Reforms and emergence

The Indian model

India is one of the fastest growing economies and has many opportunities to offer investors, but is the future really that bright? Sukumar Rajah, CIO Equity and Head of Franklin Templeton India leads us to the core of this complex market.
How transparent and efficient is Indias stock market today?
Following various moves such as the introduction of electronic trading & settlement, de-materialization of securities, T+2 settlement and corporatisation of exchanges, trading and settlement systems have become much more transparent and efficient. They are currently at par with the leading stock exchanges in the world. is expected to exhibit relatively higher growth in the years to come and corporate Indias ROE is amongst the highest in its peer group. One of India's key advantages is that it does not rely excessively on external demand as a source of growth. As a result, India has a much better balance in its growth model than the rest of the Asian region giving it a built-in macro resilience that other emerging economies lack. We believe the breadth and depth of the Indian stock markets will provide enough long term opportunities for bottom-up and fundamental investors like us.

Sukumar rajah
Franklin Templeton India

How many securities are there and how easy are they to trade for foreign investors?
There are over 7,300 securities (representing over 5,000 companies) listed on the major stock exchanges, of which over 2,500 witness trading on a daily basis. In terms of liquidity, India is now superior to most other Asian markets, with over 180 stocks with a market cap of over USD 500 million and nearly 300 companies with an average daily trading volume of over USD 1 million. The only constraint for foreign institutional investment (FII) are the stock limits on FII ownership imposed by the government. Yet the stock limits change from time to time, due to changes in regulations and corporate actions.

Since 1991, the reforms seem to have achieved a great deal: what have been the main steps and what will be the next?
India successfully implemented its first generation of economic reforms in 1991 leading to poverty alleviation and an economic growth rate of 7-8% in recent years vis-vis that of 3-4% prior to 1991. Since the liberalization of the economy in the early 90s, India has made steady progress on the reforms front which has transformed the corporate landscape and resulted in sustained high economic growth. The past few years have clearly indicated that reforms enjoy support across a wide section of the political spectrum and are unlikely to falter due to a change in the government. In that sense, while the pace of reforms has slowed down due to the coalition nature of the government, we expect the overall direction to be positive. The government has already taken initial steps in terms of pushing back foreign direct investment (FDI) limits in other sectors especially retail and has constituted a committee to formulate the frame work for introduction of capital account convertibility. The proposed introduction of goods and services tax (GST) augurs well, as the worldwide experience has been that such a regime would broaden the tax base and also makes revenues less sensitive to economic cycles. This would also help the government in meeting its increased spending needs and its Fiscal Responsibility and Budget Management (FRBM) targets for the next year. We believe that as more political consensus emerges there might be some progress on the labour reforms front too.

What is the proportion of foreign and domestic investments?

While foreign investors own 18.9% of the market (through direct FII investments as well as through subscription to ADR/GDRs), domestic investors (institutional as well as retail) own 26.7%. The residual stakes are held by promoters or the government.

How are the present stock valuations compared to other markets?

On a relative basis, the Indian markets seem expensive when compared to other emerging markets, and the valuations of Indian markets have moved beyond their 10year averages. At the same time, the economic and earnings drivers in India are not strictly comparable to those of the other emerging economies. The Indian economy

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The Swiss Asset Management Magazine Excerpt from Invest in India June 2006

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Reforms continued despite changing governments

Congress Led Coalition 1991-96 First steps towards liberalization Liberalization of the currency regime De-licensing of industry Beginning of a rationalization of indirect and direct taxes Opening of many sectors to FDI Authorization of foreign portfolio investments Beginning of capital market reforms initiated Big cut in corporate and personal tax rates Continued reduction in import duties First steps on allowing private sector in insurance First steps towards dismantling administered pricing in oil & gas De-materialization, electronic trading starts New Telecom Policy Massive road upgrade programs Electricity Act to usher in private competition Banking Securitization Act Refinancing state government. debt at cheaper rates Concrete steps on privatization Removal of tax on long-term capital gains Implementation of VAT & proposed Goods and Services Tax (GST) Continued focus on infrastructure Renewed focus on rural infrastructure FDI limit relaxation in key sectors Fiscal consolidation along with rationalization of taxes

Third Front Coalition 1996-98

NDA Coalition 1998-04

UPA Coalition 2004-

Are foreign direct investments encouraged and in what ways? What are the limitations?
The government has always encouraged FDI flows, but bureaucratic and political obstacles have penalized such flows into India. However, FDI flows have picked up in recent times, backed by policy support (relaxation of FDI limits in sectors such as telecom, construction, media and civil aviation). This trend is apparent in the metals and mining sector (Posco announced a USD 13 billion steel plant in Orissa) and in other sectors - telecom (Vodafones purchase of a 10% stake in Bharti Telecom) and IT (investments by Cisco, Intel and Microsoft). The progress on tax reforms in terms of introduction of VAT/GST and any introduction of labour reforms should attract much higher FDI flows as global companies aspire to take advantage of Indias strengths. AT Kearneys FDI Confidence Index 2004 ranked India as the third most attractive FDI destination in the world, after China and

the US, attributing it to Indias educated workforce, management talent, rule of law, cultural affinity, regulatory environment and large market.

How is the infrastructure developing?

India has been amongst the fastest growing economies in the world and is currently ranked the 4th largest in PPP terms. However, a burgeoning population, rapid economic growth and increased urbanization have started making pressing demands on Indias existing infrastructure. In that sense, the importance of improved infrastructure for the sustained economic growth cannot be understated. India made some progress on this front over the years in the form of power sector reforms and allowing private sector participation in various key infrastructure sectors such as roads, ports and airlines/airports. The past few years have clearly indicated that successive governments have realized the need to remove infrastructural bottlenecks

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and have initiated various projects. This is clear from the fact that infrastructure investments are projected to be around USD 171.3 billion between financial years 2004 and 2007, a sharp rise from the previous years.

to generate USD 60 billion in export revenues. At this level, these two industries alone can ensure India's GDP grows by around 1 percent for the next five years.

Investments on infrastructure
In billions of US Dollars Airports Irrigation Ports Power Railways Roads Telecom Tourism Urban infrastructure Total

Could you please give a few figures about the population of India?
Projected 2004-2007
2.4 28.1 3.5 65.7 10.5 18.2 15.8 0.6 26.4 171.3

Effected 2000-2003
1.3 11.8 0.9 16.4 9 13.9 14.7 0.1 11.5 79.6

Source: CRIS INFAC

As per the previous census 8% in 2001, the countrys > 59 years total population was 35% 16% 1028.7 million, a < 14 years 40-59 years 21.3 % increase over the number for 22% 1991. Indias popu25-39 years 19% lation is young, with 15-24 years 54% under the age of 25 and 80% under 45.

How much does Indian economy depend on oil imports?

India imports over 70% of its oil requirements, which currently accounts for around 35% of its total imports. Both oil consumption growth (-0.3%) and petroleum products demand growth (-0.4%), have been flat in 2005, due to lackluster diesel demand, which accounts for 3540% of total oil products and 80% of auto fuels. Better roads, new cars (better fuel efficiency) and increasing usage of Compressed Natural Gas (CNG) could be contributing partly to this trend. However, a fast growing economy along with heightened demand for automobiles on the back of rising incomes and increased infrastructure spending, are likely to push oil demand further up. However, compared to the past, India is in a much better position to tackle the high oil prices due to stability on the external front. Foreign exchange reserves accretion has continued helped by increased services exports, rising inflows from overseas Indians and foreign portfolio investors.

Do you think the country can ensure appropriate education for a significant portion of the population in order to secure enough increase in labour supply for specialized outsourcing services?
India has a robust higher education system that operates through a network of universities and autonomous colleges designated as deemed universities. India has the largest English speaking IT talent pool in the world over 120,000 trained IT professionals and approximately 3 million other graduates are added each year. Firms such as AT Kearney and IMD have ranked India amongst the top countries in terms of availability of educated and skilled manpower.

What are the main challenges to address for India?

Over the short to medium term, there are few risks that could manifest themselves as road blocks for India. Given the fact that India imports most of its oil requirements, the rising energy prices certainly pose a problem for the economy. However, if they do not move up sharply, the growing economy might be able to absorb the additional costs. Rising interest rates in developed economies might impact global liquidity and flows into emerging markets. And lastly, political wrangling might slowdown the key reforms which are essential for sustaining the current momentum of economic growth and moving into a higher growth trajectory. Overall, these risks might impact short term sentiment, but the long term outlook continues to be positive.
An interview conducted by Indira C. Tasan

How much does outsourcing (from foreign countries to India) weight in the actual economy and how could this evolve in future years?
Indias IT-IT enabled services sector is expected to log USD 36 billion in revenues in financial year 2006, accounting for 4.8% of GDP in 2006. The NASSCOMMcKinsey Report 2005 indicates that the offshore ITbusiness process outsourcing segment has the capability

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The Swiss Asset Management Magazine Excerpt from Invest in India June 2006

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China and India

The new titans face To face

Though often compared, India and China do not have much in common, except that they both promise to be the next great economic powers. On their way to global supremacy, each one has its own distinct strengths and weaknesses. The more that is known about them in detail the better, as the success of an investment in these countries depends on the capacity to play on the best of both worlds.
Sukumar Rajah, CIO Equity and Head of Franklin Templeton India

China
PROS Quick development of a world-class infrastructure. Acquisition of a global scale by different sectors Overinvestment in various sectors. Fast growing job creation allowing a smooth restructuting of various state owned enterprises. Record FDI inflow. Faster policy making and implementation. Lax labour laws. Opacity in operations. Crowding out of the private sector from capital markets due to the governments strong involvment, leading to inefficient allocation of capital. Delayed reforms in capital markets and banking systems. Inefficiency of the banking system due to a high level of NPAs. CONS

India
PROS Acquisition of a global scale by entrepreneurial and new sectors like IT and related services. Global competitiveness of the manufacturing sector in general. Early institutional reforms. World-class capital market and banking system. Early shakeout in the corporate sector in the reform process. Establishment of a strong and independent regulatory framework in different sectors. CONS Negative impact of the lack of world-class infrastructure on growth prospects. Scarcity of companies having reached a global scale. Slow FDI inflow compared to China. Slowness of the tax reforms. Complexity of the tax structure. Impediment of slow policy making and bureaucratic red tape to efficiency and effectiveness.

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