On Hold For How Long

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?
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?
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?
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.
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?
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…
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?
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.
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.
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.
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.
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.