Who's next...?

This one is on a serious note. CNBC had an excellent talk this Sunday...and here's the pollution:

China's Shanghai stock market had a 9% plunge..and led to a global sell-off on 27th Feb, 2007.
And the question was..who' next?...

I strongly believe(now), it's India next..to me, the country(mostly) looks like it's on the road to a *genuine* economic and political crisis...
(me going pessimist?? NO!...hold on your arguments for a while please...)

Reasons being:

• we're as big as China. It's growing just about as fast...
• Our economy is in more danger of overheating...
• And...we now are more dependent on speculative hot money...
• We have already suffered a ~30% drop in May-June, 2006, so similar volatility cannot be ruled out.

To mention the obvious..any short-term blip in a major developing market such as ours *could* set off big ripples across the globe...

In the long term, however, I think India still remains the most attractive of all global stock markets:

• Our population is younger than China..
• Our education system is expanding and improving..
• Our companies are now more focused on creating wealth for shareholders...ha!

All this makes me more inquisitive...

• Do the long-term rewards outweigh the short-term risks?
• Should I (as investor)..buy in now...determined to weather any storm that may come?
• -> or instead, should I simply wait for the rain to fall and the clouds to clear?...and how long?

Myself..not being a finance expert..but I'll have my take :)

Short-term risks:

• Asset prices are high...so high that they show all the signs of a classic asset bubble. Property values have soared...value of prime office space in metros are up by double digits (>50%) the last year...these high asset prices depend on a flood of easily withdrawn overseas hot money...and India being very dependent on global cash flows...makes it all the more vulnerable
• Bank lending is out of control...RBI trying hard to control it but in vain till now.
• Inflation is out of control. Nationally, inflation recently hit a two-year high of 6.7% and is running even higher specially in rural areas where two-thirds of India resides.

• RBI recently raised its benchmark interest rate to 7.5% at the end of January...without noticeably slowing neither inflation..nor..the lending boom.
• FM has *intelligently* undercut the central bank's efforts...urging banks not to pass on interest rate increase to lenders...kudos!!

Short-term prognosis:

• A big domestic credit crunch ahead...caused when lenders stop lending...and..borrowers can't get the cash they need to run their businesses.
• Causing India to fall far short of all current forecasts of annual growth...foreign investors start withdrawing money from BSE...resulting in yet another *major* correction...
• Consider Congress Party government losing power. After stumbling with politically motivated attempts to reduce food and fuel prices in rural areas...the new government bites the bullet...and raises interest rates, and cuts down bank lending enough to slow inflation...and eventually the economy slows down. On the other hand, this might lead to return of overseas cash back in also.

It won't play out exactly like that, of course :)
It's difficult to predict...how deep any credit crunch might be or how much RBI might have to slow down the economy to reduce inflation to its..so called..5-5.5% comfort zone...

Subduing inflation in India would require big increases in supply...
Indian companies..now operating at full capacity...and with improvements in infrastructure that reduce the costs of moving food and fuel...this seems achieveable.

But, I don't know...
---->how long the Congress government will be able to *cling* to power...
---->how other global markets would react to a big drop in Indian stocks...
---->when all of this *would* happen... :)

The core of the problem (per the talks..):
"The imbalance between urban-areas-quickly-growing-wealthy (in Indian terms..) and rural-areas-left-behind in the boom."

All this mess took a while to create...and it will take a while to correct. Crises could be seen within that 18-24 month window...

Long-term rewards:

• There's no going back to the highly-regulated-economy of the past...open-up is the theme.. Even the Congress Party..(clearly not a friend of open economy)..wasn't able to resist the momentum. And with Indian companies increasingly making big bucks from the global economy, there's no reason to put the genie back in the bottle. That means future growth should be pretty decent..(7-10% ?).
• We have enough numbers (population) to make a decent consumer economy/market. So, even if we are still poorer than China, growth in consumption should be able to take off the overall economy...
• Government realizes the need to catch up...education is getting the attention..and money too. Recent budget has shown the same.
• Thanks to the recent population explosion..half of our population in below 25 years of age...This means that we have the required time to fix our problems before the needs of a huge old aged (60 and older) begin to dip into national savings.....younger economy grow faster..
• Our companies have a culture of creating value for shareholders. It's subjective..but it's important. Many companies here...and some of the biggest...have family driven culture. I think that culture takes much better care of shareholders!..than that of corporate China..where companies are often run to enrich local officials, managers and elites.
• Companies traditionally have shown above-average profitability...inspite of being short of cash flows...so coping up with cash shouldn't be much of a problem.

All in all...India should remain the most attractive stock market in the world in the long term...

Stats: The average return on equity for Indian companies(BSE): 21%.
Average return on equity for the U.S ($INX): 18.7%
-> Middle class population(2005): 200-300 million (approx.)
-> India's Per capita GDP(2005): $3,460
-> China's per capita(2005): $6,660 (We are still poorer than China...)
----> Only 10% of Indians have life insurance.
----> Only 2% have credit cards.
----> Only 15% Indians have refrigerators.