"Modi's reforms are critical for India"

Earlier the world’s financial markets used to catch a cold when Wall Street sneezed. Now, the tremor time zone seems to have moved to China and its market downturn is the one that makes the headlines. China may not be enjoying all this attention but everybody with any interest in the stock market wants to know what the current state of affairs could further lead to. So, Outlook Business spoke to emerging-market veteran Mark Mobius of Templeton Group for his outlook on China and the Indian market.  

What is your reading of the Chinese crisis? Is it structural or something that can be repaired with measures like currency devaluation or a rate cut?
I think the Chinese probably made a mistake in aggressively interfering in the market, both on the upside and the downside. As you know, they encouraged people to go into the market and they gave a lot of signals that they want the market to go up. The second mistake was to try to rescue the market when it went down. Of course, this will be forgotten but it will take half a year or so before things settle down. In terms of the currency, I think that move was a good one in the sense that they want to liberalise the currency because they want to become part of the special drawing rights basket. So, this is a step in the right direction but it is not helpful in terms of their global relationships because the US is concerned that the Yuan will get too weak. If you look at the valuation, it is very small relative to other countries and therefore I don’t see this as a big problem going forward.

Since 2008, much of the growth in China has been government-led. Now that growth is shrinking, what kind of structural changes does China need to stabilise the economy?
Their objective is to transform China into a consumer economy from an export-oriented economy. The problem is that cannot happen overnight because you can’t ignore the export industry and its employment intensity. For them to have local consumption, you must have rising income. So the first order of business for them has been to increase the wages of workers and they are well on their way through that. Their per capita income is rising and that is working pretty well. The other thing they have got to do is to get the government out of a lot of these industries and liberalise the entire economy. Here again, if you read the 10-point program that the Communist Party has made, it has clearly stated that it wants government enterprises to get out of various businesses. So clear policy is there, the question is implementation. Now, when you free up the financial sector to the degree that they have, it creates all kinds of dangers. You have got the various trust companies that have gone a little bit too far in leveraging and you have got all these other regulatory issues to be addressed.

Every emerging market is competing with the other at the global level.  Will the Chinese devaluation not have a cascading impact?
You must remember that many exports today require imports. In other words, if you are assembling an iPhone in China, most of the components are coming from outside. The value-add in China itself is not that great. It is a mistake to think that a weaker currency will necessarily help them to dramatically increase their exports. To give you another example, in India, devaluation of the rupee for companies like TCS may not really help them that much because they are moving more and more into high tech. It is more important for them to get well-trained educated people. That is why we have to be very careful when we draw conclusions regarding devaluation.

What is your take on commodity prices given the falling demand in China? Do you feel that Indian companies in this space are presenting a buying opportunity?

The low-cost producers represent a buying opportunity as they will be the ones that will survive. The high cost producers will have to go under. There will be quite a lot of repercussions as a result of that. But there are other more important issues at stake here and that is government regulation and quotas. In India, there are a lot of restrictions with regards to mining of iron ore, etc. I would say that it depends upon the country to a great extent but we really have to pay attention to the low-cost producers.

I think we have probably reached the maximum downside. For all these commodities, the supply and demand does not fluctuate that much. What fluctuates is the price and price is based on sentiment. For example, if you look at the last 20 years the average growth of production and consumption of crude oil has been roughly 1-1.5% a year. The fluctuation within each year is plus or minus 5. But the price has gone all over the place – 20% up and 20% down. This indicates that these price fluctuations have very little to do with actual supply and demand. I believe commodity prices may have overshot on the downside and will probably recover from here.

How do you rank India among emerging market economies and do you feel that India can remain insulated even if this crisis turns worse going ahead?
We rank India very highly because it is growing at a very rapid pace for an economy its size. We believe that at some point India will probably overtake China in terms of growth. Now, in terms of the impact of what is happening globally, India will be impacted like everybody else. Nowadays nobody is isolated. But the good thing about India is that it is not so much tied to the Chinese model. If you see India’s exports and imports, it is not really tied to what is happening in China.

In that light, does it make sense to be greedy in the Indian market at this point in time?
If you look at the P/E ratios of Indian companies, it is generally hard to find single digits. Most of them are double digit. If you have interest rates that are 1% or 3%, you can justify a very high P/E ratio. If you have interest rates at 2%, the reciprocal is 50X. So, you can justify a very high P/E ratio. The problem is that if you are expecting higher interest rates, then all these valuations begin to fall apart. Valuations in India reflect the very low interest rates we see globally and so we have to be very cautious because if interest rates do go up, then all these valuations become very expensive.

Has the India story then lost some sheen as we have seen a fair bit of outflow this month?

There has been an outflow from mutual funds globally. Given that, they are forced to either sell and they don’t have the cash to add to their holdings whether it be India, China or Brazil. Nevertheless, banks around the world have tremendous assets but they are not lending because the bank prudential requirement of regulators is preventing them from lending. If you look at what the Chinese have done recently, they not only lowered interest rates but they also reduced the reserve requirements of the banks. We have to watch that closely as reducing interest rates doesn’t really help anything unless the banks are willing to lend. Coming to India, interest rates are high and could go lower as inflation is under control. The lending rates really have to go lower in line with what you see globally. In the US, you had lending rates that are 5-6% or even lower. India has to have rates that are much lower than they are now. If you go to any bank today and ask, “How are your NPAs?” and if they say, ‘We don’t have any NPA’s”, they are not telling you the truth. So you have to really look at the economy. I think interest rates in India can only go one way and that is down. That will be helpful regarding NPAs.

What are the key risks that you see for India at this point in time?
Well, for India I don’t see any big issue or problem. The big worry is a sudden rise in inflation but we don’t see that. Usually, there are risks that we don’t know about yet. The only thing is that India will be affected by what is happening globally. That is a negative of course. I don’t expect a long bear market in India. You must remember that bear markets usually last for a year. It is very sudden and frightening but they don’t last very long. The best time to invest is when there is volatility.

Can China manage the current slowdown? Will Brazil, Russia or South Africa get their act together and what does it mean for India if it were not to happen?
China certainly can, because they have got huge foreign reserves. They have a lot of tools they can use. Brazil is in deep trouble but they have tremendous natural resources. South Africa again needs reform. If you go to South Africa, Indonesia or even India, all these countries need reform. When there is more government transparency, there is more predictability for business so that they know what the tax situation would be. Once these things are in place then you will see growth really take off. Russia’s problem is the sanctions. They have got to come to some kind of accommodation with the west. Otherwise, their economy and people will suffer.

I think for India the reforms that Modi promised when he came to office are critical. If he is able to get only half of what he set out to do, that will be a tremendous improvement. I would say that is where your focus should be, how fast Modi can get in his reform agenda.