Conquering A Gradual Recovery

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.

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.

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.

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.

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.

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.

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?
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.

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.

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.