Isolated from the rest of Asia by the supreme continental wall of the Himalayas, the Indian subcontinent touches three large bodies of water and appears as a huge, terrestrial beak between Africa and Indonesia, making it a visible landmark on any world map.

India, or Bharat, as it is also known, is one of four large and fast growing emerging markets, known as the BRIC (Brazil, Russia, India and China) and the eleventh largest economy in the world. With nearly 1 billion citizens, it is the second-most populated country. In fact, India's puzzleboard of 26 states has 10 of the 30 fastest-growing urban areas in the world and has an average annual GDP growth rate of 5.8 per cent for the past two decades.

Last year, the Global Competitiveness Report ranked India ahead of several advanced economies in terms of its financial market sophistication, banking sector business sophistication and innovation. The country is also the second most favourable outsourcing destination after the United States, since growth oriented companies stand to benefit from a more easily accessible Asian market, lower labour cost and availability of skilled human resources willing to work during the night just to be on the same time zone with their US colleagues.

When a crisis results in growth oriented policies India's Socialist-inspired policies (adopted between the 1950s and 1980s), shackled the economy with extensive regulation, protectionism, and public ownership. This ultimately led to pervasive corruption and slow growth. The nation's liberalisation in 1991 which came about after an acute balance of payment crisis has moved the economy towards a market-based system. The emphasis since then has been to use foreign trade and foreign investment as integral parts of India's economy. In the late 2000s, India's economic growth averaged 7.5 per cent per annum.

Following its decisive election victory in April 2009 the United Progressive Alliance coalition cemented its political gain with victories in several state elections and a less aggressive opposition. With a light election calendar, this year should allow the government to focus on contentious reform measures. However, the lack of a majority in the Upper House of Parliament may continue to slow the reform process. While cross-border terrorism has been brought under control, heightened Maoist insurgency in select states will remain high on the security agenda.

A speedy recovery

The country is heavily dependent on the agriculture sector, since more than half of the population depends on it for their living. The sector accounts for 28 per cent of GDP, while the service and industrial sector accounts for 54 per cent and 18 per cent, respectively. India's growth was hampered last year by the global economic crisis and a poor monsoon season, but has shown signs of recovery, riding on healthy manufacturing sector growth. There is limited doubt that the economic upswing will be sustained and strong, even in the context of fiscal tightening and the withdrawal of stimulatory monetary policies. High wage gains, combined with low household debt levels and the ready-availability of credit should continue to lift consumer goods sales.

In addition, on-going infrastructure improvement projects will keep the demand for capital goods strong as well. Investment demand should improve on easy funding, the improved business outlook, resilient capacity utilisation and rising demand. The government's emphasis on increased infrastructure investment via the public-private partnership model should further boost investment demand. The structural advantages which helped India to weather one of the world's worst financial crises - strong domestic household demand, due to higher population growth and thus higher private investment - are expected to strengthen further. The Reserve Bank of India also relaxed restrictions and provided incentives to encourage more flows to the capital market and commercial real estate sectors.

The bad news is that the rapid economic upswing is already beginning to stretch capacity use, which means that core inflation has started to pick up. Moreover, the 2010-11 Federal Budget presented in February which is targeting a deficit reduction of 5.5 per cent of GDP in FY11 (began April 1, 2010) from 6.7 per cent of GDP in FY10 (ended in March 2010), is likely to increase near-term inflation pressures as well following the announcement of higher import duties and increased excise taxes on fuel. In fact, the Reserve Bank of India raised its key interest rates for the second time in a month on April 20. Meanwhile, official sources estimate growth of around 8.5 per cent in FY11.

Market cheer the budget

The country's improved growth performance, has prompted Standard and Poor's to upgrade the outlook for India recently to stable from negative, and affirmed the long-term sovereign rating of BBB-. The local stock exchange - the Sensex has rallied sharply since February's Budget, because the rise in indirect taxes was not as sharp as feared. Indian equities do not look cheap however as they trade on a historic earnings multiple of 25. Further upward trend from here will therefore depend on what happens to corporate profits which the market anticipate will be at a double-digit pace in 2010 and probably also in 2011.

Investors are drawing confidence from the prospect of continuing growth in a sustainable economic environment. Moreover capital inflows are expected to pick up this year, as Indian interest rates climb more sharply than elsewhere. Foreign direct investment should also improve given the economic outlook, while portfolio investment inflows into Indian stocks have already turned positive again. Rupee appreciation has resumed in March as investor risk appetite has climbed again. The RBI rate hikes will probably hold the market back for a time but policy rates will be rising in the context of strong economic growth, which should lift corporate profits.

Is everything rosy about India?

Although the Indian economy has grown steadily over the last two decades, its growth has been uneven when comparing different social groups, economic groups, geographic regions, and rural and urban areas. In addition, it is still hampered by poverty, illiteracy, corruption, disease, and malnutrition. The World Bank suggests that India must continue to focus on public sector reform, infrastructure, agricultural and rural development, the removal of labour regulations, improvement in transport, energy security, health and nutrition. As a matter of fact, further investment in these areas is imperative for the economy's growth prospects. The authorities need to reduce unnecessary bureaucracy and make changes to rigid laws to attract private investment, given the government's persistent budget deficit.

This article has been prepared by the Research & Analysis Unit at BoV Wealth Management.

This document is issued by Bank of Valletta plc for information purposes only. This document is not and should not be construed as an offer or recommendation to sell or solicitation of an offer or recommendation to purchase or subscribe for any investment. This information may not necessarily be appropriate to your particular investments requirements and risk profile. It is therefore recommended that if you require investment advice or wish to discuss the suitability of any investment decision, you should seek financial, legal or tax advice from your professional advisers as appropriate.

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