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How to build an infrastructure stocks portfolio

By Devangshu Datta in New Delhi
April 26, 2010 16:57 IST
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Financial crises blow up suddenly and end gradually. Between September-November 2008, financial institutions went into collapse.

That caused a major recession and negative global GDP growth in 2009. Global GDP growth in 2010 is not expected to recover very strongly.

India and China are well ahead on the recovery curve due to strong domestic economies.

Both Asian giants rely on trade and export growth and on FDI and FII flows to buoy equity valuations and capex.

Until demand picks up globally, there isn't much to be done on the exports front. But an interesting thesis is that India could gain from hard currency weakness and poor fundamentals across First World economies.

The USD is weak because America has a huge fiscal deficit, weak GDP growth, massive overseas debt and an unfavourable trade balance. The Euro and Yen have both gained relative to USD. But Japan and much of the EU are still in recession.

Large fiscal deficits are the norm. Another crisis like that in Greek government paper could trigger off a slide in Euro value.

Investors are nervous about hard-currency assets and would ideally, like higher returns.

India is one of the very few economies large enough to absorb large quantities of FDI and portfolio investment. It is also one of the very few economies with reasonable fundamentals and growth prospects.

Comparisons between China-India are often invidious and always a case of apples versus oranges. But in the specific instance of attracting FDI, India possesses more upside. China already has an open FDI regime; and attracts far more FDI.

Hence, it has few policy options to further accelerate FDI inflows. The Yuan is artificially depressed through its USD peg so an investor into China also has low prospects of currency appreciation.

In contrast, India could continue to liberalise to attract overseas investment and the rupee (INR) may be allowed to further appreciate. INR has risen through the past 12 months against major currencies anyhow.

FDI inflows in fiscal 2007-08 hit $34.8 bn and inched up to $35.2 bn in 2008-09. Between April 2009-Dec 2009, $ 28.5 bn has come in. There has also been a positive reversal of portfolio investment trends.

In 2008-09, FIIs sold Rs 73,229 crore (Rs 732.29 billion) net. In 2009-10, they invested net Rs 38,425 crore (Rs 384.25 billion). In April 2010, they have so far invested net Rs 1943 crore (Rs 19.43 billion).

More liberalisation could reasonably be expected to lead to larger inflows. Certainly India could absorb any conceivable quantum of investment. For one thing, roughly $500 bn equivalent must come from private sector resources to fund investments in infrastructure alone during the Twelfth Five Year Plan (2012-2017). That would be difficult without strong FDI inflows.

Full convertibility is very unlikely. No political formation wants to risk it. But FDI clearances could be less tedious and controls eased a lot without stepping across the line into full convertibility. Almost everyone expects higher FDI inflows in 2010-11. The beneficiaries are mainly likely to be players in infrastructure.

Accelerated inflows should lead to a stronger rupee. This suggests exporters will continue to struggle. However, crude contributes the lion's share of imports and that will become relatively cheaper in rupee terms.

Energy subsidy is a major contributor to the fiscal deficit. Cheaper oil means less stressed public finances. Cheaper imports in general could also help control domestic inflationary trends. Hence, the GoI may not be unwilling to allow further INR appreciation.

It's possible to be continuously long INR through selling currency futures contracts. That carries a fair amount of risk. But the returns could be huge. INR was below Rs 51 in April 2009 - the last 12 months have seen an appreciation of 13 per cent.

In the past two months, INR gained 7.5 per cent against both Euro and Yen. Margins on currency contracts are about 2-3 per cent. So that works out to spectacular returns for traders who got it right.

What about being overweight in infrastructure stocks? This is a distinct possibility. Since infrastructure consists of several different industries, an infra-focussed portfolio can be well-diversified.

There are big differences of quality and valuations between different players in the same infrastructure industries. Also there are vast differences in terms of growth prospects for industries.

In many cases, forex inflows could arrive through project-specific special purpose vehicles (SPVs), or via debt rather than equity. So an infra-focussed portfolio cannot be built blindly; it requires careful assessment of news and its impact on balance-sheets.

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Devangshu Datta in New Delhi
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Related News: FDI, INR, USD, GDP, India

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