The East's new powerhouse

Huge potential, huge volatility - Simon Hildrey asks if investors should go into India

The outcome of the recent Indian elections shocked political analysts as the Indian National Congress Party swept to power, knocking the ruling Bharatiya Janata Party off its perch. They weren't the only ones in shock: the Mumbai stock market fell 20 per cent in the two days after the result.

The outcome of the recent Indian elections shocked political analysts as the Indian National Congress Party swept to power, knocking the ruling Bharatiya Janata Party off its perch. They weren't the only ones in shock: the Mumbai stock market fell 20 per cent in the two days after the result.

The Indian market, which has since recovered half these losses, is no stranger to volatility: it rose 83 per cent last year. But while this unpredictability might scare off investors, there are fund managers who believe India offers better long-term prospects than the current flavour of the month, China.

In India's favour are its demographics and greater potential scope for growth. "India is 10 to 15 years behind China in terms of economic development," says Sanjiv Duggal, chief investment officer of HSBC Asset Management in India. "And in absolute numbers, there are more people aged under 25 in India than in China."

While the country is well known for its call centres and IT industry, it has been less successful than China in attracting manufacturing investment from the West. Its foreign direct investment is between $2bn (£1.10bn) and $3bn a year, while China's is around $50bn.

Mr Duggal says the Mumbai market still offers attractive valuations: "Equities are only 10 per cent above their all-time low on a price/earnings multiple." He expects earnings growth of 15 to 20 per cent a year and similar increases for equities over the next three years.

Bijay Pohani, senior analyst at investment house First State, also argues that India offers greater diversification across sectors than other Asian markets through the 6,000 companies listed on the Mumbai market.

Mr Duggal says fears about the Congress Party's coalition with the Communist Party have been overplayed, although the Budget, to be published towards the end of June, will reveal more about its commit- ment to reform. He believes the signs are good because Prime Minister Manmohan Singh was the finance minister who started economic reform in 1991.

Adam Matthews, regional specialist for Asia Pacific at JP Morgan Fleming, is more cautious, citing the Congress Party's statement that it will not privat- ise profitable state companies, to the detriment of share prices in the oil, gas and banking sectors. He is also concerned about political instability, though if the coalition collapses this summer, he believes it may present a buying opportunity to speculative investors prepared to "ride the volatility and possible short-term losses of 20 to 25 per cent".

But investors wanting to dabble in Indian stocks face a problem as there are no India funds based in the UK. One way in is via an investment trust or offshore fund, and returns have been impressive: the net asset value of the JP Morgan Fleming Indian investment trust in the year ending 19 May increased 65.8 per cent. Be wary of offshore investing, however, as many funds don't have distributor status, so capital gains are taxed at your usual rate of income tax.