Lately I’ve been diving into the so-called BRIC countries, Brazil, Russia, India and China, and now I’m turning my focus on India. Just as Brazil is not as bad as it’s been painted and China’s debt situation is worse than reported, there are deeper layers to consider when investing in India.
There’s been a renewed focus on investing in India for reasons which I totally agree are positive developments. They’re doing all the “right” things on a macro scale as evidenced in particular by the election of the new Prime Minister, Narendra Modi, and the central bank chief, Raguram Rajan.
Modi’s election marked a turning point in India’s politics as the politically active middle class finally exerted its muscle and backed a business-friendly, anti-bureaucratic Prime Minister. From a modest background himself, he embodies the middle class, and has their support to continue the liberalizations of the 1990s, which led to increased entrepreneurship and has fueled the private sector.
Rajan, the Governor of the Reserve Bank of India (RBI), is a former University of Chicago professor who has already made a dramatic impact by enacting policies that brought India’s current account deficit for the fiscal year in at $56 billion, well below estimates of $70 billion, and certainly less than the $88 billion the previous year.
Furthermore, he has made it his mandate to reduce inflation in India. Although he’s been criticized for not focusing on growth, I say you cannot have growth with high inflation. It must be brought down: The prime lending rate is very high and small- and medium-sized enterprises cannot afford to borrow and invest.
So, what’s not to like?
India is on a positive path, but there are many obstacles still in its way. In particular, the issue of transportation has been tempting investor interest, but I believe will not and cannot be the first place we see major growth.
In a nutshell, even though India already spends more on transportation per GDP than any other country with a comparably-sized economy, the transportation infrastructure is somewhere between virtually non-existent and a mess.
The problem is, when you want to take goods from one part of the country to another part, you have to forge rivers, carry things on your head, there’s a challenged infrastructure in place. So, while they can make goods cheaply, they can’t get them to market, which is India’s problem
While I’ve seen many articles pointing to the fact that India’s government has pledged $10 billion to improve its infrastructure and implying investors should follow the money and invest in infrastructure-related corporations, I have three reactions.
First, $10 billion is not enough. It’s a $2.5 trillion/year economy with limited infrastructure. I’d say $500 billion would be closer to a number that would make a significant difference.
Second, as of now, most of the money appropriated for infrastructure spends gets stolen. It’s a problem that hasn’t been solved.
Third, and most importantly for the investor, I believe something else must happen first before we will see dramatic improvements in infrastructure.
Why the financial services sector is of interest
If I were going to put a bet more narrowly in India I’d do it in financial services, which is directly tied to the growth of the middle class and indirectly tied to better transportation allocations.
Here’s what I mean: Over time, the middle class is going to need more complex financial savings vehicles than they have available. Right now they either keep their cash under their mattress or wear it on their wrists in the form of gold.
Eventually, that’s not going to be enough. They’re going to have to have banks, investment products, and other investment mechanisms. Technically, they have some of those things, but they’re in a state of relative infancy compared to the rest of the developing world, like Brazil for example.
You have a huge percentage of Indians avoiding banks, preferring to carry their assets out into the fields with them where they’re working.
If you can increase savings, and get the money out from under the mattress and off the wrists of women, then what that will do is drive down interest rates. Don’t forget the willing RBI. Such deposits will be huge and they will be used to supply credit and/or to buy government bonds.
This will in turn drive down the borrowing costs and increase the government’s ability to borrow which can then be used as a way to grow their infrastructure.
What’s my proof? That’s what China did. China artificially depressed spending to encourage savings, which lowered internal interest rates (they didn’t match the pace at which the economy was growing in the 2000s). Then they dramatically expanded infrastructure, largely on the backs of citizens’ savings.
With India, I believe the horse (financials) has to come before the cart (infrastructure) in order for the economy to reach its true potential.
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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing in a specific sector involves additional risk and will be subject to greater volatility than investing more broadly.
