AMP strategist sees cost of capital hitch

India's country risk premium is estimated at about 7 per cent at a time when long-term bond deals are being executed in the US at 5.5 per cent. "So the cost of capital in India is clearly not cheap, though not very out of line," said Alan Jacobs, international senior economist, strategist and key member of AMP Capital's asset allocation committee.

The pre-election campaign had heated the market up with its feel-good story. While there has been a correction since, the stock valuations still do not look cheap, he said.

"In the absence of any undervaluation to support the market, there is room for some volatility. However, the medium term definitely looks good for the Indian equity market. As a small open economy dependent on global liquidity, the Indian stock market readings show a leaning towards the optimistic side," Jacobs said.

He sees eight per cent as the achievable overall economic growth rate for India. "This has not been achieved in the past due to bad economic management," he said.

The short-term setbacks with change of governments have contributed to the slow pace of economic improvement in the country. However, if all the impediments are removed India should be able to strike this growth rate, he added.

On the other hand, he sees a lot of muscle in the corporate sector's focus on profitability. "The companies here are run fairly well, making for a business environment that is quite rational. The corporates have a keen understanding for the cost of capital and are profit oriented, " he said.

This is not the case elsewhere in the region, he also pointed out, offering Korean business as a case study.

"While Korea saw a fantastic economic growth in the past, the country's companies were not earning anymore profit in 1998 than they were in 1996, " he said.

Speaking on AMP Capital's investment strategy for Asia ex-Japan, he said that that the region is currently weighted pretty small, as it is seen up for struggle in the next three months.

Though India is one of the countries seen doing pretty well in the short run too, it is only eight per cent of the weighted index. However, economies that carry greater weightage such as Korea, Malaysia, Singapore and Taiwan, are seen on an uncomfortable plane.

Even the developed economy of Hong Kong is seen in the struggle zone. "We are taking a wait and watch approach to the region for the next year or so," Jacobs said.

The FII's current investment exposure in the region is about one percent. It has a guideline for investing in Asia, up to five per cent of its share portfolio.

AMP is pretty excited about investing in India's infrastructure, having already launched The Infrastructure Fund of India, in association with ADB in February this year to raise a corpus of $100 million.

He also see the country having a natural advantage in information technology. Though there has been a short term setback with the change of government, he maintains that the foreigners have discovered India and capital inflow will return once they become comfortable with the new government. He welcomed the capital gains tax changes benefiting the long term investors. However, felt more needs to be done on the FDI front.

"Government must contain the budget deficit if low interest rates are to be sustained long term," his presentation on India highlighted.

With the interest rates hardening in the US and Europe, Jacobs admits that there are possibilities of flight of capital from the emerging markets.

However, he rushes to add that though this is part of a cyclical change, he is not anticipating a severe cycle, this time round and does not see an out and out exit of capital.

He expects this cycle to be fairly short-lived. He is not impressed by the latest job data released in the US.

"I do not think that a one-month should be of such significance, in the light of the data that came through in the earlier months," he argued. Interest rates in the US, he says is too low from the point that the rate of interest should be higher than the rate of inflation.

Jacobs is in India on a whirlwind six-city tour, during which he will persevere to convince local corporates to increase the exposure of their annuity funds to equity.

His argument in favour of equity investments is that in the long term the return from equity is higher. "A mixed portfolio will help decrease the risk and increase the return," he pointed out.

Graham Meyer, managing director, AMP Sanmar, further urged that managers of annuity funds in India need to wake up to the need for a more dynamic investment portfolio to yield higher returns. The portfolios can be tailored to the average age of the companies, he said.