To start with, the decision to allow FDI in single brand retail like Tesco, Carrefour or Marks and Spencer will go a long way in opening up the retail sector. The total retailing industry is largely unorganised, with organised retailing accounting for only $4 billion of the $200 billion industry. We estimate that close to 50 million sq ft new retail space will be developed over the next five years. Any scaling up in the retail sector can only come on the back of a strong food processing industry. The most important part of a strong food processing sector is managing the logistics, cold storage, etc, and getting FDI is important to acquire that expertise. Already, the US food processing major Del Monte has acquired a company in India, whilst Cadila has bought a stake in Carnation. ITC and Reliance are planning huge forays in contract farming to support their food processing businesses. Reliance recently announced that Punjab will be its hub. We estimate that its size could double from the current $100 billion over the next few years.
Secondly, I think the power sector is now poised for significant investment. The government’s announcement of five mega power projects, which will be completed through private-public partnership, have signalled that power sector reforms are under way. The Tatas, Reliance, etc, who could take on these projects don’t really need foreign partners. But this sector is ripe for foreign investment and a fair amount of FDI could come in through such a partnership route.
Thirdly, the textile sector will also see strong growth now, I think. I had been disappointed by the lack of new capacity being built in this sector. But now we have three years before quotas come off for China. And I am seeing capacity getting built and order books are looking strong. In his budget, the finance minister stated that there is an opportunity for India to be a manufacturing hub for the world in the textile sector. I think that for that to happen, the most important thing is that labour laws need to be liberalised. This can create tremendous job opportunities in the rural areas.
When all these take off, we will see strong economic growth and strong waves of FDI coming in. We could see an FDI influx of up to $15 billion in FY-07. While the investments will be fairly well spread out, I think we will see investments in power, retail, textiles and food processing. More importantly, the impact on economic growth could be significant as for every one rupee spent on construction, an estimated 75-80 per cent is added to the GDP. The biggest possible pitfall I see to this growth scenario is the rising oil prices. If oil prices rise over $70 a barrel, then India’s current account deficit will rise and there could be currency pressure. In that case, interest rates may rise which could curb further investment and capex by companies in the near term.
But, if realised, the GDP growth will spur on markets. Right now, analysts are predicting about 15-17 per cent earnings growth, leaving the Sensex trading at around 16 times one year forward earnings. But if GDP growth does touch 9 per cent, we will see much stronger corporate growth. I think we will see earnings upgrades, and indeed corporate earnings growth in cement, construction, etc, have already been raised by between 20-40 per cent. So we may be trading on a forward P/E of around 16 times earnings right now but with increased earnings growth that will fall.
Our estimate is that the Sensex will touch 12000 by October this year. There could be some hiccups on the way as the markets have been liquidity-driven. I think we will see $10 billion in fii investment in 2006. We are still seeing strong liquidity coming in from the foreign investors. There is more European and Japanese investment and more India-dedicated funds coming in. But while this surge of international investments will go on, local retail presence is also expanding. This year, local retail investors have already invested $3 billion through mutual funds, which is equal to what they invested in 2005—and that was a record year for domestic retail investment collections. Local retail investors could bring up to $6 billion in the markets this year.
Last year, there was a sense that the unprecedented foreign flows were coming into the Indian market because it was the year of emerging markets. This year, more than $20 billion has come into emerging markets so far. Of this, more than $3.5 billion has come to India, even though India is not the cheapest market. So, in conclusion, the economy looks set to move up a gear and with it earnings too.
(Holland is executive vice-president, DSP Merrill Lynch.) (The views expressed here are the author’s own and DSP Merrill Lynch may/may not subscribe to them.)
