“Infrastructure is our biggest opportunity. In the next 10 years we must invest at least $150 billion (Rs6.51 trillion) to modernize and to expand India’s infrastructure. I am not an astrologer to predict the course of events. But I have a dream. Like I said in my first speech as finance minister in 1991, I quote ‘No power on earth can stop an idea whose time has come’.”
These words are from Prime Minister Manmohan Singh’s speech at the New York Stock Exchange in September 2004. The infrastructure boom was just gaining momentum then. Private investors have since then brought in billions of dollars.
UTI Mutual Fund capitalized early on the boom by launching the first dedicated infrastructure fund in April 2004. In 2006, it was the best performing fund out of 145 diversified equity schemes. Infrastructure schemes sprouted and flourished and their assets under management rose from Rs5,201 crore to Rs24,675 crore in the past two years (May 2006-08). Not surprising, since the returns were as high as 90%.
How the mighty have fallen (Graphic)
No one could have expected the sector to tumble to the current levels. The $150 billion figure has now been revised to $500 billion and Singh’s dream seems to be a distant reality.
The current economic environment doesn’t help. High interest rates do not show any sign of abating immediately. Infrastructure firms typically have high debt levels. Investing in a company with a high level of borrowed capital in times of rising interest rates is risky because of the additional debt servicing cost. A project that was attractive when interest rates were 8%, ceases to be so when they touch, say, 11%.
Inflation is hurting. High input costs are impacting profit margins. A large backlog of projects has to be completed at fixed prices which are lower than the current costs. So, over the short term, profitability is going to be impacted. Thanks to inflation and high fiscal deficit, interest rates will not ebb.
What really captivated investors about the infrastructure story was the $500 billion outlay in the 11th Five Year Plan (2007-12). Infrastructure stocks hit ridiculous levels. As long as the market is on a roll, investors gravitate towards stocks with the highest potential. But once the market takes a turn, it is the stocks which outperform that are also the ones that tend to plunge sharply.
So, while the infrastructure dream has not really gone sour—it’s still as relevant as ever—it is the fall in stock prices from unrealistic levels that has caused nervousness in the market. As the standard of living increases, the demand for infrastructure shoots up. The per capita electricity consumption rises, while the demand for better and more roads goes up as the number of cars increases. The demand for housing follows.
A report by the Planning Commission says infrastructure spending is the key to sustaining GDP growth rate at more than 8%. A report by Emkay Research in November said government expenditure on infrastructure had witnessed a substantial jump—Rs3.96 trillion in the nineth Plan, Rs6.32 trillion in the 10th Plan and Rs14.72 trillion in the 11th Plan now.
Higher interest rates will definitely put pressure on growth. But it appears that the consequent slowdown in corporate India and infrastructure companies could be short term. When we say short term, we are referring to at least 18 months. Infrastructure expenditure requires a strong government. One that is facing elections in the near future will be more constrained in coming out with projects to boost infrastructure spending.
If you have invested in infrastructure funds, it would not be wise to exit now. You could lose heavily—hang on for at least a few more years.
For investors with a short- to medium-term time frame, Amar Ambani, vice-president of research at India Infoline, suggests avoiding mid-cap, sector and thematic funds and sticking to those with a large-cap orientation. According to him, India is no longer a top-down story with low inflation and high GDP. “One needs to stick to bottom-up selection when you have high inflation, high interest rates, high crude oil prices and an economy going through a bad phase.”
If you want to get into infrastructure, valuations seem to be reasonable. But be prepared to put your money aside for—to be safe—three-five years. But as always, when getting into a thematic fund, make sure your core holdings are proven diversified equity funds.
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