The New Investor Friendly India

Earlier this week the president of India, Mr. Pranab Mukherjee, addressed the Indian Parliament. This was on the occasion of the first sitting of parliament following the elections that brought the new Prime Minister Narendra Modi to power with a landslide victory. The emphasis of  the presidential speech was on economic reform and a return to double digit growth, something that has been lacking in the last two years, which have seen less than 5% growth apiece. According to Mukherjee, putting the economy back on track is of paramount importance. 

How will this be achieved? Through initiatives like the introduction of a goods and service tax, encouragement of foreign direct investment, making the tax regime more business friendly, controlling inflation, and investing in infrastructure, just for starters. The infrastructure promise includes the pledge that by 2022 every family will have a good home with a constant electricity supply. The railway will be upgraded, and new roads and airports will be built.

Investment, both domestic and foreign, will lead to job creation. With 10 million people entering the workforce every year, that will be music to the ears of so many of the younger voters who wanted an end to the rule of the Congress Party. After being in power for 55 of the last 67 years, and most recently for a continuous 10 year period, the Congress Party is perceived as being responsible for the recent poor economic performance, in spite of almost double digit growth in four of those years. It is also seen as a party riven with corruption.

Controlling inflation is seen as high priority. Consumer Price Inflation hit a high of almost 9% in April, due mostly to higher food prices. The volatility of food prices has been linked to a poor supply chain – namely warehouse shortages, food hoarding and black market activity, unpredictable supplies of vegetables, and the generally weak infrastructure. These ‘bottlenecks’ will be addressed by the new government. Meanwhile, in an effort to contain inflation the Reserve Bank of India has raised interest rates three times since last September.

The coal sector will be one of the first industries to be targeted in a drive to improve efficiency and output in a ‘transparent’ way. Corruption and bureaucracy have seen mining output decrease, and India is a large importer of coal even though it has plenty of it available at home. One suggested plan is to break up the state owned Coal India company into smaller independent units, and also to open up the sector to private investment, including foreign investment. Coal is a cheap and potentially plentiful form of energy from India’s perspective, so improving the efficiency of its production is an urgent task.

India is also expected to lift restrictions currently limiting online retailers like Amazon from selling their own products in the country. Freeing up the ecommerce space is predicted to boost a contribution of 4% to economic growth by 2020, as opposed to 1% at the moment. Opening up the economy to online giants like Amazon is expected to benefit local manufacturers and suppliers as they form partnerships with Amazon and others to source cheaper local products. The decision to press ahead with this more liberal approach may well be announced in the first budget of the new government in July.

Another area for improving the ratio of foreign direct investment is in companies in the defence sector, where figures of up to 100% have been quoted. In the last ten years foreign investment has accounted for only $5billion of a $322 billion dollar overall investment in the sector. Private Indian companies have only been permitted to operate in the defence arena since 2002. Although the need for investment exists, there is some resistance to allowing such a high level of participation by foreign investors. If they are to be allowed to invest it should be conditional on a transfer of technology to India and training of Indian employees, said a source from Larsen and Toubro, a large Indian private defence contractor.

It is one thing to talk a good reform package, but can Mr. Modi deliver? He was credited with  great success as Chief Minister of Gujarat, where under his stewardship the economy grew and the state prospered. He even saw to it that the state had electricity 24 hours a day. Whether he can apply that golden touch to the economy of India as a whole remains to be seen. His image is one of a man who is corruption free, which no doubt helped him get re-elected as Chief Minister of Gujarat three times.

Responding to the president’s speech on Wednesday, Mr. Modi said "It is the collective responsibility of all elected representatives to fulfil the faith reposed in us by the electorate. I reassure the house that all the promises made in the President's speech will be delivered." He went into detail, citing enhancement of agricultural productivity as one step on the path, and encouraging the wider use of organic farming methods in the whole of the North East of the country, with the aim of entering the global market in organic produce.

Elimination of poverty will be reduced through more educational opportunities and the lowering of food prices. Even currently skilled workers should be given more chances to improve their marketability through further education. This also leads to improved social status, and the improvement of the social infrastructure in India is another important factor in the resurgence of the country. Mr. Modi admitted that the Gujarat model could not be applied across India, saying that “Different states offer different lessons and we plan to implement the best examples.”

The new government is in the honeymoon phase, and euphoria is high. There can be no underestimating the challenge facing Mr. Modi though as he begins his reformation. The mood has been optimistic and was certainly reflected in a surge in the stock markets once the election results were almost certain. Mr. Modi’s first budget in July should give a clearer indication of just how he intends to begin the great Indian comeback, and also give a clue as to just how investor friendly India might turn out to be. 

Modi Mania

The inauguration of India’s 15th Prime Minister, Narendra Modi, since British independence, early this week was a momentous occasion.  Guests and high level dignitaries from across South East Asia attended the ceremony to show their respect for Modi as he took the oath of office, swearing to uphold the nation’s constitution with dedication and diligence. Security throughout the entire affair, which was held at the Colonial-era presidential mansion in New Delhi, was unprecedented.

Modi, enters office with a landslide victory and also high expectations from the Indian electorate. Indeed, Modi’s newly elected government will need to hit the ground running.

On social issues despite India’s rapid growth over the past two decades, that elusive trickledown effect has not yet materialized; India remains near the bottom of the nutrition and literacy league. Moreover, the lack of jobs for young people entering the work force is another pressing problem for the government to tackle.

On the economic front there are also a number of challenges that lie ahead. Inflation remains stubbornly high 8.59 per cent in April 2014 with food and beverage price accelerating to an annual 9.66 per cent in April. Monetary tightening by India’s Central Bank, in other words raising interest rates,  is likely to be a delicate balancing between dampen price rises, but simultaneously not choking off business investment, consumption and economic growth.  Getting it right can be tricky. Speaking to journalist in Deli, India’s new Finance Minister Arun Jaitley, a supreme court lawyer and strategist for the governing BJP party said, “The balancing act will have to be done,” said Jaitley  in response to a question about how he intends to tackle inflation. “I will wait a few days before announcing the government’s program.”    

  

Additionally, reenergizing capital investments into infrastructure projects will also be a critical issue for Modi’s government to resolve.  The chronic underfunding of large infrastructure projects due to a lack of capital investment, which accounts for 35 percent of economic activity in India barely grew since the previous fiscal year that ended in March. The issue of capital investments is likely to touch on the thorny issue of alleged irregularities (corruption) of the previous administration in awarding public infrastructure projects.

Bolstering capital inflow into India is most likely going to be also on Modi’s list of things to do. India’s sovereign debt rating has been downgraded to a "BBB-minus", by the credit rating agency Standard & Poor, which has a negative outlook on the nation’s sovereign debt. What this implies is that India currently has an adequate capacity to meet its financial commitments, however, adverse economic conditions or changing circumstances could have an adverse impact leading to a weakened capacity on India to meets its financial obligations..   

So investors are eagerly waiting to see what Modi’s new government proposes to do in order to continuing meeting its financial commitments.  Reducing the budget deficit would be perceived as a step in the right direction, for investors.  Modi has a target of reducing the deficit below 4.8 percent of Gross Domestic Product (GDP). India’s deficit was 5.3 percent of GDP in 2012-13 (estimated figure).  But reducing the deficit results in fiscal leakages from the economy and the outcome of this reduced public spending is lower employment and possibly a fall in GDP.  Pedaling austerity to voters who are eager to see job creation will not be an easy sell for Modi’s administration.  Young job seekers make up 49 percent of the unemployment statistics, according to a recent study.

With respect to India’s burgeoning energy needs, the country is tipped to overtake China in 2020s as the principle source of growth in global energy demand and by 2025 India will be the world’s largest coal exporter, according to the International Energy Agency's latest World Energy Outlook.  Modi’s goal is for every Indian citizen to have access to a house with water and electricity by 2025.  Thus, Modi’s energy policy or foreign policy is likely to be not to put his eggs in one basket, which means strengthening diplomatic relations with the main energy suppliers, China, Russia and the USA.

It maybe still too early days to gauge what impact Modi’s new government will have on the true economic direction of the country. On the upside it appears that Modi has been true to his electoral motto of, “minimum government and maximum governance,” Modi’s Cabinet of Ministers has been streamlined.  All the sound bites from the newly elected government seem impressive; make the government more efficiency, energize growth, creating millions of jobs and spreading prosperity. However, little is understood about what is their strategic plan is to achieve these objectives, so far on this point the Modi government has been mute.

Admittedly, if all the stars could align, If Modi could get inflation under control, increase capital investment and net inflow of foreign capital, tackle corruption, make the administration more functional and get the youth in work, and then the opportunities could be tremendous. Consequently it is no surprise that the markets have been euphoric about Modi’s election victory.

 

But perhaps the outcome is not entirely in Modi’s hands, it may not even be within India’s sovereign boarders. It maybe thousands of miles away, within the central banking system of the USA, the Federal Reserve. If the Fed withdraws from its bond buying stimulus policy (tapering) the India Rupee falls, which would have an adverse effect on Indian Inflation, investments etc. So Modi may have an uphill struggle on his hands with the Fed winding down its monetary stimulus program, of billions of USD bond buying.

Volatile time may be ahead for the India markets.  Both the rupee and the S&P BSE SENSEX (India’s stock exchange index are down on the week, with the latter down 1.31 percent as I write this piece.  

Darren Winters

Real Estate Investing - The Role Of REITS

If you have a mortgage then you're already invested in real estate, no doubt with the not unrealistic expectation of seeing your asset appreciate in value. In spite of the periodic concerns about rising prices fuelling an unsustainable bubble, real estate in the UK, especially in London, continues to promise a healthy return on investment. 

 

Apart from direct investment in a property, another way to enter the real estate market is to buy shares in a REIT - a Real Estate Investment Trust. REITs come in three flavours: -

1. An equity REIT, which uses your money to buy and manage commercial and rental property.

2. A mortgage REIT, which buys the mortgages on properties at an advantageous rate of interest, with the intention of profiting on the difference between that and the higher interest rate the occupiers of those properties are paying.

3. A hybrid REIT, which contains both property and mortgage elements.

The principle is similar to ordinary investment trusts - you are pooling your money with other investors to own a portion of a real estate asset, which will ideally gain in value, and provide you with an income stream in the form of a guaranteed dividend. It's a bit like owning property without the hassle of maintaining and selling it. 

 

A word of caution though - not all REITS are publicly traded. The untraded versions are obviously less liquid, and can be subject to early redemption penalties. There's also less company information available to the prospective investor in many cases. So if liquidity is an important factor in your investment decision you need to sort the traded REITS from the un-traded before proceeding.

REITs are seen as a good vehicle for investors seeking income, because in order to exist as a REIT the company must pay out 90% of its operating profit in the form of a dividend. At the same time (where publicly traded), the shares retain the characteristics of an ordinary share tradeable on the stock exchange.

REITs originated in America in the 1960s, and were introduced into the UK in 2007. So as an investment vehicle they are arguably less familiar to investors here. Since then however, a number of property companies have converted to REIT status. From their perspective, being structured as a REIT has significant tax advantages - there is no corporation or capital gains tax payable, which means there's more capital available to add to the dividend pot.

From the investor's point of view, the advantages of being in a REIT as opposed to direct real estate investment include:

• Being invested in a company with multiple categories of property that provide a level of diversification, thereby diluting risk.
• High rate of distribution of profits of the company to investors in the form of a guaranteed dividend (unlike a regular company, which pays dividends on a discretionary basis)
• Liquidity. Unlike regular property, you can sell your shares quickly in a publicly traded REIT.

Some disadvantages include:

• In a financial crisis such as that of 2008, A REIT heavily invested in mortgages is susceptible to mortgage defaults, which affects its profitability.
• Paying out 90% of profits in dividends, while good for investors, leaves only 10% to re-invest into further propery acquisition, possibly slowing growth.
• The very liquidity that makes a REIT attractive also makes it volatile.

So if you were thinking about buying into a REIT, here are some factors to guide your research:

• Check out the management team. What is their track record like in terms of strategy and property investment choices? Are they paid on performance? If so, their interests co-incide with yours.
• How are they diversified? Is there a spread of investment across different property categories? Good diversification reduces risk.
• Look at past financial statements to see how much cash was available for distribution, and whether that amount is increasing annually.
• Are the types of property they invest in likely to produce good returns? For example, if they are heavily into retirement and nursing homes there is an argument that the ever aging population will ensure a continuous occupancy rate. On the other hand, if they're concentrated in commercial property and the economy suffers, then tenancy of offices will also suffer.

 

In terms of performance, there is data showing that REITs outperformed the S&P 500 index on a consistent basis over 30- 40 years at around 2%. But currently there are concerns in some quarters that higher interest rates will adversely affect REIT performance. Higher interest rates hit building industry borrowing costs. The riposte to this argument is that higher interest rates also mean higher levels of income for REITs holding mortgages, and that it's a sign that the economy overall is doing better, which should boost property values. 

This year started strongly, with the FTSE NAREIT All REIT Index gaining 3.3%. In February this increased to 4.69%, fell in March to 0.32%, and ended April at 2.88%. An alternative to a REIT is a Real Estate Mutual Fund, which invests in REITs and other property companies. Instead of receiving an income your money is retained in the fund itself, so your units continue to appreciate. There is of course the issue of management charges and the tendency of mutual funds to underperform the broader market, but there is arguably less research to do before taking the plunge. 

 

A couple of links that should assist you in getting a handle on the performance of mutual funds are:

1.http://fundresearch.fidelity.com/mutual-funds/category-performance-annual-total-returns/REAL  

2.http://finance.yahoo.com/funds/lists/?mod_id=mediaquotesmutualfunds&cat=%24FOCA%24SR%24%24&rcnt=50 

In conclusion, REITS offer the investor an opportunity to get involved in the real estate market and receive a regular income, while at the same time offering liquidity in the form of a tradeable instrument (for tradeable REITs). Real Estate Mutual Funds offer the same market segment without the income, but with the potential for growth in unit value over time.