India: Financial Markets
Prepared by:
Joel Vilmenay
For many equity investors affected by three consecutive years of losses in the world's major markets, India is competitive in offering a combination of strong economic growth opportunities and high-quality companies (Holland, 2002). If the world's economy dips back into a recession posture in 2003, India's cost-competitiveness will help protect the Mumbai market from a downturn. And if the international economy rebounds, India's dominance as a service exporter will give Mumbai a healthy head start as a well-positioned player in the recovery (Holland, 2002).
India has its fair share of geopolitical risks, violence and terrorist activity (Sullivan 2001). In addition, agrarian failures and water shortages could increase India's rural poverty. But with the threat of all-out war with Pakistan averted, the remaining instability should not significantly concern careful investors, given the benefits India has to offer (Holland, 2002).
To begin, there is India's favorable economic trend. GDP growth is forecast by the Asian Development Bank to hit 696 in 2003, a rate second only to China among Asia's most viable economies. For once, foreign exchange is flowing into India. Official foreign-currency reserves rose in excess of $500 million a week during November of 2002 to reach a record $66.6 billion. As low costs increasingly attract foreign direct investment into India, the state governments are embarking on a round of competitive deregulation in order to attract investment dollars, making it as easy for foreigners to do business in India as anywhere else in Asia (Anonymous, 2002).
Moreover, the rupee has stopped depreciating, increasing 1.5% since May 2002, to the benefit of foreign investors. With moderate inflation and a reduction of interest rates to a record low 6.5% in October of 2002, the rupee’s strength has prompted economists to forecast further rate cuts from the Reserve Bank of India, boosting businesses across the board. With long-term interest rates at just 6.5%, for the first time many companies' cost of capital has fallen below their return on equity, which, as of December 2002 stood at a market-wide 18% (Holland, 2002).
Notwithstanding, there are still economic problems. The most serious difficulty is India's fiscal indiscipline, which is expected to push the combined central and state governments' budget deficit to nearly 10% of GDP this year (Sabharwal, 2002). But even that high level should not prove insurmountable for an economy growing at 6% a year (Holland, 2002). International rating agency Standard & Poor's (S&P) in September of 2002 said India faced a downgrade to its BB credit rating. For now, though, Indian debt prices are performing well, with the GOI 7.40% 2012 (the benchmark 10-year bond) hitting a record low yield of 6.82% (Sabharwal, 2002).
The outlook for government debt looks reasonable, with the authorities heeding warnings that the fiscal deficit must be kept under control. Revenues in 2002 were in line with forecasts, and further evidence of fiscal responsibility is provided by asset sales. As such, S&P's warning may not now be followed by a rating change (Sabharwal, 2002). Even if it is, according to Holland (2002), one Mumbai-based analyst thinks that any effect on debt prices would be minor. The key fact is that liquidity conditions are favorable, and should remain so. The Reserve Bank of India (RBI) wants to keep monetary policy nimble to provide cheaper funds for companies. With firms having borrowed at high nominal rates in early 2002, when expectations for economic growth were too aggressive, they are now reluctant to take on new obligations. Therefore, the government is prepared to rectify this error (Sabharwal, 2002). As well, the external market trends give India’s central bank room to maneuver. The recent weakness of the US dollar means that there is pressure on the RBI to allow the rupee to appreciate (Sabharwal).
With all these considerations in mind, there is even some room for a moderate uptick in Indian bond prices, over the short to medium term. There is a culture in India of banks providing short-term working capital to companies, and other institutions lending to them on a longer-term periods. Staples would do well in securing competitively priced capital if needed. India’s financial markets are competitive and are presently attractive to foreign direct investment.
References
Anonymous. (2002, Sep). Indian Debt Holding Up. Asia Monitor: Indian Subcontinent Monitor. Retrieved January 9, 2002 from http://mdusa.lib.umd.edu/proxy/uc/umi
Holland, T. (2002, Dec). Reversal of Fortunes. Far Eastern Economic Review. Retrieved January 7, 2002 from http://mdusa.lib.umd.edu/proxy/uc/umi
Sabharwal, M. (2002, Feb). New Freedom Needed. Business India. Retrieved January 7, 2002 from http://mdusa.lib.umd.edu/proxy/uc/umi
Sullivan, J. J. (2001). Exploring international business environments. Boston, MA: Pearson Custom Publishing.