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Profit powered by the middle class

Newly prosperous consumers snap up goods, driving India's economy and luring investors, THERESA EBDEN writes

As the Bombay Stock Exchange's Sensitive Index blew past 10,000 to hit a record this week, major corporations and investors around the world were lining up to court the Indian market.

In recent weeks, Wal-Mart Stores Inc. made an official application to open an Indian office to research a possible entry. Dell Inc. said it will expand its Indian call centre from 10,000 people to 15,000 by 2008, and executives at Conde Nast Publications Inc. say they are planning an Indian edition of Vogue for 2007.

For the most part, these companies are attracted to the rising wealth of India's middle class, which is the largest in the world. As its citizens snap up consumer goods from televisions to motorcycles, India's corporations are booming. The benchmark stock index has grown by half in the past year even as foreign demand for stocks is outstripping supply in a market where many major corporations' shares are still held by a select few.

"It's the best growth story in the world from the viewpoint of accessible profits," said Jon Thorn, whose India Capital Fund last year was ranked best single country fund at the Asiahedge Awards.

The apparent thawing of relations with Pakistan is also a big factor in India's ebullient investment climate, said Mr. Thorn, who oversees $250-million in Indian equities from his office in Hong Kong.

The high expectations for growth are not expected to fade any time soon, said Clark Winter, chief global investment strategist at Citigroup Global Wealth Management.

"India is interesting in that it's not like some of the other emerging markets -- it's not an energy play. It makes it a lot more stable," Mr. Winter said from Australia in a telephone interview.

He is among the hundreds of people who witnessed India's big splash at the World Economic Forum annual meeting last month in Davos, Switzerland. In all, 115 business delegates from Asia's third largest economy attended, more than double last year's number. Indian officials promoted the country as a major investment opportunity, while Finance Minister Palaniappan Chidambaram said economic growth would range from 8 to 10 per cent this year, higher than the forecast of 7.5 per cent for 2005.

With more than 60 per cent of India's 1.1 billion people living in rural areas, the agricultural sector makes up a large part of the economic success. The country relies on heavy rains from the monsoons to boost farm income, driving demand for goods and services from the country's massive middle class.

If this growth continues, India could become the third largest economy in 2050 behind China and the United States, Goldman Sachs said in a report last week. India has better long-term growth potential than China, the report noted.

"Everyone is getting excited about India," said one of the report's authors, global economist Roopa Purushothaman. "Consumption is growing strongly."

Government reform during the 1990s, particularly the abolishment of its licensing system, helped set the stage for economic success, said Bhim Asdhir, president and chief executive officer of Excel Funds Management Inc., a Toronto-based wealth management firm whose primary focus is India. The red tape that strangled open competition, known as the "License Raj," unravelled after a macroeconomic crisis forced reforms.

"Prior to 1991, India was more or less a closed economy -- politicians played a big role in giving licenses for opening factories. Whoever could give a bigger bribe got the license," said Mr. Asdhir, a former actuary who was born in India and moved to Canada as a teenager. The subsequent changes "opened up the economy to competition and foreign capital."

Today, his Excel India Fund stands at $140-million. Recently it brought in about $2-million a day for several weeks, and $10-million the day before Christmas, he said. The fund's one-year return as of Jan. 31 was 32.5 per cent.

"People have finally come to realize the growth in India is a no-brainer," Mr. Asdhir said. "If you missed the boat on China's growth, India is right here."

The telecommunications sector makes up the largest segment of the Excel India fund, led by Bharti Tele-Ventures Ltd. at 5.3 per cent. India has a population of 1.1 billion and only 115 million connections for both cellphones and land lines, he said. Analysts predict that cellphone use alone will grow to 300 to 500 million users within five years.

India's high level of education, rule of law and entrepreneurial spirit are helping to add 25 to 30 million people each year to a middle class that is hungry to buy consumer products, Mr. Asdhir said.

In addition to investing in cigarette maker ITC Ltd., India's biggest tobacco company, and Pfizer Ltd., Mr. Asdhir has exposure to the relatively strong banking sector, including the State Bank of India. He also holds Hero Honda Motors Ltd., India's top motorcycle maker, and such technology firms as Tata Consultancy Services Ltd. and Satyam Computer Services Ltd.

Because of the huge demand for infrastructure, Mr. Asdhir also holds Larsen & Toubro Ltd., India's largest engineering and construction company.

Interest from such investors as Mr. Asdhir is on the rise. Overseas investors bought a record $10.7-billion (U.S.) in Indian stocks last year, according to the country's Securities & Exchange Board.

Under the harsh glare of the global spotlight, however, India's flaws are gaining notoriety. In particular, foreign demand is outstripping supply for the country's stocks, which are generally closely held by the families who control the major corporations, said Michael Smedley, chief portfolio manager of Morgan Meighen & Associates, based in Toronto.

Like many investors, Mr. Smedley has had difficulty purchasing Indian stocks even though the country's market has been established for more than a century.

"There is a lot of red tape," he said. "You have international investors limited in what they do . . . unless they have local settlement and custodial facilities, and that can take a long time to obtain."

Before Mr. Smedley was able to arrange this last year, he instead invested in India via American depository receipts, which are stocks that trade in the U.S. but represent a specific number of shares in a foreign corporation.

But even with the added challenges, Mr. Smedley said he far prefers investing in India to China. About 16 per cent of his Canadian World Fund is comprised of Indian stocks, including the country's biggest tractor and utility vehicle maker, Mahindra & Mahindra Ltd., and baker Britannia Industries Ltd.

"You're basically seeing a country move into the modern times, and it's being done with this framework of acceptability, unlike China, which is still difficult to invest in," Mr. Smedley said.

"In China you've got the performance of the Chinese economy, where the huge growth is remarkably unaligned with the performance of the stock market."

Mr. Smedley dismisses the notion that Indian stocks can't go much higher.

"The values of Indian stocks have been pushed," he said.

"But I don't think they're overvalued relative to the growth that's yet to come."

Theresa Ebden is an associate producer for Report on Business TV.

© 2007 The Globe and Mail. All rights reserved.

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