FOREIGN INVESTORS CHASE INDIAN ECONOMY'S GOOD NEWS BUT WEAK

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TAGS: ECON EFIN EIND EINV ETRD EAGR IN
SUBJECT: FOREIGN INVESTORS CHASE INDIAN ECONOMY'S GOOD NEWS BUT WEAK
IT SECTOR AND A MISSING MONSOON COULD SPELL FUTURE TROUBLE

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1. (SBU) Summary: According to investors and finance
professionals in Mumbai, economic sentiment in India is on the
upswing. Key indicators, including rising capital markets,
corporate earnings, and manufacturing indices confirm this
belief. Foreign institutional investors (FII) are returning to
India, bringing with them much-needed cash infusions to the
capital markets. In addition, domestic companies have raised
almost $8 billion from foreign and domestic investors in recent
months, after almost a year of poor prospects. Certain sectors,
however, remain in precarious positions. The IT industry, which
largely served U.S. markets and the financial services industry,
projects a severe drop in earnings growth. The agricultural
sector, too, is likely to suffer from a weak monsoon season,
with rainfall levels hovering approximately 20 percent below
average, barely above drought level. Despite continued public
spending on rural development, low agricultural outputs may lead
to consumer inflation and lowered GDP growth, further stumbling
blocks on the road to economic recovery. End Summary.





Foreign Investors Put Their Money on India



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2. (U) According to market participants, corporates, and
economists, the Indian economy is seeing a renewal of investor
confidence and a rise in economic sentiment. The Bombay Stock
Exchange's SENSEX - a barometer for Indian stock market
performance - stands at around 15,900, approximately the level
it was in June 2008, and up 90 percent from late-November 2008.
Volumes on the derivatives market have doubled since March 2009.
A number of large Indian companies have posted better than
expected corporate returns for Q1 2010 (average profits were up
23 percent, y-o-y),including auto and motorcycle manufacturers,
buoying stocks prices. The purchasing manufacturer's index
(PMI) shows an increase in manufacturing orders, consumer demand
remains strong, and there is strong liquidity in the banking
sector with deposit growth outpacing credit growth. Exports are
still contracting, though the pace has slowed.




3. (SBU) Tushar Poddar, Chief Economist for Goldman Sachs,
believes that the Indian economy turned the corner in mid-May,
when key indicators - specifically credit growth, industrial
production, money supply, consumer spending, and housing loans -
either stopped declining or turned modestly positive.
Corporate earnings for Q1 2010 have been surprisingly good,
indicating that many companies have weathered the worst of the
crisis, cleaned up or restructured some of their debt now that
conditions are more favorable, and benefitted from continued
rural spending. Investors have returned to India, he observed,
because it is one of the few growth stories at the moment.
Poddar predicts 6 percent growth for India in 2009, making it
one of the world's fastest-growing economies.




4. (SBU) Similarly, Sidharth Punshi, Managing Director and
Country Head of investment bank Jeffries, also attributed
increased foreign institutional investor inflow to unexpectedly
strong first quarter corporate results, as well choice
indicators, such as a 12 percent increase in car sales. He
highlighted the fact that large companies such as Tata Steel,
Tata Power, Suzlon, and Sterlite, among others, have raised
almost $8 billion since March 2009, $7 billion of that from
FIIs. The recent Adani Power IPO was oversubscribed by 20
times, demonstrating that there is now demand for new equity in
the market after almost a year of inactivity. He also pointed
to major real estate and infrastructure companies, such as
housing giant DLF, who have retired some of their debt, sold
assets and land, and largely avoided the major defaults that

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many expected would be the "next shoe to drop" in the financial
crisis' impact on India. He expects this investment trend to
continue, with Indian companies raising approximately $20
billion by year's end.




5. (SBU) Bharat Doshi, the Chief Financial Officer of Mahindra &
Mahindra, agreed, noting that now is an excellent time to raise
funds in India, either through capital markets or other
investment avenues. In June, Mahindra raised almost $100
million for Mahindra Holidays, a travel and resort company.
Doshi said that because international borrowings were still
expensive compared to domestic borrowing rates, and the banking
system is flush with funds, Indian corporates would likely
increase their domestic funding operations. Some small and
medium-sized companies would still have problems getting credit
due to continued risk aversion, but top-line corporations would
be able to borrow at affordable rates. For Mahindra, the large
increase in rural spending over the past year has contributed to
a 40 percent growth in tractor sales, year-on-year. He feels
that sales will continue to be high at least through October,
when the impact of decreased government spending and the
disappointing monsoon will be felt.




6. (SBU) India Capital Research Service's Managing Director,
Dan Tennebaum, also reports a rise in foreign institutional
investment citing net $6.5 billion FII investment since the
Indian elections in May 2009 (versus net $13 billion of outflows
in 2008). However, Tennebaum does not link increased investment
to market fundamentals or recovery of the Indian economy.
Rather, he thinks that developed markets present such a grim
picture to investors that the Indian market--soft earnings and
government inaction on economic reforms aside--appears
attractive by comparison. He also cited increased FII appetite
for risk as developed economies tended toward stabilization.
Gopal Jain, managing partner of private equity firm Gaja
Capital, affirmed that FII inflows were returning to 2006-07
levels. However, he believed that the source of the inflows was
a dollar-carry trade, as investors borrowed cheaply in the U.S.
and reinvested in high-yielding emerging markets like India.
While this benefits investment in the short-term, he worried
that these investments could unwind suddenly if more financial
problems develop in the U.S.



IT Sector Struggles to Find Good News



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7. (U) Despite the overall economy's turn for the better,
important sectors continue to suffer. The Information
Technology and Information Technology-Enabled Services (ITes)
sector, a major driver of growth in the Indian economy, recorded
13 percent growth in 2008-09, significantly lower than the 30
percent growth recorded 2004-08. While export revenues grew by
16.3 percent during the year, almost all of the growth was
witnessed before October 2008, when effects of the global
slowdown first reached India. Sangita Gupta, Research Associate
with the National Association of Software & Service Companies
(NASSCOM),reports export revenues either contracted or were
flat after September 2008. Since the U.S. market and global
financial services sector comprise 60 percent and 40 percent of
the sector's export revenues respectively, the double impact of
the U.S. recession and the global financial crisis have hit the
Indian IT sector hard. NASSCOM estimates that growth during the
first half of 2009-10 will be flat or negative and will only
marginally pick up in the second half of the year, leading to an
overall growth rate of 4-7 percent for the sector in 2009-10.
Going forward, Gupta said that this industry had already matured
significantly, and 30 percent growth levels are unlikely to be
sustainable, in any case.

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Weak Monsoon Has Potential to Erode Recent Economic Gains



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8. (U) A weak monsoon is currently one of the clearest, if
not biggest, threats to the Indian economy. Rainfall levels in
June were approximately 35 percent below average, leaving India
teetering on the cusp of having an officially "deficient"
monsoon (defined as rainfall more than 19 percent short of
average). Rainfall levels over the next few weeks will
determine whether normal conditions or drought prevails; steady
rains in August could elevate the monsoon into the "normal"
range. The lack of rain, however, has already led to an 8.5
percent decrease in agricultural sowing - mainly affecting the
rice crop in the crucial growing states of Andhra Pradesh, Uttar
Pradesh, and Punjab - putting the effects of a weak monsoon
already in motion.




9. (U) The results of a poor harvest could have rippling
effects throughout the Indian economy. While agriculture only
accounts for 16 percent of total Indian GDP, roughly 60 percent
of Indians live and work in rural areas. The last weak monsoon
was in 2002-2003, where a 19 percent deficiency contributed to a
2 percent drop in overall GDP growth. A Citibank report
estimates that negative agriculture growth will, at a minimum,
decelerate GDP growth from 6.8 percent to 5.8 percent, despite
governmental buffers such as the National Rural Employment
Guarantee Scheme (NREGS),farm subsidies, and other fiscal
interventions. UBS researchers estimate that GDP growth could
fall 1.2 percent from their current 7 percent estimate, if
rainfall does not improve. However, other economic forecasts
suggest any decline will largely be compensated by other areas
of the economy.




10. (SBU) Many observers fear that a poor harvest will lead
to food price inflation, as poor harvests drive up commodity
prices and spur rural unemployment. While the Wholesale Price
Index (WPI),India's most data-reliable measure of inflation, is
currently negative, the food portion of the basket, led by
sugar, is positive. The more inexact - but more representative
- Consumer Price Index (CPI) is already above 10 percent,
reflecting a rise in food prices generally. Inflation, which
Credit Suisse estimates will stand at 6 percent by early-2010,
could have a strong dampening effect on the economy. Mumbai has
already seen public demonstrations in the past few weeks over
the rising prices of food goods, especially vegetables.




11. (SBU) Comment: A series of positive economic indicators
has turned investor and market sentiment positive, at least in
Mumbai. Good corporate earnings and the rebounding of capital
markets have excited financiers and investors, although
economists and Indian officials remain anxious about the impact
of the so-far weak monsoon. While agriculture makes up an
increasingly small part of overall GDP, a poor monsoon would
have a disproportionate impact on the majority of India's mostly
poor population, including a rise in basic food prices, more
rural unemployment, and more defaults and impoverishment in the
countryside. The Indian government will likely hew to election
promises and continue to boost rural stimulus spending to stave
off the most dire results, placing other economic reforms on the
back burner. Nevertheless, this spending - much of it
necessary, some of it wasteful - is already having an impact on
the growing fiscal deficit, raising further long-term concerns
about the economy. End Comment.
FOLMSBEE