What investors need to know about the Indian economy

By Emerging Money>,

Shutterstock photo

As a member of the BRICs, India's economy ( EPI , quote ) has recently received a lot of attention from international investors. However, before putting money into this South Asian economy, investors must understand this country in the context of its economic past and future.

[caption id="attachment_59480" align="alignright" width="300" caption="Mumbai skyline"] Image courtesy Steve Evans: http://www.everystockphoto.com/photographer.php?photographer_id=5010 [/caption]

Throughout most of the post-World War II era, the Indian economy ( INDY , quote ) was a wasteland for international investors. From the '50s to the '80s, as the result of Communist leanings amongst policymakers, the economy plodded along, growing on average three percent annually; the Indian economy's tortoise-like pace was often derided as the "Hindu growth rate."

However, starting in the early '90s, now-Prime Minister Manmohan Singh was appointed Finance Minister. During his tenure, Singh implemented landmark reforms which allowed India's long-dormant economy to finally blossom.

Since then, India swiftly became a favorite of emerging market investors. Unfortunately, as a result of both capricious and myopic economic policy of recent, as well as poor management of the economy, India faces formidable hurdles going forward as its structural deficiencies continue to exacerbate extant problems.

Over the past two years, the Indian government has served as a significant impediment to economic growth in the country. A decision to retroactively tax foreign takeovers has spooked foreign firms ; a demand to telecom firms to pay significant additional fees for 2G licences has peeved the likes of Vodafone ( VOD , quote ) and Tata Communications ( TCL , quote ); policies based more on populism like maintaining costly fuel subsidies have weakened the foundation underneath the country's currency , the rupee ( INR , quote ).

Of late, the country has also proven to be a poor manager of the economy. Inflation remains problematic , and recent interest rate cuts will not ease inflationary pressure; India's current accounts deficit remains troublesome; growth is still slowing, which has resulted in a scenario of potential stagflation going forward.

While the structural integrity of the Indian economy is questionable, there are still a number of Indian-based companies that are able to thrive. In particular, companies that derive the majority of their revenues from abroad are positioned to outperform other Indian equities over the medium-term. Car manufacturer Tata Motors ( TTM , quote ), especially through its Jaguar-Land Rover division, is a good example of one such company . As well, information technology firms like Wipro ( WIT , quote ) and Infosys ( INFY , quote ) that generate much of their revenues from the U.S. and Europe are less exposed to Indian economic weakness.

On the other hand, firms with large domestic exposure could underperform. Sectors such as financial firms like ICICI ( IBN , quote ) and HDFC ( HDB , quote ) will be adversely affected by a rupee that is perpetually decreasing in value when their ADRs are denominated in a strengthening dollar. As well, banks are likely to see smaller loan growth and potentially more defaults if growth continues to slow, as Goldman Sachs projects.

Telecommunications firms like TCL may suffer both because of rupee exposure, but also because the government's interference in the sector has placed these companies under pressure .

In sum, investors looking to put money into India must be mindful of the structural pitfalls plaguing the economy. In order for India to return to growth, efficient policymaking and effective economic management must materialize. Until then, investors should lean towards Indian stocks with significant foreign exposure.

Disclosure: Author's immediate family is long EPI and TTM

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Stocks
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