Investing in India – Now What?

I recently finished a good book on India, one of the best I've read about the country. Edward Luce is the author of In Spite of the Gods: The Strange Rise of Modern India. He was the South Asia bureau chief for the Financial Times, living in New Delhi from 2001- 2006.

It seems Luce travelled everywhere in India, meeting with local officials, business people, journalists and more. This is the kind of research I put a high value on. There are things you learn by being in a place that you simply can't from afar.

The portrait that emerges from Luce's work is one of incredible complexity, colour and contradiction. Many of the stereotypes you might have heard about India only deepen, while others explode in the face of contrary evidence.

For an example of deepening stereotypes, take the tangled and corrupt Indian bureaucracy. Its army of workers is immune to dismissal. Corruption is rampant and widely accepted in a way strange to Western eyes. This leads to some absurd circumstances. The highway department in India, for instance, employs 1.25 people per mile of road, the highest number in the world. The government pays them more than three times the market rate for such labour. "Many of these employees do not bother showing up for work," Luce writes, "because they cannot be sacked."

Many of India's roads are terrible. Seldom can you go more than 65 km an hour, even on highways. Traffic switches lanes unpredictably and absurdly. Luce writes of driving in a highway lane and having other cars come at him from the opposite direction. Then there are the ox carts and bicycles and the traffic laws that no one enforces.

The Indian bureaucracy is as expensive as it is useless. Much of the government's spending is tied up in paying itself. Salaries for its bloated payroll soak up money that could have gone to building better roads, power systems and water and wastewater plants. Of course, all of these government employees have cushy pensions.

The legal system is also a mess. Widespread corruption is one issue. It is so open that some judges have a menu of fixed prices. Luce writes: "You pay x thousand rupees to get bail if you are standing trial for a narcotics offence, y thousand for manslaughter..." Then there are lots of vacancies and the fact that judges don't work much - maybe from 10 to 3, with at least an hour for lunch. "Perhaps the biggest problem," Luce writes, "is the gigantic backlog of suits in India, which in 2006 amounted to 27 million cases. At the current rate at which India's courts wade through proceedings, it would take more than 300 years to clear the judicial backlog." By some estimates, 10% of the economy's capital is tied up in legal disputes.

Suffice to say, this is a deep-rooted problem. I can only imagine the frustration of trying to do business there. (One memorable quote from the head of Proctor & Gamble's India operations: "In my 30 years in active business in India, I did not meet a single bureaucrat who really understood my business, yet they had the power to ruin it.")

The social problems chronicled in the book are alarming, too. This is another area where stereotypes deepen by reading the book. The old caste system is depressing in its inhumanity. You'll also see the violence of religious strife and stark portraits of extreme poverty.

But the book also explodes stereotypes of India. The big one here is the economy itself, which is peculiar and complex and not what most investors think of when they think of India.

When thinking of India's economy, most investors probably associate it with its outsourcing companies - India as the world's back office, with call centres and armies of computer programmers and engineers. But as Luce makes clear, this part of the economy is still tiny, and much of India's strange economy is poor and backward.

"Fewer than 1 million - that is, less than a quarter of 1% of India's total labour pool - are employed in information technology, software, back-office processing and call centres," Luce writes. Most Indians work in an unorganised and primitive economy, working on farms, running small shops or street stalls, driving rickshaws, working as servants, serving as seasonal labourers and other tasks. More people work for the government (21 million) than in India's private organised sector (14 million).

There is a long way to go in India...which is, oddly enough, part of its great appeal to investors and businesses.

The Indian "middle class", depending on how it is measured, is between 50-300 million people - which alone is larger than the populations of entire Western countries. Then there is brisk economic growth - 9% last year. For these reasons, a long list of companies continues to try to crack the market. AIG, Citibank, Pepsi and many others have already become market leaders in their segments in India. Many more are trying to gain a
foothold.

"During my time in India," Luce reflects, "I have often been amused by the foreign executives I have met who spend years occupying the same hotel rooms while they await the green light for their company to invest in India so they can set up a permanent office."

If you're interested in more on-the-ground reportage on India, I recommend Luce's book. Since the book's publication, a couple of events stand out as interesting landfalls marking India's continued ascent.

There is, for one, India regaining investment-grade status after a 15-year hiatus as the big ratings agencies removed the speculative tag from India's debt. This is important, as it will lower the cost of borrowing for many Indian companies.

Then, probably more importantly, there is Tata Steel's big acquisition of Corus, its Anglo-Dutch peer - the first large acquisition by an Indian company. It has brought out a certain boldness in India's corporate culture. As one leading Indian commentator put it: "I look forward to the day when ICICI Bank takes over Citibank; when Infosys acquires IBM; when Reliance takes over Exxon; and Tata Motors takes over General Motors." Will the Tata Steel acquisition be something future historians muse over as a harbinger of a new trend, or will it be but a footnote?

Plenty of head winds remain. According to the World Bank, the average Indian manufacturing firm loses 8% of sales per year due to power outages. Roads are still lousy. India, like China, is a voracious consumer of energy and raw materials.

Yet such head winds also create opportunity. The daunting prospect of feeding India's economy bodes well for investors in energy and in all of the components of infrastructure. India currently imports 70% of its oil needs, for example, compared with only 30% a year ago.

So should we buy today?

One day, India will be cheap again - and worth a bet. Don't forget last year's nasty sell- off in May and June, when India's markets lost a third of their value. In retrospect, that was a great buying opportunity.

Regards,

Chris Mayer
for The Daily Reckoning

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