Once the global subprime crisis gets over, international money will flow back to India

To gain from capitalism, this time just turn to nationalism
Sandeep Singh Indian Express : Sunday, August 19, 2007 Home > Business > THE BIG BIZ STORY The US subprime crisis, faster economic and corporate growth, consistent markets, and the rising rupee have made India a lower-risk, higher-return haven for investors

Sixty years of political independence and 16 years of relative economic freedom have catapulted India to the top of the investment charts — only China’s gross domestic product (GDP) is growing faster than India’s and only Brazil’s stock market has generated a higher five-year return. At such a time, when product sophistication and innovation mean creating opportunities for diversification of “country risk”, it seems rather naive for an Indian household to invest its money outside India.

In April 2007, the RBI increased the limit on overseas investment for the mutual fund (MF) industry from $3 billion to $4 billion, and for individual fund houses (FHs) from $150 million to $200 million. Following this decision, FHs have started offering funds that plan to invest in emerging markets. But in a situation when the Indian economy is on a strong foothold and is shaping itself in a way that makes the developed nations depend on it for higher returns, should Indian investors venture abroad? More so in the context of the subprime mess, which has taken risk to a more dangerous level of uncertainty.

It makes sense for American, European and Japanese investors to invest in emerging markets considering the slow growth rate of their own economies — US (3.3 per cent), UK (2.7 per cent), Japan (2.8 per cent), and the low returns in their domestic markets (8.8 per cent, 8 per cent and 11.8 per cent respectively). It is justifiable for them to get out of their own markets and look for faster growing, greener pastures. For them, opportunity lies in emerging markets like India, Brazil and Mexico, which have generated five-year returns of more than 35 per cent per annum. Investors in developed markets are not entering these “risky” markets to diversify their country risk (minus the subprime fiasco, country risk in developed nations is less), but to fetch higher returns. But does this logic apply to Indian investors?

Better Returns: Not quite . The Sensex has grown at a three-year compounded annual growth rate (CAGR) of 42.8 per cent and a five-year CAGR of 36.4 per cent. At this rate of return and a high GDP growth rate, both of which are strongly expected to sustain with slight moderation, the Indian market is expected to remain strong on the back of robust domestic consumption and infrastructure growth. In comparison, the other emerging markets seem riskier.

• Mexico has a GDP growth rate of 4.5 per cent and its BOLSA index trades at a PE of 19.9;
• Egypt has a GDP growth rate of 6.9 per cent and its Hermes index has a PE of 21.5;
• Brazil has a GDP growth rate of 3.7 and its Bovespa index is trading at a PE of 13.5.
• Only China, with a GDP growth rate of 10.7 per cent, fares better than India but with its Shanghai Composite Index trading at a very high PE of 41.8, its market becomes high risk.

Economic growth in India is also steadier — over the past 16 years many governments have changed but the growth momentum has been sustained. There are, however, factors other than the GDP growth rate. The stability and rate of returns of the Indian market make investing abroad less attractive.

Tax Considerations: There are tax related considerations as well to take into account. Funds that are planning to invest most of their assets abroad will be treated as debt funds. Thus, any long-term capital gain on them will be taxed at the rate of 10 per cent without indexation benefits.

Exchange Rate: This is another factor that those planning to invest abroad must factor in. Over the past few years, there has been a significant flow of funds into the Indian market, which has caused the rupee to appreciate. This is emerging as a big concern for dollar earners. At present, the rupee is trading at around 40.5 against the dollar. If it were to appreciate to 36-37 to the dollar, investors would see a huge fall in returns. The rupee has already appreciated by 14 per cent in the past 12 months and a large section of economists feels that “the rupee appreciation is here to stay”.

Thus, with a robust and sustained domestic growth rate, strengthening rupee and unfavourable tax rules — which make rupee returns higher than dollar ones— this may not be the right time to invest abroad. The damage from the US subprime debacle is still being calculated. And Indian investors still need to be able to grapple with exotic products like securitised debt and its derivatives like collateralised debt obligations. In fact, once the global subprime crisis gets over, international money will flow back to India.

Home sweet home
• The US subprime debacle’s impact on global markets makes this an inopportune time to invest abroad
• On criteria like GDP growth and recent stock exchange returns,India is now more attractivethan other emerging markets
• Funds investing abroad don’t get indexation benefits
• An appreciating rupee will further diminish returns earned abroad