It has been a good May and an okay June. Do you think a large part of the one-time rerating that we saw because of the election mandate is behind us?
Yes, I think so. It is largely done. The election result surprised everybody on the upside. I do not think people thought we will get a government with such an overwhelming majority. That warranted some move in the market and it is mostly done. For the next leg, you need more triggers now. You need policy action from the government.
There are two things that will drive this market. One is, of course, how growth rolls out in the second half, on which we are constructive, and the second is what policy choices the government makes. I can put out my wish list, but I am not sure what exactly they are going to prioritise. These are the two things that the market will pay attention to. On one side, there are global developments that are not looking so pretty. If there is any disappointment on the domestic front, the market will quickly react to poor global cues. For now at least, the market is holding out hope that we will get good domestic cues. So, the global stuff is not mattering apart on a day-to-day basis.
Are investors heaving a sigh of relief after the mandate or are they happy and excited about the next five years and policy making?
Given what was priced in by the market going into the elections, it is more like a sigh of relief. Essentially, the biggest takeaway is policy certainty.
So from Google trend for the past few years, we have been picking up something called the policy uncertainty index. Google actually uses big data to basically create this index and it does it for many countries and we plot India’s policy uncertainty relative to the world and that was at an all-time high going into the elections. My view was that it will start rolling over but it would not now, because the biggest takeaway from this election result is that we have an administration which was already in office and, therefore, has its agenda pretty clear.
From what I understand, Delhi did not actually shut down during election time, because bureaucrats were told by the Prime Minister that he is coming back and so work continued. Therefore, a lot of policy is in the works. I do not know which exact policies are in the works, but a lot of policy work has been going on in the background during March, April, May, when things usually wane. That is the biggest advantage that the market has. There is some predictability, like for example we are in this benign inflation environment.
The BJP-led NDA is not prone to increasing minimum support prices and has not succumbed to that tactic, because while triggering food inflation may seem to support farm incomes, it usually creates generalised inflation and then it gets bad for everybody, including the farmers. It is not a good strategy. So we know they will not do that. We know for example, that they are focussed on infrastructure and that is not going to change.
We have already seen a slew of announcements on how they will boost it. In fact, their manifesto says there will be $1.4 trillion investment on infrastricture over the next five years. Maybe that is ambitious, but it is good to have an ambitious target. If we get to 10% GDP in next three years, it will be a great outcome. Can I rely on such a possibility? I can, because I have a track record. Some things like these the market can easily say is going to happen. Of course, there is a whole new set of policies that need to be launched and that is what we will wait for.
During NDA-1 regime, the market pretty much managed to map global markets. We got a powerful mandate, crude prices were benign. We had strong foreign flows yet Indian markets were simply aligning to global markets plus or minus 5% depending on the data point. Would we be very cognisant of the global reality?
The outperformance was in a pretty challenging macro environment for India where we could not generate earnings. My throat is dry calling for an earning cycle and it is not coming to us. I thought that would help an earning cycle but that really did not pan out for one reason or the other.
In hindsight, I can explain all this but that was not the foresight I had. You have to put it in context that we still had the bid on the market despite the fact that we are disappointed on macro growth. So, just to extend that point slightly, we underperformed emerging markets on earnings We dramatically underperformed the SPX on earnings but we did not underperform on share prices. What it means is that the market is of the belief that the earning cycle is at its doorstep and to some extent, the next 12 months earnings growth is already priced in. It has to surprise on the upside, a 20% is kind of baked in the cake and that is not going to do magic for the market.
That 20% number has to get repeated in the following 12 months and I dare say the market has not priced in a new growth cycle but believes that there is a growth recovery in the next 12 months.
Which are the factors which convinces you that a new growth cycle has dawned and what do you think is going to be different in the next 12 to 18 months? Research reports show that you have one of the most optimistic views on the Street.
I do not know about the relative comparison with the Street, but here are the factors. First, we have kept the inflation jinni in the bottle. That is not coming out in a hurry. Even rising oil prices did not upset it. So, we have achieved a lot. I think we must pay attention to that. It is the combined effort of the central bank and the government.
Second, the government has spent counter cyclically by boosting infrastructure spending and that is not just the government in Delhi; lots of state governments have participated in that.
Third, we have successfully executed on Aadhaar DBT (direct benefit transfer). This is a sea change for India. In fact, most people under-appreciate what this means for the Indian economy. In summary, for the first time in our history, it tries to induce fairness in a capitalist model. We can now safely transfer resources to the poorer sections of society and bring them up in the income curve. We have had a fair bit of fiscal consolidation and it is not like that we went into the down cycle and the government exhausted its fiscal capacity. It did not. So it has retained that.
We have at least made sure that the state-owned banks have got enough capital to survive Basel III. They do not have enough capital for growth but they are surviving Basel III. We put GST in place which has been painful but most of the pain is behind us and you will see that uptick in GST revenues because it has now been fully implemented.
GST plus the formalisation explain the growth pangs of the last two or three years. The profit share in GDP is at all-time lows. It begs a view that we are going to turn. The timing is not very easy to point out but it ought to happen and we saw the signals in this quarter. The banks will lead the way. They were the ones that led the way down, and now they will be leading the way up. The banks are doing okay now. Banks will probably continue to print good earnings and that is what is going to drive the Nifty earnings. So 20% is something that we should now hope for and expect over the next three-four years.
But in terms of positioning and ownership, isn’t corporate banks a crowded trade because that is like the pretty girl in the town and everybody wants to be with that pretty girl.
Yes, ownership does not have any predicted power on share prices. It only predicts share prices when something else goes wrong. Using that as an isolated metric to say oh! this stock is over owned but over owned versus what? Over owned by whom? Why do we distinguish institutional investors from retail and why do we distinguish foreign portfolio investors from domestic? Yes, institutional ownership in say a corporate bank is 65%. Is that over owned, under owned? I think it is a faulty argument.
Unless you have other things going with you which is that oh the earnings are going to come bad, oh something else is going to happen and because there are too many institutions sitting in the stock, the stock falls. I am not worried about ownership. I would pay attention only to valuations and earnings and so far, the valuations are okay as they are benign right now. The earnings are coming through and the stocks will continue to do well.
10 years ago, if you would have made a case that ADA Group of businesses will go belly up, that would have created a panic. Two years ago, if you made a case that some NBFCs could go belly up, it would have created panic. But do you think by and large at the current juncture, markets are pricing in that one or two NBFCs will fall flat?
We did not bring this up in my discussion when you asked why do I think the growth cycle has stopped because a couple of other pains that we took in the last three years was RERA and IBC. These are not run-of-the-mill reforms. They are structural in nature. They changed the way business is done. For the first time there is a threat on an Indian businessman that if he does not pay his or her interest, his company can be taken over and sold and this is a very big change. We are seeing that now playing out in the market place, which is either people who are feigning liquidity or solvency issues, have to react or those who are in real trouble are going to fall by the wayside.
It did not happen in the old India. In the old India everybody came together to make sure that people survived and that was not optimum utilisation of capital. One of the calls that we have is that coming out of IBC, return on capital in India will improve because bad capital allocation will get flushed out of the market place quickly and IBC is still a work in progress. It is not completely stabilised. The laws are still being framed. But a fair bit of work is behind us.
I would say 90% is done and this is a good thing. It is not a bad thing. It is what has made America such a great market because bad businesses get flushed out. We in this country for years have been supporting bad businesses for the fear of losing entrepreneurs. That fear is now being shed. So I think it is okay. It is a good thing. Now as to whether the market has priced in a failure, I do not believe this is systemic. What is happening in NBFC, is more idiosyncratic and in hindsight it should not surprise us because the whole sector grew its loan book at 30-40%. This is a thing which I learned long time ago when banks did 40% CAGR on loan book for three years in a row, you have to be worried because you will inherit some bad loans because the credit standards do drop when you are growing in that pace. Nobody is built for credit assessment to grow at that pace.
It happened in 2009, 2010 and 2011 to be large Indian banks and it happened in the last three years to some NBFCs. So the market is not worried. You can see that in the price action not on the day but a day or two later, how quickly the market comes back. It is more or less priced in. If this becomes a bigger problem, then it may not be priced in.
Corporate 2.0 and Disruption — the Mega Trends
We often speak about mega trends. The last time you spoke about three-four mega trends – electric cars, inflation permanently coming down that was last year’s conversation. What are the mega trends according to you now this year?
Two things – one is at the company level. It is Company 2.0, take the name of the company that you want. A lot of C-level people are coming to this summit to explain how their businesses are transitioning. Mostly by choice but sometimes by force, the external environment forces you like the external environment will force the auto companies to change. Regulations will make electric a reality and therefore they will have to change. Other companies are making their own choice because the market place is changing. Company 2.0 investors need to be very careful. Companies that are not changing their business models will just lose in this environment.
The second is the ongoing theme of disruption. A lot of things are happening there, disruptive technologies. I have my European industrials analyst who has penned an essay on the second machine age and how manufacturing will change. It is reminiscent of the late 19th century when alternating current became a reality. A lot of factories were not designed for AC electricity, alternating current. A lot of factories chose not to revamp their factories. It was very painful. Those factories went out of business. Those who took the pain and remodelled their factories were the one that survived. We are in a similar situation with respect to robotics, with respect to artificial intelligence, all these things are coming to the fore.
We discussed it last year but it is going to start now. There is a fair bit of disruption themes that are embedded in this summit as well. So two things – corporate 2.0 and disruption.
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3 reasons Ridham Desai's confident a new growth cycle has dawned have 2525 words, post on economictimes.indiatimes.com at June 11, 2019. This is cached page on Talk Vietnam. If you want remove this page, please contact us.