March - 2000 - issue > Cover

Last year was a spectacular year for the Indian stock market. The Bombay Stock Exchange Sensitive Index (the BSE Sensex) was up 60 percent measured in dollars — that is, after adjusting for depreciation of the rupee against the US dollar. Broader market indices were up even more: for example, the S&P CNX 500 index was up by more than 93 percent in dollar terms.
This performance was quite a turnaround from the returns provided by Indian stocks in recent years. In 1998 the BSE Sensex was down 23% in dollar terms; the 1997 dollar gain was just 8.5%. In fact, after first crossing 4000 in 1992, the Sensex has oscillated between 2000 and the mid-4000s, and only broke through the 5000 mark late last year. From early 1992, while the Dow Jones index went from a level of about 3200 to over 11000 today, the Sensex, on a net basis, went nowhere. And adjusted for rupee depreciation, the Sensex’s performance was even worse vis-à-vis that of U.S. stocks.

But looking at the Indian market over a longer time period, the rewards for patient investors have been better. In early 1985, the Sensex was below 300; it crossed 500 for the first time in mid-1985 and passed the 1,000 level in 1990. In 1992, the market surged to over 4,000, before collapsing to just below 2,000 in June 1993. So investors were very well rewarded by the Indian market in those years, even after adjusting for currency losses for investors who focus on dollar returns.

Today’s Indian business has changed dramatically from the mid-1980s, when industry was heavily regulated by the government. An entrepreneur looking to start or expand a business had to battle through bureaucratic red tape to access a government license, a process that took months and often years. Business was controlled by a small number of family business houses, who had access to politicians and thus to these valuable licenses. Imports of foreign goods were restricted or banned, and, when permitted, were taxed with prohibitive custom duties. Indian manufacturers thus faced limited competition, both from domestic competitors due to the license raj, and from international business due to trade barriers.

Inevitably, such restrictions led to bloated and inefficiently run companies in India, and the consumer ultimately paid the price.

Think of what a car buyer faced in the India of the early 1980s. There were two cars available in India then, the Premier (Fiat) and the Ambassador; in either case you were on a waiting list of many months (or longer) before your car was available. Once you picked between these two cars, you could consider yourself lucky if you got the color of your choice. No other “options” were available; all cars had manual transmissions and manual windows and door locks.

Consumers were ecstatic when air conditioning became an option, even though the car engines were ill-equipped to handle the additional strain. Not surprisingly, an active black market developed for cars – you could pay a premium to obtain a car immediately rather than waiting nine months to get one legally.

The auto industry today is completely different. Now over a dozen types of cars are available. You can generally get the car of your choice immediately. Price competition is fierce, and the quality of the product has improved immeasurably — there are options galore. All of this has occurred because the government has permitted competition in the car industry.

The same scenario has been played out in most other industries in the country, making the consumer the biggest winner. And where the government has continued to play an active role in stifling competition, the consumer has suffered.

International phone calls is a clear example. In 1985, a call from the US to India cost over $3 per minute; today we pay perhaps $0.60 per minute. Today a call from India to the US still costs over $2 per minute, because the government-controlled Videsh Sanchar Nigam Limited faces no competition from other telecommunications companies. This too will change; if not with the government’s blessing, then the advent of Internet telephony will result in substantially lower prices in the future.

Long Term Rewards

The stock market in India has undergone a similar evolution during the last decade. The Indian stock exchanges of the 1980s were dominated by industrial companies. The darlings of Dalal Street then were conglomerates like Reliance Industries; engineering companies such as Voltas, TELCO, and Mahindra & Mahindra; and commodity suppliers like Associated Cement Companies, TISCO and fertilizer companies. The picture today is completely different. Intellectual capital is king, and the list of companies with the largest market capitalization is dominated by software companies such as Wipro and Infosys and branded goods companies such as Hindustan Lever. The wealthiest Indians used to be industrialists such as the Ambanis, Tatas and Birlas; today they are the new economy entrepreneurs like Aziz Premji of Wipro and Subhash Chandra of Zee Telefilms.

This change raises several questions: How will Indian stocks perform over the next few years? Should Indians living in the US look for opportunities to benefit from the changes in the Indian stock market? And, if so, how can one go about making such investments?

We all know that stock market trends are notoriously difficult to predict. Certainly there are sectors of the Indian economy that are thriving today and will continue to grow during this decade. The software and IT services industry is the most visible example, with exports by these companies projected to explode from less than $3 billion annually today to over $50 billion by about 2007. The Indian government has encouraged the growth of this industry by declaring profits from software exports to be exempt from taxes. Another sector that should experience steady growth for decades is the pharmaceutical industry. Per capita spending on pharmaceuticals in India today is about $3, compared with about $370 in the US and $50 per capita worldwide, so the growth potential is enormous. Additionally, there are many fine drug companies that are publicly traded in India, both subsidiaries of multinational companies (such as Pfizer, Burroughs Wellcome, Glaxo, SmithKline Beecham) and India-grown companies (such as Ranbaxy and Cipla). Consumer goods is a third industry experiencing growth and with numerous high-quality companies to invest in (examples are Hindustan Lever, Indian Shaving Products/Gillette, Procter & Gamble, and Marico Industries).

The BSE Sensex is close to record highs today, but is barely above levels first reached as long ago as 1992. The Indian economy is stronger than it has been in some time; the current government appears to be the most stable one in years; and inflation levels are low, leading to declining interest rates. So it is possible that the stage has been set today for a big rise in the Indian market over the next decade, akin to the robust performance of the US market in the 1980s and 1990s. With low inflation and interest rates, it is also likely that the rupee will depreciate at a slower rate during this decade than it did in the 1990s and 1980s.

Indians living in the US seeking to invest in India can do so in either closed-end Indian funds on the New York Stock Exchange; open-end funds, or trade American Depositary Receipts (or Shares), known as ADRs (or ADSs) on US exchanges. An investor may also choose to register as a Non-Resident Indian.

Four Options

There are four options available for those wanting to invest in the Indian stock market. They are:

* Direct Investment

Non-Resident Indians may buy stocks traded on Indian stock exchanges through a broker in India. NRIs are permitted, even encouraged, by the government to invest there. Although this process has steadily improved in recent years and will continue to improve, it is still somewhat messy to execute.

* Mutual funds

There are four closed-end funds available for trading today: The India Growth Fund, The India Fund, Jardine Fleming India Fund and the Morgan Stanley Dean Witter India Investment Fund. The India Growth Fund was created in 1988; the other three have been in existence since early 1994. The benefit to investing in India through these funds is simplicity: you can buy or sell the funds through your broker in the US the way you would invest in any other stock. The bad news is that none of these funds have performed particularly well since they were created, as shown here:

Another concern about closed-end funds is that they often trade at discounts to their net asset value (NAV), so the investor’s return may be less than the return of the underlying stocks.

* Other funds, such as the open-end Eaton Vance Greater India Fund or Kingfisher India Partners L.P.

* Companies trading on U.S. markets

There are three Indian companies with ADR stocks trading on U.S. markets. Infosys (NASDAQ: INFY) was the first to list its stock in the U.S., with an ADR issue in March 1999. Infosys is an outstanding company, and has rewarded investors handsomely: the ADR has appreciated by over 1,000 percent over the last year (and the underlying stock in India has given much larger gains over a longer period of time). ICICI (NYSE: IC) followed with ADRs in September; that stock is up 70 percent from the IPO price.

Satyam Infoway (NASDAQ: SIFY) issued ADRs in October 1999, at a price of $4.50 per ADR (adjusted for a subsequent 4:1 stock split). The stock hit a high of $100 recently, yielding returns of over 1,000 percent since the IPO less than four months ago.

SIFY is interesting in that the company went public in the US without first selling stock in India, so that NASDAQ is the only market where the stock trades. More common with ADRs, as is the case with Infosys and ICICI, is for the US issue to be a secondary offering for a non-US company that trades on the stock exchange of its home country.

The good news on the ADR front is that there are many more Indian companies with ADR issues in the pipeline, so that there are likely to be over a dozen Indian companies trading on the NYSE or Nasdaq by the end of this year.

Some Indian companies considering such moves are Bank of Baroda, Bharti Televentures, Hughes Software, Mastek, MTNL, NIIT, Pentafour Software, Reliance, Satyam Computer (the parent of SIFY), State Bank of India, VSNL and Wipro. US investors will thereby find it easier to gain access to shares of good Indian companies.

A final word of warning: the volatility of the Indian stock markets can be difficult to stomach for investors who do not have a long-term perspective. If you are focused on the scoreboard on a daily or monthly basis, Indian stocks are likely the wrong place for you to invest. But if you are willing to focus on the state of the playing field, rather than the scoreboard, then India is likely to provide attractive returns to a long-term investor. Ultimately, the stocks of good companies do well, assuming you do not overpay for them.

Short-term volatility can provide attractive opportunities to a long-term investor. In the words of the legendary investor Benjamin Graham: “In the short run, the stock market is a voting machine. In the long run it is a weighing machine.”