Tapping into India's investment opportunities

India is a large and diverse market that offers attractive investment opportunities, writes Ragu Sivanesarajah.

Sitting in traffic on the outskirts of Delhi certainly gives you time to think. “Excuse me sir, there is nothing here, can you please try to phone the company again?” enquires our very polite driver, Ashwani.

Unfortunately, we have the wrong address for one of the Indian companies we had planned to visit. The mobile phone networks are congested, so we can’t get fresh directions. We are left on a sandy, pothole ridden road with just the company of a few stray dogs loitering nearby.

At times like this it is easy to dismiss the progress India has made over the years.

However, here lies the real opportunity. There is still much room for India to continue to grow, and not just through infrastructure. India is a country with an extremely young, large population with a median age of only 25.

As this young population matures and people move from being dependents to earning and finally spending, it will be a powerful force for economic growth.

In considering investments in India, it is worth exploring:

• gross domestic product (GDP) growth rates;
• debt levels;
• transparency and disclosure;
• the profitability of Indian companies; and
• equity market performance.

GDP growth

As investors look for new opportunities, the GDP growth of an economy gives us a scorecard. Economies that are able to grow without excessive debt should provide ample investment opportunities.

India has shown impressive GDP growth rates over the past 20 years, exceeding global and developed countries. In addition, the economy has also shown great resilience during periods of stress.

Over the last year the economy has grown close to 6.5 per cent despite the global financial crisis.

Furthermore, during the 1997 Asian currency crisis India still recorded reasonably robust economic growth despite a severe downturn in the region (see figure 1).

Debt levels

Until recently, Standard & Poor's gave Indian Government Debt an inferior rating to Greece (BBB- for India versus BBB+ for Greece until its downgrade to BB+).

At first glance, it highlights that India is running a sizeable fiscal deficit. However, upon closer look a large domestic savings pool is revealed, so overall credit to GDP is low compared to the Western world.

The key is that despite the Government spending more than it is collecting, it is financed domestically by the savings pool.

Very little of this debt is external, which is reassuring to investors. Even if the economy deteriorates, there will be little likelihood of India facing the refinancing problems that have plagued Dubai, Iceland and Greece (see figure 2).

In contrast to the government sector, the household sector in India is in a financially strong position.

Bank deposits dominate the household balance sheet, making up more than 50 per cent of total household assets.

Household debt is very low, not just compared to developed markets but also to other Asian nations, in total making up only 10 per cent of GDP. Debt levels in India at this stage should not be an impediment to further economic growth (see figure 3).

Transparency and disclosure

There seems to be a view that it is safer to invest in US, European or even Australian equities that are exposed to Asia rather than investing directly.

Delving deeper, this view seems to stem from concerns around disclosure and accounting standards. India has a market capitalisation of US$1.4 trillion and close to 4,000 listed companies.

Disclosure standards vary across companies, from some of the best in the region (including Australia) to the bare minimum.

As an example, Infosys Technologies, an Indian and US-listed company with excellent disclosure, consistently reports its results 10 business days after the end of each quarter, giving details on hiring plans, industry exposure and customer wins.

Dismissing the whole Indian equity market based on transparency and disclosure alone is severe.

Profitability of Indian companies

A metric that we use to assess companies is return on equity, which is simply the profit a company generates relative to the net assets of the company.

This metric allows us to compare the performance of companies not only within their own industries but also across the region. Ideally, we are seeking companies that earn attractive returns on equity and are able to continue growing their business.

Over the years, Indian companies have generated high returns on equity, approximately 15 per cent to 20 per cent, which is consistently higher than the global average (see figure 4).

In addition to the profitability of companies we consider the volatility of earnings.

Companies with volatile earnings can be difficult to manage and can encounter problems when financing their growth.

This is another reason why we prefer to avoid companies with high levels of debt, as it can make earnings highly volatile.

Listed Indian companies have displayed less earnings cyclicality compared to the rest of the world and to other emerging markets.

The ability to earn high returns on equity combined with lower earnings volatility is another attractive quality to us when considering Indian equities (see figure 5).

Performance of Indian equities

The Morgan Stanley Capital International (MSCI) India Index has performed strongly over the last year, returning close to 90 per cent in US dollar terms.

Longer-term performance has also been significant, with the MSCI India significantly outperforming the MSCI World. The returns for MSCI Australia have also been significant, assisted by the strong Australian dollar (see figure 6).

So why invest in India?

India remains a large, diverse market for investments.

Valuations and risks should be considered, however, we have chosen to focus on a few of the attractions we see with investing in India. More precisely, factors that we believe are not as well appreciated by investors in Australia.

Ragu Sivanesarajah is one of AMP Capital’s Asian equities senior portfolio managers.