Modi’s anti-free-market stance in by passing pro-business measures to revive India’s stalled industrialisation.

India’s new Prime Minister Narendra Modi had only been in power three months before he did an estimated $1 trillion worth of damage to the global economy. In Bali in August of this year, India’s 15^th prime minister sank the biggest deal the 160-member World Trade Organisation has ever nearly reached in its 19-year history. Modi reneged on a global agreement approved by his predecessor that would have reduced the cost of moving goods through the world’s ports. His motive was to indefinitely protect subsidies that lower food prices for about 800 million of India’s 1.25 billion citizens.

While the domestic political motive of India’s first prime minister born after independence in 1947 was stark, Modi’s sabotage of one of the least-contentious aims of the almost-dead Doha round of WTO negotiations was a surprise. For it clashed with the promises of free-market reforms Modi used to propel his Bharatiya Janata Party to victory in elections in May after 10 years in opposition. The BJP’s triumph was so sweeping the right-wing party gained India’s first lower-house majority in 30 years.

Thankfully for investors, the aberration is likely to be Modi’s anti-free-market stance in Bali. And by passing pro-business measures to revive India’s stalled industrialisation, the 64-year-old former chief minister of western Gujarat province could well repair some of the damage he has done to the world economy. The Hindu-favouring BJP’s rare majority in India’s lower house gives Modi the ability to compensate for China’s diminishing role as a driver of global growth. For with a little more government help, India’s economy can achieve a rate of growth that exceeds China’s – say, India’s could top 7% while China’s sinks below this level. Such an outcome would be a rare feat, for only once since New Delhi implemented market-based reforms in 1991 has India’s economy expanded at a faster annual pace than China’s. That was in 1999 when India outgrew China by 1.2 percentage points; 8.8% versus 7.6%. The average annual gap in growth over the past 23 years is 3.4% percentage points in China’s favour – 9.1% average annual growth for China against 5.7% for India.

Modi has taken control of India at a time when it has much catching up to do compared with China mainly because India gave China a 13-year start at reform. India, almost ironically, last had a higher GDP-per-capita than China in 1990, the year before the IMF helped India navigate a balance-of-payments and currency crisis on condition the country modernised. (US$395 output per person India versus US$341 for each Chinese). After more than two decades of better performance, China’s GDP-per-head is now more than four times that of India’s (US$6,747 for China versus US$1,505 to India in 2013), which means, as they have roughly the same population, that China’s economy is more than four times larger than India’s – China’s 1.36 billion people created US$9.2 trillion in output in 2013 versus US$1.9 trillion produced by Indians. (The size difference means India’s economy needs a rate of growth four times faster than China’s to contribute the same amount to global GDP growth.)

Much could disrupt a Modi-led rejuvenation of India, of course, for the country’s challenges are vast. The flipside to India’s ascent over its northern neighbour in terms of the pace of growth is China’s economic descent as it confronts the consequences of the lending boom that Beijing engineered to protect the country during the global financial crisis. So perhaps Modi won’t need to be too much of a star for India to outpace its neighbour. Much of the credit for any improved showing by India would be due to the Reserve Bank of India under Governor Raghuram Rajan, if the central bank were to win its battle against inflation, now down to a five-year low of 6.5%. But whoever Modi would deserve to share any acclaim with, the more pertinent fact for investors is that India’s policymakers are helping unleash, once again, the entrepreneurship of the world’s largest liberal democracy.

Modi’s mojo

India achieved praiseworthy economic growth after reforms were enacted from 1991, even if the pace of growth undershot China’s. But the economy has spluttered in recent years. Economic growth slowed from an average of 8.5% from 2009 to 2011 to less than 5% in 2012 and 2013 as corruption scandals tore at the minority government led by Manmohan Singh of the Indian National Congress party.

The resulting political paralysis and reform setbacks battered foreign and local confidence in a country where inflation is the highest among Asia’s major economies. India’s stock benchmark, the S&P BSE Sensex Index, only rose 3% over 2011, 2012 and 2013 as investors held back their money (compared with, say, the S&P 500 Index’s 47% gain over those three years). The rupee sagged to a record low of 62.62 to the US dollar on 30 September 2013 while foreign investment stagnated.[1] Amid all the economic inertia, widening current-account deficit and budget red ink, rating agencies threatened to slash India’s sovereign credit rating to “junk”.

In contrast, the BJP victory in May this year that ended a decade of rule by Singh’s Congress party drove the Sensex to an immediate record high, the benchmark having already risen 15% since the start of the year to the election day as polls predicted a Modi triumph. (The rally can almost be said to have started with Rajan’s appointment to head the Reserve Bank of India on August 6 last year. The Sensex rose 13% from that day to year end.) Investors saw that the electorate was largely voting for capable and clean administration and for higher economic growth, thus making the politics of reform easier, all accomplishments Modi achieved in his near-13-year stretch as chief minister in Gujarat. Investors became upbeat that the (sometimes disputed) pro-business and corruption-free reputation that Modi brought to the country’s top office could overcome India’s political paralysis and spark a wave of investment.

If Modi is successful, it may well prove because India has so much potential rather than any genius that resides within the leader from India’s lower caste who started out selling tea. India’s economy has potential because the country’s population is young (800 million people are aged under 35) and fast-growing. It is the world’s largest liberal democracy, which means, for all its faults, that the country is blessed with a free media, an independent judiciary, enshrined property rights, a bias towards transparency, an apolitical public service and moderate politics. Its people are industrious and risk-takers. Many of them are highly educated and speak English. Past growth has created a situation where development is self-perpetuating for it’s fashioned a middle class whose consumption can drive the economy. There is much Modi needs to overcome, of course; poor infrastructure, bureaucracy squared – India is ranked 134 out of 189 economies in the World Bank’s “Ease of doing business index”[2], a lame export performance that leads to a chronic current-account deficit, tangled land laws, an energy shortfall, a stubborn budget deficit, benchmark interest rates at 8% as a result of high inflation, a weak banking industry, debt-heavy companies, poor public services and hundreds of millions of Indians who lack basic education and the means to meet everyday needs. Politically, Modi needs to engage about 175 million Muslim Indians who are wary of a Hindu-chauvinistic government.

Modi’s is enjoying a boost from the fact that world economic events are helping his cause. The drop in oil prices helps oil-importing India’s trade performance. It eases pressure on the central government’s budget by reducing subsidy payments. Most of all, it helps reduce inflationary pressures, hopefully allowing the Reserve Bank of India to ease monetary policy to spur the economy.

On top soon

Modi is up against excessive, perhaps even unrealistic, expectations. He faces cynicism that his promises to remove supply-side bottlenecks, attack the fiscal deficit, stimulate investment in infrastructure, encourage labour-intensive manufacturing and improve governance will largely prove talk. Some wonder that he might care too much about his approval rating to take unpopular reform. His first 100 days were a good reply to these critics for he took some risky steps. His boldest moves included boosting railway passenger fares by 14%, reducing the subsidy on diesel and announcing an assortment of changes to encourage more foreign investment in restricted industries, such as introducing a bill to allow 49% foreign ownership of insurance companies. He is trying to impose a national sales tax, a policy he has opposed in the past, and has laid out plans to streamline the country’s rigid labour laws, even if he seems reluctant to privatise state-owned companies or curb many of the subsidies that help India’s poor while cruelling the government’s finances.

The budget brought down in July was viewed by some as a missed opportunity, even though it included steps to reduce the deficit. Critics say it failed to take tougher action against subsidies to mend government finances. More to Modi’s reform credentials, his Independence Day address on August 15 contained a promise to abolish the Planning Commission that recalls India’s pre-1990 socialist ways and the announcement of a goal to boost India’s share of world exports from 1.6% to 2.4% in coming years. (China’s exports comprise 11.1% of the world’s total.) In September, Modi launched a “Made in India campaign” to boost manufacturing from 15% of GDP to 25%, to create jobs for the 12 million young entering the labour market each year. In October, he took steps to shift to make energy prices more market-based.

Perhaps Modi’s biggest economic accomplishment so far could well be that the optimism he generated during his election campaign and by his victory helped India’s economy grow 5.7% in the June quarter from a year earlier. While this is still slower than China’s 7.3% achievement for the September quarter, it was India’s quickest expansion in two years.

It will be a while yet before Modi can be judged. But the Sensex’s 32% surge to record-setting highs over the first 10 months of 2014 shows that stock investors think Modi is as credible a reformer as any country has. They are inadvertently saying that within a couple of years the fastest growing of Asia’s superpowers on an annual basis will be India. The IMF forecasts India to be ahead by 2018;[3] others predict 2017. On a quarterly basis, India’s leap ahead of China could occur even sooner.

Information on Indian and Chinese economic growth rates comes from the IMF World Economic Outlook Database http://www.imf.org/external/pubs/ft/weo/2014/01/weodata/index.aspx. India and China’s share in world trade comes from the WTO trade profiles. http://www.wto.org/english/thewto_e/whatis_e/tif_e/org6_e.htm

Other financial information comes from Bloomberg unless stated otherwise.

by Michael Collins, Investment Commentator at Fidelity

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Important information

Investments in small and emerging markets can be more volatile than investments in developed markets. Investments in overseas markets can be affected by currency exchange and this may affect the value of your investment.

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Nathan Lim

Australia Headlines

• Western Australia’s energy market is broken – wholesale electricity prices ($180 per megawatt hour) cost more than unsubsidised solar and wind, more than double rates in Eastern Australia
• Renewable Energy Target review delivers on preconceived conclusion – local renewable energy industry in peril

AEI Assessment

The Renewable Energy Target review lead by climate skeptic Dick Warburton has recommended changes that would effectively arrest renewable energy development in Australia. While the grandfathering option in the recommendation should provide some security for existing investments (assuming it is adopted), there is nothing to support further large scale developments. We are disappointed that the government seems to be deliberately ignoring the global trend whereby nations are reducing their emission intensity from power generation to address climate change. Support for this trend also comes from the added benefit that it also improves local air quality.

North America Headlines

• California oil refiners take in record oil-by-rail from Utah
• Colorado activists drop fracking opposition in return for new task force to address concerns regarding hydraulic fracturing
• Consolidated Edison sees nearly 100% growth in solar rooftop installation in 2013 – solar cheaper than residential electricity rate
• Democrats increasingly backing oil and gas industry
• Energy Information Administration (EIA) says imported oil to meet 22% of US demand, the lowest level since 1970
• Reinstatement of the Production Tax Credit by Congress before year end remains highly uncertain
• California, under Assembly Bill No.327, starts rulemaking process to integrate cost-effective distributed energy resources into the grid
• Department of Energy, 2013 Wind Technologies Market Report – Wind Power Purchase Agreements at record low of US$25 per megawatt hour
• California passes bill to streamline residential solar applications and installations
• Gina McCarthy, Environmental Protection Agency (EPA) head, says renewable fuel standard ruling out shortly and could be higher because of increased gasoline usage
• EPA to decide this year whether to regulate methane emission from drilling (fugitive emissions)
• FutureGen 2.0 (experimental near-zero emission coal plant) gets EPA approval for CO₂ injection wells
• EPA must rule by December 1 on Ozone standard. Tightening to 60-70 parts per billions will impact power generators through additional nitrogen oxides and volatile organic compound abatement equipment

AEI Assessment

The policy debate around shale oil and gas continues to swing towards the moderates and away from the critics. The growing realisation of its transformational impact on the economy has broadened its appeal as it seems to hold the promise of jobs, prosperity and energy security. As a result we have raised our assessment for oil to Positive.

Renewable energy support policy continues to slide but the cost of solar and wind has fallen so dramatically that financial supports are becoming decreasingly important. As noted above rooftop solar and large scale wind are now competitive in conventional energy markets. Even after deducting the benefits of various subsidies, the economics are not so drastically affected as to completely negate renewable energy’s competitive position. Scale in both technologies and sensible policy support (like California’s decision to make rooftop solar installations less bureaucratic), continues to drive cost down making renewables so close to being strongly competitive against conventional energy on an unsubsidised basis.

The EPA is signalling its strong desire to continue to improve air quality by all means possible with FutureGen now able to proceed to construction and the department’s finding that ozone levels still too high.

Europe Headlines

• UK Department of Energy and Climate Change, less than one-quarter of UK public support shale gas development
• German electricity price go negative again from high wind production
• Italy passes changes to Feed-in-Tariffs for solar, effectively a 20% retroactive cut
• European Commission expected to confirm 40% carbon emission target by 2030 in October, efficiency and renewable targets to be considered
• Ukraine and Russia moving towards a permanent ceasefire

AEI Assessment

The next major policy development for the EU is their 2030 targets. Preliminary discussions continue to suggest efficiency and renewable targets will only be binding at the EU level and not at the country level. Given the ongoing divergence in energy policy amongst member states (Poland versus everyone else essentially), this seems to be a reasonable compromise as it recognises that some countries are more willing than others to migrate to higher levels of renewable energy and take responsibility for their contribution to climate change. Countries have exceeded EU targets in the past so an aggregate target does make sense as long as there are not too many other countries looking to get a free ride. Making the efficiency target non-binding is disappointing though as these are easily the most direct and least difficult technologically to reduce a nation’s energy intensity.

A political resolution in the Ukraine, at the time of publication, appears to be in the making which will substantially reduce the political risk in this region.

China Headlines

• Beijing cuts coal consumption 7% in first six months of 2014
• Smaller cities steer away from GDP as primary performance metrics, focus on raising living standards for poor, reducing poverty and environmental protection
• 70% of Chinese coal companies losing money as coal price at seven year low
• China appeals mixed World Trade Organisation ruling on US duties levied on solar panels, wind towers
• National Development and Reform Commission says China will start national carbon trading by 2016

AEI Assessment

It is becoming abundantly clear that China has recognised that business-as-usual will further aggravate the economic, societal and environmental imbalances in the country. Bringing forward its national carbon trading market and the move away from solely using GDP as a measure of success is tacit recognition by the government that externalities cannot be ignored forever. This will continue to put downward pressure on energy intensive, high emission industries.

Japan Headlines

• Japan has added 9,770 megawatts of clean energy since July 2012 – 98% is solar
• Minister of Environment, Japan should target 30% renewables by 2030
• Abe appoints new cabinet with the popular Yuko Obuchi tasked to push through the unpopular nuclear re-start agenda

AEI Assessment

Japan’s version of President Obama’s “all of the above” energy policy is best demonstrated by the expansion of solar power over the past two years. Over this time, Japan has approved an astonishing 65 gigawatts of new solar projects which actually exceeds Australia’s entire installed base of all forms of generation. The comment made by the Minister of Environment hardly seems necessary but is an important recognition by the government of the role of renewable energy in the energy mix. Yuko Obuchi appointment as the first female Trade and Industry Minister is hoped to appeal to the broader electorate as a recent Nikkei newspaper poll found 65% of female respondents opposed restarting Japan’s nuclear fleet.

Global Headlines

• India is considering adopting a Feed-in-Tariff regime for solar
• India proposing 10,000 megawatts of wind per year
• Brazil energy auction attracts offers of 26 gigawatts of wind, solar
• Africa to install more renewable power in 2014 than in previous 14 years
• 2,200 cellphone towers in India to be powered exclusively with solar
• India does not impose solar dumping duties
• Global solar installations on track for record for 2014, 52 gigawatts
• India’s Prime Minister Modi says good governance and clean energy are top priority

AEI Assessment

Momentum is building for an energy transformation in India and Africa. The deployment of solar cellphone towers in India is significant because it was needed to address the lack of dependable power in the area. This is a reflection of the larger problem facing the developing world where a centralised grid strategy has failed to lift nations out of energy poverty. Building a distributed energy grid around where energy is consumed instead of where resources are located is expected to be a fundamental principle in grid deployment in the developing world.

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Emerging markets look good for the rest of 2014: Van Eck Global

Emerging markets economies are poised to offer higher economic growth for the remainder of 2014 than recent previous corresponding periods, according to Van Eck Global, the US parent company of its exchange traded fund business, Market Vectors ETFs. Van Eck Global currently manages over US$35 billion in assets.

David Semple, Portfolio Manager and Head of Van Eck Global’s Emerging Markets Equity Investment Team said, “The tide is turning for emerging markets, which outperformed the broad US market in the second quarter of 2014—an event we’ve not seen for some time. The asset class attracted particularly strong inflows in April and May this year, the highest inflows since March 2013.

“In the second half of 2014 we believe emerging markets will continue to perform solidly, providing better earning outcomes than we’ve seen in the past three years.”

According to Mr Semple, investors are beginning to warm up to emerging markets again as better earnings typically indicate a recovery. He believes the main risks for emerging markets in the second half of 2014 are geopolitical and interest rate sensitivity.

“Ongoing tensions in Ukraine have impacted the Russian economy and the escalation of sanctions will have a broader impact on a fragile European economy. The earnings impact from the sanctions as they exist today is fairly mild, but we think the cost of equity will rise as investors shy away from the possibility of further and more serious geopolitical tension, combined with the possible implementation of full sanctions on listed companies.

“China continues to provide a mixed picture. There is a wide range of opinions, and a great deal of scepticism about the China story,” Mr Semple said. “There is a continuing tug of war between significant positive and negative economic variables. We believe the ongoing modest and targeted stimulus is expected to continue and keep growth above the 7% to 7.5% level. Despite all that, it’s important not to forget the positives, such as the fact that China has the largest e-commerce economy in the world,” he said.

Despite geopolitical risk, Mr Semple believes most emerging markets countries have absorbed a significant amount of bad news. According to Semple, there are good opportunities in Taiwan, India and Latin America.

“The decisive win for the Bharatiya Janata Party (BJP) in India appeared to be beneficial for the stock market, although there are major hopes for better governance and acceleration of capital expenditure in the near-term. In Brazil, the outcome of the election in early October will be important. We expect a change of government will have a positive impact and will help reinvigorate the stagnant economy,” he said.

“Indonesia has some very significant long-run advantages in terms of demographics and resources, but has significant work to do to increase the return on those assets. This will mean increasing the ease of doing business, whether by investing in infrastructure, streamlining bureaucracy, reducing subsidies, and providing a level playing field for investments.

“We believe emerging market economies will continue to offer higher economic growth in the medium term, particularly as investors increasingly diversify away from their domestic economies and identify better value in stronger performing emerging market economies this year and into 2015,” Mr Semple said.

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US tapering presents investment opportunities: William Blair

Fears of stability across the globe around tapering are creating significant investment opportunities in countries like India, Thailand, the Ukraine, Venezuela and Argentina, according to William Blair’s Head of Dynamic Allocation Strategies (DAS), Brian Singer.

On a visit to Australia to promote William Blair’s DAS to institutional investors last week, Mr Singer said geopolitical events do not tend to change the valuation of assets or the value of currencies.  “Risks are definitely out there, but the developments are creating opportunities,” he said. “These events significantly motivate prices away from or towards fundamental value.”

Mr Singer said William Blair’s DAS team assesses each individual geopolitical situation, to decide whether the opportunity is adequately compensating for the risk that is introduced. “What we are doing is taking some of the risk away from just being exposed to the market and adding risk that is uncorrelated to the currency,” he said. “India became our largest position when Raghuram Rajan became the Governor of the Reserve Bank of India in August 2013.”

India is still the William Blair DAS team’s largest position due to a significant interest rate differential and because the currency is cheap relative to its fundamental value. “It looks to be a great opportunity going forward, and a great diversifier for portfolios.”

Mr Singer said the first port of call for the William Blair DAS team in deciding to invest in equity markets, bond markets and currencies all over the world, is to determine fundamental value. “We look for prices that revert back to fundamental value over time,” he said. “Within the current geopolitically unstable environment, there are a lot of strategic negotiations and it is important to understand those negotiations and the behaviours of the players as that pushes prices around.“

On currencies, Mr Singer’s said the William Blair DAS team estimates the value of the Australian dollar at about $0.65-$0.70 to the US dollar. “So it’s a long way away from fundamental value,” he said. “We are short and we are short most of the commodity currencies for a number of reasons. First of all because we believe commodity super-cycles have led investors to push prices up above fundamental values and secondly because we see the opportunity for those prices to revert back to fundamental value as commodity prices come down.”

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Singh’s alliance has since cracked under corruption scandals. The results of recent state elections will only make it harder for him to unify his political partners and push through the reforms that India’s slowing economy needs.

The results of month-long elections showed that the Congress party performed poorly in three of the five state polls. The most disappointing result was in northern state of Uttar Pradesh, India’s most populous state that, as home to more than 200 million people, is considered to be the political battleground state. Congress was banking on boosting its holding of 22 seats in the 403-seat assembly to at least 80 seats to enable it to form a coalition at state level with the socialist Samajwadi Party so it could cement this party’s support at federal level.

Even though Congress’ bid for power was headed by Rahul Gandhi of the Nehru-Gandhi dynasty that has dominated Indian politics since independence in 1947, the Samajwadi Party won a comfortable majority in the state from the tainted Bahujan Sarnaj Party (whose leader is fond of building statues of herself) – gaining at least 220 of the 403 seats. Congress only won at least 28 seats, to come fourth in a state that sends most MPs to the Lok Sabha, as India’s lower house of parliament is called.

The result follows a bleak 2011 for Congress at a national level and portends poorly for the next general elections in 2014, especially now its hoped-for prime minister Gandhi failed to win over voters. Numerous corruption scandals over the past 12 months or so have scuttled the government’s reform drive as smaller coalition partners have splintered off and thwarted any significant changes.

The most glaring reform defeat was Congress’ announcement last year that India would allow foreign department store owners such as Walmart to set up in India. This decision, which didn’t require the passing of any laws, was overturned within days after Congress’ coalition partners, opposition parties and state governments objected to a move that is seen as threatening the family-run stores prevalent throughout India. Other stalled reforms include attempts to clarify land acquisition, strengthen anti-corruption measures and overhaul insurance and investment management.

Investor verdict
Congress was hoping that a strong performance across the five states would pressure its rebelling federal coalition partners or prompt its outside supporters such as the Samajwadi Party to push on with reforms. Better results may have also improved the morale and determination of Singh’s rattled-looking government.

Even if a Congress-led coalition holds onto power in 2014 (and Congress has ruled India for most of the post-independence era), it’s now more likely to be a far more unwieldy coalition than the one that so excited investors in 2009. The Congress-led coalition that ruled India from 2004 to 2009 was a disjointed coalition that included Communist MPs.

Investors were disappointed with the state election results. “We view the election results as negative for economic reforms and the markets, though a key uncertainty has been lifted,” said Goldman Sachs in a report on the election.  “We think the results will not provide the political space for the government or the confidence to carry through unpopular reforms.”

Congress did win a majority in the northeastern state of Manipur and in the Himalayan state of Uttarakhand, but it fizzled in the northern state of Punjab (won by the incumbent alliance of the Shrimoni Akali Dal and Hindu-based Bharatiya Janata Party) and in the western state of Goa (won from Congress by the Bharatiya Janata Party).

Congress has much work to do to spark another rally in shares.

 This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”).  Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity Worldwide Investment. This document is intended for use by advisers and wholesale investors. Retail investors should not rely on any information in this document without first seeking advice from their financial adviser. This document has been prepared without taking into account your objectives, financial situation or needs.  You should consider these matters before acting on the information.  You also should consider the Product Disclosure Statements (“PDS”) for respective Fidelity products before making a decision whether to acquire or hold the product.  The relevant PDS can be obtained by contacting Fidelity Australia on 1800 119 270 or by downloading from our website at www.fidelity.com.au. The issuer of Fidelity’s managed investment schemes is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009. Details about Fidelity Australia’s provision of financial services to retail clients are set out in our Financial Services Guide, a copy of which can be downloaded from our website at www.fidelity.com.au. © 2012 FIL Responsible Entity (Australia) Limited. Fidelity, Fidelity Worldwide Investment and the Fidelity Worldwide Investment logo and F symbol are trademarks of FIL Limited.

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According to the report, sliding stock prices and ongoing concern about a prolonged global economic rout has increased the attractiveness of mainland China and India as preferred markets. “China is the standout market in the region on valuation grounds but has also been one of the worst performers. China is starting to attract the attention of value oriented fund managers and is a defensive market heading into a global slowdown.”

Despite its poor performance, Russell finds India to be the most compelling market for investors considering Asia. “The relatively attractive valuation from our Composite Value Indicator (CVI) combined with the easing of inflation pressures, peaking in the tightening cycle and India’s defensive characteristics heading into a global slowdown put this market at the top of our list”, said Pease.

Pease says that the economic issues facing Asia ex-Japan seem “decidedly old fashioned” compared to the US and Europe. Asia’s problems include overheating, inflation and policy tightening while problems impacting the rest of the world may see less need for policy tightening across the region.

Singapore, Taiwan and Hong Kong are in neutral valuation zones and are export exposed economies heading into a global slowdown. Singapore is likely to be slower to respond to global growth downturn and Hong Kong also remains vulnerable. Taiwan’s technology bias links it closely to the global demand cycle, but also could be one of the main beneficiaries if the current pessimism is misplaced and demand recovers through early 2012.

“Share market valuation for Asia ex-Japan has become more attractive as a result of the market shake-out we are experiencing, but it still lags the rest of the world. The upside of the global turmoil is that policy tightening to deal with inflation pressures is now less urgent. The downside that weaker global demand will add to the export slowdown is already underway,” said Pease. “We’re cautious near-term on global markets while volatility remains high and US growth indicators are weak. Conditions for Asian markets should improve heading into 2012 if, as we expect, the US economy begins to recover to a trend-like pace.”

Thailand is the region’s least attractive market, according to the report. It is the most expensive market in the region, according to Russell’s CVI, with inflation trending higher over the last year and reaching 4.1% in July.

“There are also concerns that the new government’s promises on wages and investment will add to inflationary pressures. A combination of rising inflation, monetary tightening, slower global demand and relatively expensive share market valuation keeps us cautious on Thailand,” said Pease.

Other key points from the report include:

• Russell says fears of a renewed recession in the US are overdone and expects a rebound in US GDP growth to a 3% pace through the first half of 2012 
• Korea looks attractive on valuation grounds as it has been hit hardest by market volatility, losing nearly 12.8% in August alone 
• Malaysia looks expensive, according to the composite valuation indicator. It has one of the highest export to GDP ratios in the region (97%) and is vulnerable to a global downturn in export demand 
• Europe remains an ongoing cause of concern for global markets. Another sell-off would signal that markets are losing confidence in Europe’s ability to solve its fiscal problems and be a pre-cursor to a larger crisis. 

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Another trend has been the proliferation of single country emerging market funds. While much of the discussion concerning emerging markets focuses on China, other emerging markets have also experienced significant growth; this article puts the spotlight on the largest democracy in the world, India.

Indian economy
India has recently emerged as a vibrant, free-market democracy after the economic reforms of 1991, and it has begun to flex its muscle in the global information economy.

With an average GDP growth rate of 8% for the last four years, India is one of the fastest growing economies in the Asia Pacific region and, according to the International Monetary Fund, is also the fourth largest economy in the world in terms of Purchasing Power Parity (PPP). Measured in Australian dollars, it is the eleventh largest with a GDP of $1.40 trillion in 2010. Growth has primarily been driven by robust performance of the manufacturing sector on the back of government and consumer spending.

As the economy grows by some 9% a year, India faces challenges to sustain this economic growth. In late December 2010, the commerce ministry judged that food inflation has reached 18.3%, with expensive vegetables mostly to blame. For example, the price of onions doubled within half a year due to unseasonal rain during harvesting season. While the price of onions has now dropped by 60%, food inflation remains sticky at elevated levels. The broader inflation rate is a less eye-watering problem and is currently around 9%.

Inflation may remain elevated despite the current anti-inflationary monetary stance. The Reserve Bank of India is very determined to anchor inflation having raised the interest rates ten times since March 2010 as growth recovered.

Infrastructure
The building of the Taj Mahal is a good metaphor for the work that lies ahead if India is to realise its potential as a global economic power. The Taj Mahal took 22 years and 22,000 workers to build under the guidance of an imperial Mughal ruler in memory of his widow.
Growth in India is best described as ‘the potholed road to prosperity’.

Persistent migration to the cities is putting tremendous pressure on existing infrastructure. In a traffic system that’s so helplessly overloaded, it takes a true miracle for things to work. Public transport is in disarray, with many of the country’s dynamic entrepreneurs wasting hours each day stuck in traffic. Firms are hobbled with the cost of building their own infrastructure, such as a fleet of buses to ferry staff to work. Aside from supply disruption, bottlenecks in infrastructure and distribution lead to inflation; for example, 40% of fresh food is rots before making its final destination.

In a positive sign that roadblocks and inefficiencies are being dealt with, the Indian Government has constituted a committee, headed by the Prime Minister, to get core national infrastructure projects underway.  The committee plans to spend US$1 trillion (8.4% of GDP) annually on infrastructure under a five-year plan, due to start in 2012, compared with a US$542 billion (7.5% of GDP) in 2010.

Performance
Foreign institutional investors (FII) play an important role in Indian securities markets. The number of registered FIIs went up to 1,713 by the end of March 2010, from 1,635 the previous year; equity transactions were worth A$22.75 billion in 2009-10 against A$10.1 billion in 2008-09.

Performance is closely linked to the global and local economic performance as was demonstrated when Indian equity markets rose on the back of strong domestic economic performance and inflows from Foreign Institutional Investors (FII) funds. The buoyant economic outlook helped the Indian stockmarket attract more than A$24.5 billion in net flows from FIIs, insurance companies and fund managers in 2010, an increase of 65% from the previous year.

Like most major equity markets, 2009 saw the Indian stock market in recovery mode followed by a period of consolidation in 2010. The Indian market (measured by MSCI India) returned 14.74% for calendar 2010, compared to the MSCI China at 2.59% and MSCI World 9.55% for the same period.

How to invest in India
India may be considered as an investment option for Australasian investors, however it has taken a back seat to China and the result is generally a very small allocation in most portfolios.

For financial advisers who have considered the pros and cons of an allocation to the Indian growth story, the following investment options are some of those available:

• India Specialist Funds* – examples include Fidelity India Fund and Fiducian India Fund – 100% exposure to India
• Global Emerging Market Funds – examples include Aberdeen Emerging Markets Fund, Schroders Global Emerging Markets Fund and Templeton Emerging Markets Fund –  typically up to 20% allocated to India
• ETFs or Index Funds – iShare or SPDR over MSCI BRIC Index, MSCI Emerging Markets Index, MSCI AC World Index
• Global Equity Funds – Fidelity Global Equities Fund, T Rowe Price Global Equity Fund, Templeton Global Trust Fund, Walter Scott Global Equity Fund – typically less than 1% allocation to India
• ASX-listed companies – some Australian resource companies, including coal and iron-ore companies, with high percentage export to India

* These are among the Funds research by Lonsec, with research reports available to subscribers.
Note: Foreign nationals are not allowed to invest directly in Indian debt and property markets.

As discussed in its 2011 Global Emerging Markets and Regional Equities Sector Review, Lonsec believes there are a few rule of thumb checklists for investing in emerging markets that can be considered.

Firstly, investors seeking exposure to global equities should primarily invest in well diversified global equities funds able to take advantage of mispricing opportunities across stocks and regions. Advisers should also be mindful of monitoring and maintaining a balance on the overall exposure to developing economies within their clients’ global equities allocation. On a look-through basis, it is possible that existing broader global equity fund holdings are already providing meaningful emerging markets exposure (e.g. 10 – 20%).

Secondly, Lonsec believes there is a compelling case for including emerging markets within a blended global equities allocation however, recommends allocations to stand alone emerging markets / regional equities funds only be made to augment broader global equities exposure dependent on client risk tolerance.  Lonsec believes a (10-20%) allocation to emerging markets from the overall global equities allocation may be appropriate for certain clients.

Thirdly, Lonsec recognises that India is a significant growth market and there is a broad spectrum of investment opportunity for advisers seeking to give clients exposure to the economy (eg. single country funds, regional funds, emerging markets / BRIC funds).  Lonsec believes a broader Asia ex-Japan mandate is an attractive initial mechanism for gaining exposure to the Indian region and, in theory at least, allows investment managers the flexibility to position the portfolio in favour or against India depending on the relative strength of their conviction in Indian stocks.  However, those clients wishing to gain a deeper exposure to the India theme may prefer a single country approach.

There is some evidence that specialist emerging markets managers with dedicated resourcing and tailored investment approaches may deliver superior performance outcomes in emerging markets versus those global equities managers primarily centred on traditional developed markets. Lonsec‘s higher rated managers will tend to be singularly focused on this asset class, with dedicated resources either on the ground or with frequent company visitation programs as opposed to a bolt on approach to another strategy.

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