May 2011

INSIDE VIEW: India's long and winding road

Road_IndiaInvestment in infrastructure is key to the continued development of the Indian economy, says Susanta Mazumdar at T. Rowe Price

India is one of the most compelling economic stories within the Asian region. Structural reforms, positive demographics and globalisation are spurring economic growth to new heights. Indeed, India is catching up fast with China in terms of rate of economic growth. Its gross domestic product (GDP) growth has moved from a range of 6% in the early 2000s to 8% to 8.5%. We believe that this higher rate of economic growth is sustainable and may even overtake China’s in the future.

For India to maintain this level of growth, however, requires continued investment in its infrastructure. Building roads or railways immediately boosts output and jobs, but it also helps to spur future growth. The World Bank estimates that a 1% increase in a country’s infrastructure stock is associated with a 1% increase in the level of its GDP.

In the past, India has suffered from a number of false dawns in infrastructure development. Encouragingly, we believe there are now definite signs that the next few years will see real progress in infrastructure development, via a combination of private- and public-sector financing. The current Indian Five-Year Plan calls for $500bn (€345bn) of infrastructure investment through March 2012. It appears that $300bn to $350bn of investment will happen during this period, implying a success rate well above the 50% norm during many past such plans. There also is great potential for infrastructure spending to grow even further. At present it only accounts for 7% of GDP, but the Indian government has targeted 10% of GDP.

Future spend
Total Indian infrastructure spending over the next seven years is estimated at $750bn. The majority of this is likely to be in power, roads and telecommunications, where a 3G build-up soon will be under way. Roads in particular are looking more attractive as the new minister of road transport and highways has indicated strongly that the government will accelerate its building programme. In the last fiscal year, 3,166 kilometres [1,967 miles] of highway projects were awarded. In the next fiscal year, that could rise to 9,000km.

India also continues to face a major power deficit with a peak deficit ranging from 10%- 15%. This is despite low per-capita consumption and only one-third of the population having access to electricity. To tackle this, the Indian government has targeted capacity addition in power generation as a key objective. The availability of various financing options and an increase in bank lending for the power sector should also help accelerate investment, while the entry of private sector players will result in growing capacity. However, the weak financial conditions of state power distribution boards continue to work against unlocking real demand.

Encouragingly for investors, infrastructure operators who have strong execution capabilities, long-term power purchase agreements and access to low-cost fuel resources should be able to post superior profits and stable returns. Additionally, with only a relatively small number of companies that have the ability to develop infrastructure projects, very attractive returns can be achieved over time. Historically, periods of rising interest rates have made it harder for infrastructure developers to raise funding capital, but we believe that the highest quality developers with the best assets will continue to succeed over the long term.

Of course, macro concerns remain, particularly as to the Indian fiscal situation and inflation. But infrastructure assets tend to offer relatively high pricing power, and assets with pricing power and stable regulatory regimes also typically exhibit high inflation protection. Revenues are often hedged or partly hedged against the impact of price rises, either through an inflation element incorporated in the price/revenue formula of the contract or through the pricing power of the business.

The inflexible demand, high barriers to entry, and the monopoly-like characteristics of many infrastructure assets (such as utilities, water, and electricity generation) also mean that their financial performance is not as sensitive to the economic cycle as many other asset classes.

Given the potential for further volatility in market conditions and the distinctive characteristics of the sector, the risk/return profile of the asset class is very compelling. Moreover, the Indian focus on infrastructure
is very much a long-term growth theme, which is only at the beginning of a long and sustainable cycle.

Susanta Mazumdar, is a vice president of T. Rowe Price Group and portfolio manager of the firm’s Global Infrastructure Fund

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