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How to Get Rich Investing in Stocks by Riding the Electron Wave

Despite India’s Optimism, There May Be a Better Time to Buy Indian Stocks

Stock-Markets / India Feb 10, 2010 - 05:31 AM GMT

By: Money_Morning

Stock-Markets

Best Financial Markets Analysis ArticleMartin Hutchinson writes: The Indian government announced Monday that the country's economy was expected to expand by 7.2% during the fiscal year that ends next month.


Agriculture - which had been expected to be a major drag on the economy because of a poor monsoon season - contracted a mere 0.2%. That is a truly stellar performance, showing that India - like China - has emerged almost unscathed from the global economic meltdown. It would pretty well justify the Bombay Stock Exchange Ltd.'s rich Price/Earnings multiple of 20 and would make Indian stocks a "Buy" even at these levels.

Unfortunately, when looked at closely, the picture is not quite so rosy.

For one thing, the Indian government - which tends to run budget deficits even in the best of economic times - engaged in substantial fiscal "stimulus" in 2009, an election year. And while the central-government-budget deficit appears tolerable at 8% of gross domestic product (GDP), provincial governments also run budget deficits - in amounts equal to an additional 4%-5% of GDP.

With a consolidated budget deficit of 12%-13% of GDP, India's fiscal position is up there with such international bad actors as Greece, Britain and Ireland. And it's substantially worse than the U.S. position. India's saving grace may be the fact that its public debt level is relatively low at around 60% of GDP, and is largely domestically held, primarily in the banking system, much of which is state controlled.

That pinpoints a problem. Since investors around the world have become worried about Greece, there's every chance that they'll one day become just as worried about India.

India does not have the overwhelming domestic savings flow that allows China to be fairly free and easy about public spending. So if India's budget deficit gets too high it relies on foreign financing - both debt and equity - to bridge the gap. While the Indian growth rate is so high and observers generally so bullish, that is not much of a problem. But any slowdown in growth could widen the budget deficit still further and cause a crisis of confidence.

Another problem is inflation. India undertook monetary - as well as fiscal - stimulus in 2009. The Reserve Bank of India lowered its repo rate to 4.75%, which may not appear all that low except that India's inflation rate ran at 10.7% in 2009. The upshot: Real interest rates are sharply negative.

As in the United States, this has done wonders for the stock market, but it has also created a bubble-like atmosphere for investments that is rapidly widening the country's current account deficit and stimulating inflation. Since food prices are currently rising at a rate of 17% per annum, because of the drought, the effect on India's poor is severe. The effect of rising food prices on the budget is almost equally severe because of India's wide range of subsidies on food products.

Markets sense the problems ahead. The Bombay Sensex Index has not again approached its January 2008 level of 21,000; its most recent peak - at 17,686 - was reached in December 2009. Since then, the index has dropped roughly 10%. But even at that reduced level, as I remarked earlier, India's stock market is hardly a bargain.

It appears that India is headed for the economic equivalent of a one-two punch - a simultaneous monetary crisis and fiscal crisis. Inflation will get uncomfortably high while the government struggles to fund its budget deficit and "crowds out" small- and medium-sized business borrowing while doing so. A period of government-spending austerity would alleviate both problems, but is pretty unlikely as the currently governing Congress Party has a history of heavy public spending constrained only with difficulty. Either way, there is likely to be a period of considerable retrenchment among India's business and consumers.

Given this prognostication, a heavy capital investor such as Tata Motors Ltd. (NYSE ADR: TTM) should be avoided, in spite of that company's recent remarkable recovery from 2008 difficulties that stemmed from a lack of available capital.

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 the drug company Dr. Reddy's Laboratories Ltd. (NYSE ADR: RDY).

Both stocks are currently somewhat expensive: Infosys is trading at 23 times the consensus forward earnings estimate for the year that ends in March, while Dr. Reddy's is trading at 20 times the consensus earnings estimate for the current year. However, both companies should be bought for their long-term-growth potential, plus the possibility of additional profits from a manufacturing base linked to a weak rupee.

Nevertheless, at some point India is likely to run into crisis. That's when you should buy the market, because the long-term-growth prognosis is unquestionably positive.

Hutchinson is now making those insights available to individual investors. His trading service, The Permanent Wealth Investor, combines high-yielding dividend stocks, gold and specially designated "Alpha-Bulldog" stocks into winning portfolios.

Source: http://moneymorning.com/2010/02/10/indian-economy/

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