Lynn Carpenter’s insufficient analysis

Rajesh Jain points out an article by Lynn Carpenter that argues China is still a good bet for small investors because India’s economic growth is doubtful. Her contention that Chinese companies are good investments is not wholly wrong – but her analysis of the Indian economy is not wholly correct either.

So far, the major business model for the more highly touted Indian companies is: copy what’s done in the U.S., do it cheaper, and ship it back to us. Innovation and R&D spending are not robust. But journalists touting India seem to be unaware of a fatal flaw in that plan. Not only are the profits to be made selling cheap substitutes limited, but it’s a plan all India’s fellow emerging economies can copy. Taiwan and South Korea are already cutting into the world IT market.

Carpenter’s contention that India’s entire software sector is a ‘copycat’ is dubious. However, even if her argument is valid, Japan, China and Taiwan got to where they are today after going through an initial copycat phase. In fact, if an economy is in a copycat phase, it may be an early indicator of the things to come. Investing in an economy at this stage may deliver excellent returns in the long term.

I’d rather find a sound business engaged in a more sustainable market: capitalizing on the boom at home. A good example of this is Sina.com or Sohu.com, the Chinese Internet companies. Or CHINA UNICOM, the telecommunications company that is gaining subscribers at home by the millions, not to mention subscribers in nearby countries. They’re not value investments today, but they are sound businesses.

I suppose Carpenter has not heard of Rediff, Indiaworld-Samachar-Sify, which have been in the act long before the Sohus and Sinas came along. China Unicom is flourishing as an oligopoly in a opaquely regulated market. Monopolies and Oligopolies do provide great returns, but their days are ultimately numbered. Contrast this with India – Bharti rose from being a virtual mom-and-pop shop to a billion-dollar company today in just over a decade; all on the strength of entrepreneurship. Reliance Infocomm built a nationwide fibre-optic network and wireless internet in just over three years. In response state-owned companies like BSNL are rising to the challenge. This is a dynamic marketplace – and it has happened in spite of frequent policy cul de sacs. Carpenter could have used Huawei as an example – but she did’nt. Was that because it is another company patronised by the Chinese government or was it because it copied unapologetically Cisco technology?

This creates a spiraling vicious cycle for India. It needs progress so that it can afford to aid its own people. But with so many of its people poor and untrainable, it is hard to make that progress. India’s largest industry is agriculture. Textiles come second. The vaunted IT sector we hear so much about is a mere 3% of the economy.

If the IT sector is just 3% of the economy, does’nt that mean India has a large, diversified economy. I would have been more worried if all India’s bets were in one big IT basket; but they are’nt. They are in pharmaceuticals, diamond cutting, agriculture, automotive manufacturing and textiles.

But the government is strapped. Its deficit comes to 10% of the GDP (the United States’ current record deficit is roughly 5% of GDP). Its cumulative national debt equals 80% of annual GDP. But when it comes to privatization, the engine for progress and Western investment, India still has strong, powerful resistance from farmers and labor trade unions.

The link between ‘Western’ investment and privatisation is tenous. However, Carpenter is right when she talks about the powerful trade-union lobby against privatisation. That is a huge challenge for India, but something on which progress is being made. In India’s democratic system, progress and reconciliation go together which creates greater stability in the long term.

India’s lack of buying power at the ground level where consumers live is astounding. Partly that’s the result of its attempt to leapfrog from an agricultural economy to a service economy – a model that excludes most of the population. The true path to successful development wends its way through industrialization first. It comes with higher rates of education, literacy and health. And it comes with heightened confidence on the part of large international investors – as represented by foreign direct investment.

Until the big boys put their money down, it’s not safe for small retail investors to get in on the game. Foreign direct investment to India just barely nudged up to $6.7 billion last year. That’s about what flows to Poland or Portugal…though admittedly, it’s a great increase from the $2 billion or less of prior years.

Yet the selfsame Indian economy grew at an astounding rate last year, and its trade deficit is narrowing. If this continues, the dogma of FDI being necessary and sufficient for economic development may be seriously challenged.

If you’re determined to catch a mainstream trend, catch the China wave rather than India’s. As an investment, I still much prefer China. An impressive portion of China’s growth is coming from industrialization and consumer products with both domestic and international appeal.

Interestingly, Carpenter has made no arguments to prove that China is a good place for small investors. Rubbishing the Indian economy does not validate her thesis.

To sustain high-economic growth, there is an urgent need for the Indian government to accelerate reform, and invest in infrastructure and human capital. Keeping fingers firmly crossed, the 2004 elections may yet provide a strong mandate for the government to do just this.