policy guarantees one hundred days of employment a year to one person in every rural household. The government would be better off redirecting these wasteful subsidies, worth billions of dollars a year, to build the roads and bridges required to spread real growth to the hinterland.
Whereas the fortunes of one part of India continue to rise at a frenetic pace, many Indians are still reeling under water crises, power shortages, bureaucratic harassment and utter lawlessness. Some estimates suggest that the government has effectively lost control in nearly 20 percent of the country's 584 districts. Those districts are instead dominated by ultraleft militant groups known as Naxals. Most large cities face regular power cuts, many villages have no electricity and business surveys show that lack of power is likely to become an even bigger infrastructure bottleneck. Logically, the power sector would be an urgent target for reform. Well, not in India. There is little political willpower to crack down on power theft, and politicians still think doling out free power to farmers is a vote winner.
It's always easiest to grow quickly from a low starting point, and given the depth of India's poverty, it should be able to at least match China as the world's fastest growing economy. But to hit that paceâabout 10 percentâIndia needs to shed the cyclical habits of other emerging markets. It needs to reform even in good times, rather than falling prey to populism.
Sharma is the co-head of global emerging markets at Morgan Stanley Investment Management.