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India to the fore

India’s rapid economic growth looks set to continue, making it an attractive prospect for the investor

Economists believe that India has broken out of its sub-4 per cent rate of growth and predict an average of 7.6 per cent from 2004 to 2007.

There are compelling reasons to believe that consumption, exports and investment will continue to grow. Half of India’s 1.1 billion citizens are under 25 which means that in the next five years its population will outstrip China’s. This grow-ing population is becoming richer and better educated, making the country more competitive. India’s exports of software services and pharmaceuticals alone could top $20bn next year.

Indians are well-qualified and English-speaking. and continued outsourcing to India is inevitable while the average income remains around $1,000 a year.

Investment by Indians in their own economy is only just starting to catch up with the country’s enormous potential. Greater political stability, good macro management by the Government and the success of India’s goods and services on the world economy have gradually removed any doubts. Indians may have had. In addition, a rising exchange rate and increases in capacity utilisation meant confidence no longer needed to be bought and investment took off with a rush, closing 2004 at a record 5,000bn Rupees.

But profits have grown even faster so that, on average, despite this surge in investment, listed companies have no debt. Ungeared returns on equity are in excess of 20 per cent.

The market today is valued at about 13.5 x projected earnings, with growth forecasted at 15 per cent. As Indian firms continue to invest, they will turn to cheaper debt financing so return on equities can be expected to accelerate further. In this context, India’s year-long stockmarket boom could be viewed as a cyclical market catch-up within a longer-term bull market. Recent currency jitters aside, it is difficult to conjure up a bubble when a market is valued at less than 15x, has no gearing and shows 15 per cent earnings growth and 22 per cent return on equities.

That said, what are the prospects for derailment?

In terms of political instability, the minority United Progressive Alliance coalition is likely to remain in office throughout its term and will not block reform.

With regards to market volatility, the Indian equity market is broad, not deep, leading to market volatility. The biggest Indian fund ($3.5bn) would only be able to find three stocks in the market where it could invest 1 per cent of its portfolio within a week without moving prices. These figures become more important when one considers the time it would take to exit the market in an emergency.

Risk in India can be best managed by investing in funds of less than $500m (at this size 39 stocks can be bought or sold within a week as opposed to three). The prospects for growth are good because India’s continental scale will inevitably drive growth in consumption, and education will support its exports.

Globalisation reduces the risk of negative political shocks and accelerates growth. In the short term, globalisation will also increase volatility. Foreign investors should be optimistic but careful.

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