What next for India?

2006 was another tremendous year for the Indian equity market, which saw the country?s bluechip index, Bombay Stock Exchange Sensex, up 46% on the previous year. This gain is well above the 19% compounded return since the inception of Sensex in April 1979. It is also the fifth calendar year in a row the Index has provided a positive return, with the Sensex up 4.2 times since 2001. Of course, the past is not necessarily an indicator of the future. Furthermore, as bottom-up investors, our portfolios bear little resemblance to the composition of the Index, so forecasting where the market will go, is for us, at best, an academic exercise of little value.

What is clear is that India today is a much more robust economy than five years ago. The confluence of a number of factors: the upturn in the global economy; the drive towards ITenabled solutions; globalisation; and most importantly of all, the benefits of structural reforms undertaken in past years, have ushered India into what could potentially be a virtuous cycle of growth. This is evident through a number of indicators: recent tax collections running well ahead of the budget; a fiscal deficit which is lower than forecast; state finances in better shape; and corporate and investor confidence at an all-time high.

Investors are attracted to the growth India offers. Corporate profitability momentum is strong and even though cost pressures have started to rise, companies have so far continued to report top line growth ahead of expectations. A good example of this is India?s leading mobile telecoms operator, Bharti Airtel. The company has seen its subscriber base treble to 30 million in the past two years. Just last week, Bharti Airtel announced that its net profit for the first quarter of 2007 almost doubled from a year ago, thanks to robust growth in new subscribers.

Increased competition, low tariffs and rising middle class incomes have helped India's telecommunications industry post impressive growth in recent years, making it the world's third largest mobile phone market after China and the United States. Adding to India?s growth is an abundance of liquidity arising from a higher global risk appetite and one begins to appreciate why the Indian market has been re-rated from one of the least expensive in the Asia Pacific region, to one of the most expensive.

The question of how long the current growth trajectory can be sustained is much more difficult to answer. India?s chronically inadequate infrastructure remains the Achilles? heel to the country?s potential. In order for the growth to continue beyond the next two years, the government needs to facilitate faster infrastructure improvement. Some progress is being made. Indeed, the positive corporate capex cycle and a step-up in infrastructure projects will support underlying economic growth and are some of India?s longterm growth drivers. The government?s focus on infrastructure has increased substantially, boosted by a number of public/private sector initiatives including road, power, port and airport projects.

But clearly much more needs to be done, and more importantly, in a coordinated and effective manner, if India is to have any hope of emulating China. Consumption growth is a second long-term growth engine. Rapid economic growth is throwing up significant new employment opportunities in tourism, retail, construction, engineering and healthcare in addition to the fast growing IT services sector. As a result of relatively higher disposable incomes, consumer confidence has grown, fuelling a consumption boom. Some of this spending addresses pent-up demand, but much of it is structural, reflecting a favourable demographic profile which should continue to grow and strengthen.

However, there are concerns. With interest rates and inflation now at higher levels than at the beginning of 2006 and rising worries of a global economic slowdown, investors? skepticisms on the prospect of India providing superior risk-adjusted returns in 2007 is understandable. In conclusion, 2007 is certainly going to be a challenging year for Indian investors as bouts of volatility are expected to be common for the high beta Indian market. However, for the longerterm investor, India remains a potentially high alpha market offering many well managed companies operating in a strong domestic growth environment. For those with an appetite for risk, they should remain invested in India.

First State Investments (Singapore)