On Hold for How Long

source:valueresearch

To find out what India’ leading Chief Investment Officers think about the future of the stock markets and how your investments will fare, we invited nine of them to a roundtable discussion. The topic was ‘The India Story: On Hold for How Long’, but the discussion ranged widely over topics of interest to investors. Here’s an insight into how our leading fund managers are looking at your investments’ future and the factors that will drive it.



What is the India story? How do you define it?
Anoop Bhaskar: Well, I look more at valuations and not too much at the broad picture. However, our economy is growing at a fairly strong rate. We have a large population of young people who will join the work force over the next 10-15 years so the demographics are in our favour. But the economy is based more on consumption and requires much more investment than is being done. Still, India offers great opportunity for an investor to create wealth.


Is the India growth story running out of steam?
Sankaran Naren: Growth is clearly slowing down. If you compare to the rest of the world, there is a lot of overleverage elsewhere. In India, leverage is very low. Barring a few players in Real Estate or Aviation, corporates in India are in the best of financial shape. Unlike 2008, we are not worried about systemic risk. So despite growth slowing down, India is more attractive because the rest of the world is not.

What is the biggest impediment?
Sankaran Naren:Corporates talk about what an unpleasant act it is to put up a new business. We are in a situation where people tell us that they don’t want to grow much but want to be stable and financially strong. That’s not good. We need growth. When one has a demographic advantage, growth is very important. Starting a business, setting up a factory, starting a new line of activity - everything must be made much easier.

That may not be an easily solvable problem.
Sankaran Naren:What I have said is an all India summary, the situation differs state-wise. Inter-state differentials in the ease of setting up a business prove a point. In some states it is very easy to set up a business, in others it is cumbersome.

The India growth story was heavily touted up to 2007, what are the elements that still survive?
Jayesh Gandhi:The current environment for equities is different from the 2003-07 bull run. That took place amidst the backdrop of over 5 per cent world GDP growth, a more stable global environment with continuous growth and without recession. The current global economic environment is much more volatile and challenging. Global GDP growth is expected to be less than 3 per cent. The environment from 2005-07 had the global tailwind to help all emerging markets, which is now missing.
For India’s GDP to grow at a much faster pace without reforms, while battling inflation and high interest rates is difficult. A 7-7.5 per cent GDP growth for India looks achievable based on stable services sector growth, favorable demographics, large consumer base, rising per capita income and moderate infrastructure spending. For higher growth we need key reforms and policy action. Unless we have meaningful reforms in critical areas such as energy policy, electricity distribution, and mining etc, it will be very difficult to move to 8-8.5 percent GDP growth.

Like I said, these issues are not easily resolved…
Jayesh Gandhi: The issues that have clogged government decision making and policy initiative over the past year can be resolved. Corruption can be solved by decisive leadership. Smart policy initiative is needed for reforms in energy, electricity and education to boost investments. Regarding inflation, some part is global and not controllable but food inflation is largely on account of domestic driven policies so we need agricultural policy reforms much more than what is currently being done.

So what still works for us?
Mahesh Patil: The Consumption story, specially rural consumption. Rural India no longer depends only on agriculture as a source of income. Its per capita income has gone up. Asset prices of land and gold have risen. Wage inflation is high. Aspirations have gone up. This is the more stable part of our growth. But to go above 7 per cent GDP growth will need the investment climate to change. Between 2005 and 2007 there was capex driving growth. Post 2008 that has been lacking due to the global crisis, scams and policy inaction. There are issues in the infrastructure space, a big thrust and driver of growth, like coal availability, land issues and clearances. All stalled growth. Interest rates are one issue but we have seen high interest rates earlier where the economy has grown. But there is room to reduce rates going forward.
Anoop Bhaskar:A crucial issue is that the cost of land in India has increased to an unsustainable level. It’s not viable to set up a project where the cost of land is 25-30 per cent of the project cost. It can be 5-6 per cent of the project cost; it is not feasible when it goes up to 20-35 per cent. That is why new businesses are being set up in Gujarat because the cost of land is cheaper and there is ease of getting a business set up compared to the rest of the country.
Gopal Agrawal:The problem we see in India has to do with supply side bottlenecks - infrastructure, supply chain management or material resources. The other two pillars of the India growth - Consumption and Outsourcing - are strong. Unless we work holistically to remove these supply side bottlenecks, it will be very difficult to sustain high growth in the long run. Inflationary expectations can come down because of the base effect but the absolute inflation won’t come down till we resolve the issue.
Prashant Jain:We are a secular growth economy. Growth has been secular and consistent and growth rates have been accelerating over the decades. I do not see that changing. In the course of this journey, two things happen. Once in a while, due to high fiscal deficits, governments of the day have followed a particular policy. Due to high interest rates, investments will slow down. But that is a cyclical phenomenon and does not mean that the economy is stalling; just that 8 per cent growth becomes 6-7 per cent for a few years. The moment growth slows down, the government has no option but to tighten expenditure and the fiscal deficit will then come down and then interest rates will fall and growth rates will accelerate.
Barring oil, we have ample resources like coal, water and land. We just need to put together a reasonable policy framework. And I think it will be done over time and should not take too long.
We are a coalition democracy and change is always difficult in such a set up. Over the past few years change has become all the more difficult. But if you look back in the last 20-30 years, every crisis has led to change for the better. Land is expensive yes, but farmers earlier were getting a raw deal and now they are not. Land was also inefficiently used in India because it was so cheap. I don’t see cost of land stalling investments in the country. We will end up using land more efficiently.
India is impacted by the global slowdown to a very small extent. Exports is the only interface in terms of the economy. IT exports over the past 10 years has grown at 25 per cent CAGR. But IT spending globally has not grown beyond 5-10 per cent. So how have we grown at such a rate? Simply because we increased our share of outsourcing. I think the same thing will happen in manufactured exports. Our global share is 1.6 per cent while China is nearly 10 per cent. The yuan has appreciated 25-30 per cent against the Indian currency. So what has happened in IT over the last 10 years will logically happen in the next 10 years in manufacturing exports. One year from today, interest rates will be lower and some reforms would have taken place because we are running out of options. Hopefully, because of the global slowdown, oil prices will also come down.
Gopal Agrawal:Land cost in India and rising wage inflation are problems. If one had to put up a new cement plant in view of the new land bill and interest cost, it will be more than $150/tonne. Based on that, cement prices which average around Rs 250/bag will not come down. In China, the average selling price is Rs 107/bag. So the competitiveness of China is much superior. We cannot compete with such bottlenecks which we are creating ourselves. If you look at the setting of the industry before 2004, it was much easier and cheaper. Till we remove supply bottlenecks, the incremental RoE of India and its competitiveness will be under pressure. We have to solve this issue or else the demographic dividend we have today we may not enjoy.

Conquering a Gradual Recovery
By Research Desk | Nov 18, 2011

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To find out what India’ leading Chief Investment Officers think about the future of the stock markets and how your investments will fare, we invited nine of them to a roundtable discussion. The topic was ‘The India Story: On Hold for How Long’, but the discussion ranged widely over topics of interest to investors. Here’s an insight into how our leading fund managers are looking at your investments’ future and the factors that will drive it.



Bhupinder Sethi:The India story has two parts.
The first part is physical and social infrastructure and government and bureaucracy, which is policy setting and transmission of that policy. In all we need better governance and less bureaucracy. The second is the Consumption story; the aspirations of the consumers are unleashed. In a recent presentation by a consumer company, I was told that 20 per cent of the organized labour force in India comprises of women. As girls get educated, they are choosing to work outside and not just become housewives. This major societal shift taking place has implications on consumption and industry and busienss.
India has benefitted from a flatter world which has got so because of telephony and internet. Because of the English skill set and intrinsic strength in knowledge intensive areas, private sector plays a role and we are well positioned. The ingenuity of the Indian entrepreneur and ability to create a business cannot be ignored. So there are two parts to the India growth story. One where the government plays a role and the other the imbedded momentum by the private sector. I am very sanguine on the private sector aspect because the public sector innately lacks energy and the momentum that the private sector has.
Having said that, no country can rise to greatness unless the government bureaucracy enables physical infrastructure which propels us to our potential growth rate. India has grown at 7 per cent over the past 10 years. In 2000, our ranking in terms of per capita GDP was 135. In 2010, it was the same. It means that we have grown but the world has also grown. So if living standards have moved up in the past 10 years, it has also happened in other developing economies. For me, the India story actually kicks in when we create an architect of physical and social infrastructure which makes us achieve our potential growth rate.


Huzaifa Husain:When we began the decade, we were investing a fifth of GDP into investments. By end of the decade, it was one third of GDP. So at the start of last decade we were absorbing $50 billion of capital into infrastructure per annum. From next year onwards we plan to absorb $200 billion per annum. That is a sea change and presents a lot of challenges.
If you take the issue of land, we are a democracy and the right to property is enshrined in the constitution. If we are uncomfortable in giving up our homes in Mumbai for a road to be widened, why should we expect a farmer to give up his land cheap for a factory? We have to figure out a way which will take us above these constraints. So if we have to pay 5x the land cost, then we should be prepared to do that. We have to figure out how to make manufacturing efficient inspite of these constraints.
If we look at the initial part from 2003-2007, we had a huge supply increase in terms of power generation, roads, corporate capacity expansion, etc. Consumption then was growing below GDP growth. Then the crisis hit in 2008. The stimulus given by the government and the RBI forced the Consumption sector to grow, which happened in the ensuing three years.
Another source of demand was exports. Pre crisis exports were $200 billion in terms of goods and services. Today it is $400 billion. That means we have doubled the exports from what it was before 2008, and this is not just in Technology because the maximum increase has come in high engineering goods.
So we had two sources of demand: domestic consumption, mainly rural, and exports. Initially these demand drivers ate up the excess capacity built earlier. Once the demand exceeded capacity, inflation started accelerating.


Anoop Bhaskar:I have a comment regarding the power sector. The private sector, through means fair or unfair, has always tried to ensure that the public sector gets a rough deal. Look at the case of power, SEBs are buying power from the private players at a rate which is much higher than what can be offered by the public sector players. It is not a fair deal. We have growth but who is it favouring?
Also, in India there is no sanctity of the paper on which we write an agreement. Look at power where we have an escrow account which states than within 60 days payment has to be made. It often becomes 63 or 64 days or even 70. But because the debt is from the state government, there is no issue, one knows they will pay. But 60 days must mean 60 days.
We have this huge set of rules and regulations which are never implemented. The rule of law says in an escrow account you have to be paid within that time frame, but it’s not done.


Prashant Jain:We are in state of evolution. If you look at India in stages you will see changes for better. Look at Telecom, over the 10 years we now have the lowest tariffs in the world. The laws are not perfect but market forces have brought it there. Look at the intercity roads, compare with what they were 10 years back. Are they not better? Every 5 or 10 years the country changes for the better. Look at the airports. Look at ports. Look at power. You have surplus power generation. Quality of life has improved for each of us. So one cannot say that the country has not progressed but we could have progressed faster. There is certainly room for improvement. There are problems and issues, but it cannot be generalized by taking individual cases.


Sankaran Naren:The period between 2002 and 2007 was good - the deficits came down, growth was good and so was taxation. But after that commodities went up particularly crude oil and we could not pass on those prices. By not doing so, inflation went up because demand did not fall. As a result we then got into this high interest rate regime. So after 2007 the economy ought to have slowed because the price of crude oil went up. We were not keen on slowing down growth so decided not to pass on the fuel price hike. Now we have a situation where interest rates have gone up to much higher levels impeding investment which is again causing inflation. Now it appears that we have to slow growth for a while to get the economy back to a situation where interest rates are lower to permit investments. Now that period of slow growth will not be pleasant.


Jayesh Gandhi:Economic growth needs energy and electricity and these sectors are largely in government domain. Only parts of electricity generation have been privatized, similarly energy related enterprises largely have been in the public sector domain. We need to re-examine the policy initiatives and rectify the mistakes here. Unfortunately we have a deficit in natural resources and hence we have to find meaningful ways to induce investment in energy sector and get the pricing and distribution policies corrected. Else the next level of growth will be difficult to achieve.


Given the backdrop of the India growth story, how do you plan to re-position your portfolios?
Mahesh Patil: We have suffered in the past one year and more recently we have seen global problems compounding and impacting our market. Challenges remain and we see no cause for exuberance. Last time things bounced back pretty rapidly, but going forward, the recovery will be much more gradual. Some of the bottlenecks we spoke about cannot be resolved over the short term, they require structural solutions.
We are looking at where we are in terms of valuations and also looking at growth. No large overweight or underweight in any sector because the disparity in valuations is large. So it would not wise to be polarized. Some sectors which we feel will do better are interest rate sensitives as interest rates fall going forward.
The market is willing to pay a premium for companies which have done well, with strong fundamentals and no corporate governance. So we are looking at bottom-up stock picking to add the necessary alpha rather than any big sector moves.

Huzaifa Husain:Over the next, say, five years there are three themes which we would like to take advantage of. There is going to be a serious shortage of calories, both in food and fuel, which India needs to grapple with in the coming years. Hence companies from across sectors which can help us manage this situation should do well.
It is difficult to envisage that consumption and exports can keep growing at this rate without the accompanying increase in supply. There is no option but for infrastructure development and other investments to accelerate to ensure adequate capacity to cater to high growth. Given the current valuations of the sector, we feel it is a good sector to play.
Exports of goods and services have doubled in the past four years despite the crisis. I read somewhere that if we take the per capita income of countries comparable to India, typically those countries export minerals, which is at the lower end of the value chain. In India we export technology services, pharmaceuticals and high-end engineering goods. So the “Made in India” is increasingly getting accepted across the world Companies and sectors benefitting out of this demand driver should be good investments over time.


Prashant Jain:We are not doing anything different. We always did focus on reasonably good managements above a certain threshold, reasonable quality of business and attempt to be reasonably diversified and invest in businesses which have high or at least reasonable potential. There is a threshold of quality below which we would not go at least to any meaningful exposure, but I am not saying that we always invest in the best quality businesses or management because if we genuinely do that, we will have only 25-30 businesses in the country. We are pragmatic, look for reasonable quality and if it is unacceptable then we will stay away. If we do not understand a business, we will not invest in it.
One noticeable thing in this market is the premium for quality. I have not seen this for the past 20 years. This is actually the opposite of 2008 where quality was at a discount. So what I am saying becomes more pertinent. Because if you confine yourself to the most high quality businesses, you will not get optimal returns. There has been a flight to quality because of the environment and number of issues. But there is a little more incentive to take risk.