Those of you who've been with Growth Engines for any length of time know that serious investors should survey the global economy to identify long-term growth stories, no matter what particular markets do in the short term.

I’ve been advocating for sometime--and still do--that the first area to search is emerging markets (GEMs), then to Europe. I write this knowing the trendy advice is to stay away from GEMs and buy US-based companies.
The reasons for buying US are well known and have to do with the idea that it’s a safe-haven market. The corollary to this is that GEMs have had their run and, now that global liquidity is being taken away by central banks, their performance will be dismal. There’s a lot of truth in this argument, as there are many other reasons why investors should stay away from GEMs.

Nonetheless, these economies now have an opportunity to mature and transition to global importance. GEMs will be the source of real future growth. Those in Asia, including Russia, remain my favorites and the locations interested investors should scout for future winners.

That said, India remains by far the most important growth story among global GEMs; it’s home to the most diverse group of quality companies across a range of sectors.

Although India has never exhibited as strong growth characteristics as the rest of Asia and can’t match China’s reported growth rates, it’s also avoided the boom-and-bust cycles so prevalent in the region’s developing economies. For an investor interested in achieving serious long-term returns, this fact is of paramount importance. And because India still represents only 2 percent of global GDP and 1 percent of world trade, it’s been less important to investors, even after accounting for the strong interest shown by investors since 2004. Nevertheless, foreign direct investment (FDI) continues to steadily increase. And as India tackles the problems that slow its growth, FDI will only grow.

Two of the main problems India faces are rigid labor laws (specifically the inability of an employer to dismiss a worker without the permission from the state government) and poor infrastructure. The latter is probably the most important problem; as things stand, it would be impossible for India to achieve double-digit growth because infrastructure at almost every level of the economy remains weak. Indian industrial production has been growing, but much more needs to be done.

The Indian government is aware of such problems, and efforts are being made to offer solutions. One is the creation of Special Economic Zones (SEZs).

Since the new SEZ law was approved in February, the private sector has rushed to capitalize. The new legislation provides a uniform SEZ policy and covers all aspects of establishment, operation and fiscal oversight.

SEZs have long been seen as a means for India to establish inroads into small- and medium-scale manufacturing. The SEZ legislation helps the government in two ways: It quickly helps create high-quality infrastructure in small areas, thus helping manufacturing exports, and it allows experimentation with the liberalization of labor laws. SEZs also attract foreign capital and technology. Projects that have recently received approval expect to command USD22 billion in investment capital.

But above all, the Indian story remains a domestic one, in the sense that domestic investment and consumption drive monetary expansion, leaving the country less vulnerable to violent moves in the global economy.

Financial services is one of the fastest growing sectors in India and a straight play in the domestic demand story. Aside from banking, mortgage and other related functions, life insurance is particularly promising as Indians have welcomed this new private service with true excitement.

The Indian market was first opened to foreign insurance investment in 2000, and since then, about 25 players have entered. Entry to the domestic market is accomplished via joint ventures (JVs) with domestic providers. The two largest foreign/JV players are Prudential ICICI Life Insurance and Allianz Bajaj Life Insurance.

ICICI Bank (NYSE: IBN) has been capitalizing on the increase in domestic consumption and credit growth. Once a poorly run operation but now a franchise in turnaround, ICICI is a good way to get exposure to India’s banking sector as well as the life insurance boom.

Prudential ICICI is the second-largest player and the largest private player in India’s life insurance industry, which is still dominated by the state-run Life Insurance Corp of India (LIC). Prudential ICICI has grown its new business annualized premium equivalent at 104 percent in the last three years and has improved its market share from 2 percent to 10 percent in the same period. Low penetration of life insurance in India (3 percent of GDP) and market share acquisition from LIC have been the key growth drivers.

My short-term expectation is that markets could rally into the end of the year--traditional September/October weakness notwithstanding. Investors interested in taking advantage should look to Asian technology stocks.

Yiannis G. Mostrous is editor of Growth Engines.

© 2006 Yiannis G. Mostrous
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