Reflections on India

It had been thirteen years since I had first visited India, and I had not been there since. In January of 1987 there had yet been no stock market crash, no Gulf war, no Tiananmen Square, no toppling of the Berlin Wall, no collapse of Soviet Russia, no end to apartheid in South Africa, no assassination of Rajiv Gandhi. Bill Gates was only moderately rich, Ted Turner still ran an independent company, Jack Welsh was a respected corporate leader, but not yet an icon, Ivan Boesky was a savvy risk arbitrageur, Boone Pickens and Carl Icahn were feared corporate raiders, Michael Milken was a financial genius, Michael Jordan had not retired even once. Rudy Giuliani was a prosecutor, not a mayor or a Senate candidate, Ed Koch was a Mayor, not a commentator, Pat Buchanan was a Republican commentator, not a Reform party politician.

With all these changes, it was not surprising that India, too, had changed over these years. Yet, in India, which is so timeless, changes seem all the more remarkable, even when they are less dramatic than elsewhere. Change is resisted there, not so much by effort but by the vast inertia of tradition, sheer numbers of people, and four thousand years of history. Geographically isolated by the majestic Himalayas to the north and by the sea on other sides, India has evolved a unique non-Western culture, one that remains largely unaffected by what the French so lovingly refer to as cultural imperialism.

Still change had occurred. The first thing I noticed on the ride into town from the New Delhi International airport was a variety in automobile styles. Thirteen years ago, India\'s roads displayed only two styles of cars, modeled after 1940\'s vintage British and Italian automobiles. Imports of automobiles and most other products had been banned. Imports are no longer banned although import duties of up to 100% make them impractical. But foreign car manufacturers have set up joint-venture production facilities all over India so that a wide variety of Japanese and European looking cars now clogged the roads along with the familiar assortment of two and three wheeled vehicles, and camel, ox and horse drawn carts that have long been the staple forms of Indian transportation. While the variety and sheer number of vehicles have grown exponentially, the roads over which they travel, alas, have for the most part changed very little. Delhi still boasts the broad large thoroughfares constructed by the British when they moved the capital there from Calcutta in the early twentieth century, and I was assured by several residents that four lane highways were planned or partly constructed connecting the capital to Agra, home of the Taj Mahal, and Jaipur, the capital of nearby Rajastahn, but I did not see any evidence of them. Bombay did sport several new \"flyovers\" which allow commuting motorists to drive over the massively congested and narrow city streets rather than through them, but on the whole road building would seem to be a growth industry of Internet proportions in 21^st century India. More on that later.

Along with the new variety of transport, the roads also displayed a riot of advertising signage that was not so evident in 1987. Banners, many in English, but most in the various offshoots of Sanskrit from which most of India\'s 4000 languages and dialects were derived, hung from every conceivable spot. So overwhelming is the advertising blitz that the government has announced a new policy to limit them, although enforcement is lax.

One category of signage in English struck me as something profoundly new. Banners promoting a green Delhi and environmental consciousness stood out. This was significant. Anyone who has ever traveled to developing countries, particularly India, knows that environmental destruction on a massive scale is the norm. When feeding and clothing the populace is the top priority, keeping the environment clean is a decidedly tertiary concern. Not that much progress had been made on the environmental front. In fact, pollution from automobile emissions was far worse than I remembered it to be, (while the ubiquitous odor of dung fires was somewhat less so), but at least a consciousness of the problem and the initial efforts to proselytize the public had started. I viewed this as one of the telltale signs of the growing middle class and bourgeois sensibilities.

Lebensraum

India claims to have the world\'s largest middle class, and that may well be true. It has the world\'s largest minority population, Moslems, and is also among the world\'s largest Moslem countries. It is the world\'s largest democracy and experts predict that India will surpass China as the world\'s most populous country sometime in the first half of this century. It almost certainly has the world\'s largest underclass, so why wouldn\'t it have the world\'s largest middle class? What it decidedly does not have is the world\'s largest stock of middle class housing. A westerner will look in vain for evidence of acceptable middle class housing in the large cities of India. In the villages, where three-quarters of India\'s population still reside, there is nothing resembling a Westerner\'s concept of middle class housing. So where does this emerging class live?

The cities of India are so congested and so densely populated that the concept of urban renewal is a total non-starter. There is simply no way that slums, shantytowns, or substandard housing could be knocked down to create room for new housing developments. Displaced residents would move back onto construction sites in makeshift housing before the construction could start. I have seen families move into large diameter sewerage pipe laid along the road before it could be buried and connected; and live there for years before the government could move them out. Squatter\'s rights are well established in India.

In an effort to address the housing issue, India\'s government has provided financial incentives for homebuilders, but the results have been mixed. A great many new structures have gone up, but a Westerner would be hard pressed to call these two story concrete boxes with an open storefront on the ground floor middle class housing.

I got a glimpse of the probable solution to the middle class housing dilemma on a trip to a rural area in the state of Harayana to the west of Delhi on my second day in India. Far outside the city limits, in what had been agricultural fields only a few years ago, I saw large, high-rise, modern apartment complexes inside gated grounds, sporting names like \"Malibu Towne.\" These isolated compounds were of very high quality with distinguished architecture and looked self-contained. Nearby were brand new office complexes that housed the new industries of India. It seems as if the solution to the living space problem of modern India is to start over in unoccupied space far outside of the traditional cities. Enough businesses remain in places like Delhi and Bombay to assure that the majority of the new exurban middle class will have to endure unbearable commutes for years to come, but the trend seems to be to create new upper middle class communities and business centers outside of historical cities and away from the crushing congestion of urban India.

CNN, Cell Phones, and the Internet

By now it is something of a clichéo rave about the communication and technological revolution and its impact on developing economies. We are familiar with the impact of these modern wonders on China, for example, and read about Chinese Government attempts to rein in the freedom that the widespread use of the Internet and other technologies promote. But China is not India. Although China has vast regions of poverty, it also has mighty centers of prosperity and technology. These disparities are separated, for the most part, with modern China comprising the Hong Kong - Shanghai-Beijing coastal crescent, while rural China to the north and west remains backward and poor. In India, the disparities co-exist side by side. A shantytown of unimaginable squalor will be right next to a modern office building or the residential compound of a wealthy gem dealer. Indians on both sides of the economic divide appear entirely unfazed by these disparities. Technological disparities also exist side by side. I found myself accessing the internet from hotels where I couldn\'t drink the water, watching CNN (and American sitcoms like Frasier and Everybody Loves Raymond) in places where camels were the dominant form of transportation, and calling my office in New York on a cell phone, while lunching at a Buddhist Monastery located in the foothills of the Himalayas.

None of these activities would have been possible, or even imaginable on my last trip to India. Yet the impact of this march of technology is not readily apparent in much of India. True, satellite dishes grace the roofs of many of the aforementioned unlovely structures encouraged by the government\'s housing programs. And, I was astonished to learn, that e-mail, which I have only recently begun to use frequently, has been used extensively in Nepal (a country so poor that neighboring India looks prosperous by comparison) for the past five or six years. Indeed, I accessed my e-mail throughout my travels in India and Nepal. Cell phones were ubiquitous in Bombay, much more so than In New York, for example, but about the same as Hong Kong.

Still, one did not get the impression that these technologies were changing India so much as they were being layered into the life of the place. If anything, it appeared that India was shaping the novelties to its own cultural needs. One example: music videos featured sari-clad lovelies singing traditional sounding Indian melodies to young lads in Nehru-like attire. And this wasn\'t the exception. All the videos were a variation on this theme. Nobody was trying to look like James Dean or sound like the Beastie Boys. (There is a version of hip-hop but it is in Hindi and it doesn\'t sound threatening.) An Indian fashion designer summed up the point best; \"I am fortunate to have been born an Indian and to be in the profession I am. The richness of our fabrics and colors is a tremendous advantage over designers from the rest of the world. If we can just avoid aping the West, I am sure we can show the whole world India\'s rightful place in the twenty-first century.\" It seemed to me that she had more than just fashion in mind.

That leapfrog technology and the communications revolution will play a role in shaping modern India is not an issue, but the impact is not so predictable as it seems to be in other countries. Bombay, the city most like western metropolises, is adapting to the new possibilities these technologies bring in much the way that other financial capitals have. Trading rooms are wired to Bloomberg machines and to electronic exchanges around the world. Brokers all carry around cell phones and are on them constantly. The Indian version of CNBC carries round the clock financial news and, from my point of view, does a far better job of interviewing business and government leaders than Squawk Box does here in the U.S. But outside of Bombay, India is a very different place. The average Indian will not be connected to the net from his home for a very long time, if ever. (There is a better chance that his connection will come from some type of wireless device, as is the case in Finland.)

Avoiding the Flu

While the country was not totally unaffected by the Asian contagion that rocked the developing world in 1997 and 1998, India avoided the worst of the problems. In part this is due to the fact that India\'s economy never reached the red-hot levels that Indonesia, Thailand, the Philippines, Korea and others experienced in the run-up to the melt down. The other reason is that the economy is still not highly integrated with the global marketplace. Import duties on most products are almost prohibitively high, though this is in the process of slowly changing. Similarly, exports, except for selective items are not a key to the economy. This, too, is changing with the success of software and other exporting companies. The currency is not freely tradable by the citizenry, although it is tradable for capital transactions. The average Indian cannot own foreign currency or foreign equities. Foreign financial institutions that want to invest in India need government permission to do so. Agriculture still represents an enormous portion of economic activity (30%). The country has recently become self-sufficient in foodstuff production.

For all these reasons, as well as a few others, the collapse of the Asian economies did not have a direct impact on India. Nonetheless the economy did slow down from its historic 8% growth rate to something less than 6% in 1997 and 1998. Growth picked up somewhat in 1999, and most business leaders feel comfortable with similar growth forecasts for the coming year.

India\'s protected industries, of which there are many, needn\'t worry about external competition in the near future. There is no consensus for truly free trade, and no constituency. Moreover, with labor among the cheapest in the world, India\'s costs of production on a host of items is already world class. A new car, for example, costs between $8,000-$9,000. Taxicabs in Bombay cost about $4,000. The well-publicized success of the software companies relies in very large part to the ability to pay $100,000+ per year software developers only $20,000.

Low costs and a partially closed economy tell part of the story. Another factor and one that will become of greater and greater importance as growth continues, is the enormous size of the domestic market. Even excluding the 600 million or so of its citizens who constitute the agrarian class, India\'s markets are huge. India\'s cement consumption approaches that of the United States. Various consumer products, like toothpaste and soap sell into vast markets, larger than that of many of the countries in Western Europe. These vast markets give producers opportunities for economies of scale on a global basis without having to sell into the global markets.

Liberalization of the Indian economy is continuing at a significant pace. Only thirteen years ago a socialist and a bureaucratic legacy hamstrung the economy. Indians refer to the period after colonization as the \"Permit Raj.\" Economic activity that was not directly state-controlled through public companies was indirectly controlled via a system of licenses and favor-granting that prevented competition and efficiency. Much of that has changed in the past thirteen years. Privatizations are rolling out in most of the major industries. In my brief visit, the floatation of the major domestic airline was announced and a major government-owned food company was sold to Hindustan Lever a partially owned subsidiary of Unilever. Of perhaps greater importance, the government announced its approval of internet stock trading, ADR and GDR issuance, a new private pension plan scheme which allows direct equity investments to replace the current state-sponsored regime, and opened up segments of the life insurance sector to foreign companies. This pace of change is expected to continue. As long as it does, the internal momentum of liberalization should propel economic activity, and strengthen India\'s immunity to new outbreaks of the Asian Flu.

Kid in a Candy Store

For a value investor, the most fascinating thing about a developing economy like India, is that what would be mundane, mature industries in the West are dynamic, fast-growing industries in the developing world. With an economy growing at a fairly steady rate of 6 to 8% per year, and an emerging and growing middle class eager to upgrade its lifestyle, the growth characteristics of such old economy stalwarts like cement, steel, energy, automobiles, consumer products, etc., all have exciting growth potential.

Historically, Tocqueville has adopted a disciplined approach to international investing. Our desire to own equities outside of the U.S. was a function of our ability to find companies with unique characteristics that were not available in the U.S. market. As a general rule, we believe there are ample opportunities in the domestic market, so any foreign equity must present an opportunity to invest in an industry or company with no obvious counterpart in the U.S. In short, we take a bottom up approach to investing abroad. I visited several companies while in Bombay and came back with a few recommendations of companies that meet our criteria. The Tocqueville International Value Fund has not previously invested in the Indian sub-continent, but there is very clearly significant opportunity there.

The Indian stock markets rallied smartly in 1999, registering one of the best performances among all global exchanges. So, this is not an undiscovered market. Still valuations are reasonable. Disappointment with the government\'s most recent budget proposal has recently caused a correction of around 30%.

Before getting into specifics, a few general comments are in order. I was greatly impressed by the quality of management I encountered. Most officials I met were highly educated, primarily at U.S. universities, and in possession of graduate degrees. Many were members of the founding families, which on average tended to hold a large minority stake in the publicly traded companies. Their knowledge of their business and markets was impressive, and they were very open to discussing their business prospects and the economic outlook. It is worth mentioning that unlike most emerging market countries, India has an independent judiciary and proceedings are in English. Annual reports, press releases and investor communications were also all in English. Most companies either were on GAAP or were planning a transition in the next year or two. Many had listed GDR\'s on the Luxembourg Exchange. Some were considering a New York listing, although most were not in the need of external capital and were likely to wait until a future financing before tapping the U.S. market.

Investment Ideas

Essel Packaging. This is a unique company that would be an interesting investment idea wherever it was domiciled. The company is one of only two worldwide laminate tube packagers, which are fully integrated. The other is a division of a U.S. company. Founded in 1984 to serve the Indian market, Essel now has a dominant 85% market share in India and is expanding into similar markets internationally with a well-conceived strategy.

The company provides toothpaste tube and cosmetic packaging to local and international consumer product companies. About 10% of its sales are laminates to competing manufacturers. The company\'s growth has resulted from the substitution of plastic laminate tubes for aluminum tubes in the toothpaste market as well as a growing use of toothpaste in the company\'s major market. Plastic tubing now accounts for 50% of the market in India. The opportunity in cosmetic and pharmaceutical packaging could be even greater than in toothpaste because the margins are greater.

Management expects revenue growth of 35 to 40 per cent in fiscal 2000, and 20 to 25 per cent growth over the next five years. Because of a new pricing arrangement with its major multinational customers, margins are expected to grow. With these prospects, cash flow is expected to be strongly positive. The company, which is 45% controlled by the founders, plans to devote a third of its cash flow to capital expenditures, a third to investment in joint venture international expansions and a third to dividen