OB: So what are clients being advised right now?
Gumashta: One of the things that we have done is to diversify our client’s exposure internationally. We are also very traditional in our approach and that reflects in our AUM, where the majority is in basic debt products. To that extent, while we missed the alternatives bus, we were saved from the crisis. But there are opportunities today. For example, the dividend yields of some of the country’s large PSU companies are currently more than their bond yields. So, one doesn’t have to do anything exotic to fetch returns. In tough times like these, if you are not very smart, stick to the basics and follow an asset allocation model.
OB: Would that also mean buying stocks at 100x PE?
Iyer: The point is that you must wait for economic tailwinds to set in before taking bold bets. Right now, it’s the time to stick to quality stocks and not get adventurous.
OB: How would you define quality stocks?
Saluja: Quality doesn’t mean blue chip. In fixed income, DHFL was rated AAA, but was it a quality instrument? Besides the size of the business opportunity, planning and capital efficiency, other parameters such as corporate governance and the integrity of the promoter matter too. As far as equity is concerned, you have to consider whether a company is a capital guzzler or capital efficient, and also assess the quality of its earnings growth over the past five years. Just because a stock has been battered 60-70% doesn’t necessarily make it a good investment.
OB: Have valuations captured the impact of corporate tax cuts in terms of earnings growth?
Kapoor: From a macro perspective, for the first time, we are seeing monetary and fiscal easing being administered concurrently, which shows the policymakers’ resolve. The tax cut is more to do with the competitiveness of India Inc rather than its earnings. Our macro is great minus exports — engineering and non-oil exports are struggling. Just wait for another two years -— quite a few large groups are contemplating floating new companies to take advantage of the tax cut. The cut will improve our competitiveness because, today, pricing is everything,
Saluja: Companies that enjoy a higher return on capital will use it differently than those who are poor capital allocators. The first ones can dole out higher dividends, build capacity, or look at price cuts to spur demand. But it’s important that the government does something on the demand side, which, in my opinion, could be expected in the run up to the Budget — either by lowering personal income tax or further rationalisation of GST. If demand still doesn’t pick up, the cut would end up as a one-time bonanza for promoters who have been through the pincer over the past couple of years.
Das: The tax break is a huge opportunity for both domestic and foreign investors to set up a manufacturing base in India, and we will see that playing out over the next two to three years. Looking at equities, the second half of 2020 should be better than the first one. If you look at the consumption sector, the valuation looks expensive, but good quality companies will continue to corner a disproportionate share of incremental liquidity. Hence, we will see prices being driven higher.
OB: Will the tax cut revive the capex cycle?
Kapoor: It will come with growth.
Gumashta: Once India Inc’s capacity utilisation crosses 80%, you could see fresh investments.
OB: But RBI data shows that some sectors have touched 80%. This is not reflecting on the ground.
Saluja: Mere tax cuts won’t help. We need to ensure land and labour reforms as well. To that extent, the government’s move to appoint a single person as relationship manager for a certain threshold of investment is a step in the right direction. Companies moving out of China could be the prime candidates. So, let’s see if investors take the bait. If we don’t fix the issues mentioned, then reviving capex in the country would be a challenge. Money will continue flowing into services sector, particularly in financials, but not manufacturing.
Das: Credit offtake is very slow as the sentiment among India Inc today is still one of caution. It is not percolating down to the industry despite the rate cuts.
OB: So, is it asentimental or structural issue?
Kapoor:The big trigger is credit availability. Till that doesn’t trickle down, demand creation will be in trouble.
Gumashta: It’s not structural. Look at the auto sector, everyone was talking about a slowdown, but two-wheeler sales numbers are good.
Saluja: There are metro projects underway in 40 cities across the country, and given the state of the roads and massive traffic jams, there is no urgency to buy cars. So, I also don’t believe auto is structurally facing a challenge from the so-called Ola-Uber phenomenon.
OB: Why do you think transmission is not happening?
Saha: One big trigger is corporate governance. There are hardly any quality promoters out there that bankers can bet on.
Shah: Not to mention that PSU banks are still dealing with their past problems.
Das: Private sector banks today are better placed to gain market share from the public sector banks, but one has to err on the side of caution, as the credit environment is weak.
Saluja: During the global crisis, banks played safewhen it came to risk management, even with the products they were selling. The same thing is playing out in India. NBFCs have turned cautious now, while the PSBs turned off the tap three years ago. So, in the absence of capex, over the past five years, credit has flown only to consumers. That’s showing up in the savings rate, which has come down from 27% to 17%.
Gumashta: If the government can portray its intent to pursue a stable policy, it will spur sentiment. As a lot of investments happen at the state level, any reversal or instability in state government policies can impact business sentiment, which is a bigger concern than Central level reforms. So, a stable economic policy is critical in order for investment sentiment to revive. Besides, people now prefer to understate themselves despite seeing recovery in their business, given the all-pervasive talk of a slowdown.
OB: So, what are the key challenges and positives for the coming year?
Shah: From a perspective of managing portfolios, we will continue to focus on capital preservation. One needs to keep an eye on how the US-China trade war plays out. It’s becoming a battle of egos and we will continue to see that impacting currencies. India will not be immune to it.
But I am positive from the perspective of portfolio deployment for the long term. Clients penalise you if you lose capital and they stay only if you show consistency. They are not worried about 2% plus or minus return. None of us are paid to take risks. So, we have to focus on capital preservation and smart compounding, which is a 4-5% return over inflation.
Saha: India is still one of the high-growth countries and will continue to attract foreign capital. FII equity flows are already at $10 billion and domestic flows are steady. So, we feel there is a lot of opportunity in the market for investors, but clients need to temper their equity return expectation. As far as challenges go, the trade war is wearing out China and America. India will also be caught in this crossfire, currencies will be under pressure, along with capital deployment. However, if the government is able to take advantage of the trade war just like Vietnam, Bangladesh and Sri Lanka did, then you could see a rise in GDP, especially in the manufacturing sector.
OB: Do you see a further fall in GDP growth?
Saha: We could see a further de-growth to 5% in the short run, but it should bounce back by the third quarter of 2020.
Das: The biggest domestic challenge could occur if liquidity and credit risk worsen and turn into a contagion risk. Globally, if the trade war escalates, it will impact India as well. As far as positives are concerned, it would be the cut in interest and corporate tax rates. With a global slowdown, we could see more inflows coming into emerging markets, including India. We will see a slower economic recovery, but things will likely get better after eight to nine months. We believe that today, the risk-reward is in favour of equities.
Saluja: We still don’t know if there are any hidden skeletons waiting to tumble out of the NBFC closet. Smaller businesses continue to reel under the impact of the GST transition. Then, there are global factors such as the trade war and Brexit. However, if the government gets its act together, India has an opportunity to garner higher FII flow. There is a lot of money waiting to be deployed globally, given that major economies are grappling with negative yields, low interest rates and weak earnings. I think investors are waiting for the currency to stabilise and will keep a watch on how the government handles the fisc. The other big reform that the government can take is in agriculture, which accounts for 44% of the country’s labour, but contributes just 10-11% to the GDP. In the interim, we are advising clients to be selective because the moment a client’s portfolio falls by 20%, they want to rush to the bathroom! So, it’s better to remain safe and have a portfolio that is more large-cap oriented.
Kapoor: The single biggest positive playing out now, for both businesses and consumers, is the falling cost of capital. Further, the tax cut will have a positive spiralling effect on the economy. Today, home loans are available at 8.1%, and this interest rate could go down even further. Importantly, real interest rates are still high. So, once sentiment changes and the trust deficit goes away, we should attract a lot of foreign capital.
However, the trust issue must be resolved for credit growth to take off, and if it snowballs into something bigger, then we will have a cascading impact across the economy. Till now, we've only seen corporate defaults; the end game would be consumer defaults. That’s possible across segments such as SME, credit card and unsecured lending. I would really watch out for that.
Shah: What’s critical to note is that for the past five to six years, income of consumers has been flat, but their borrowings have risen. So, there is a real threat of retail delinquencies.
Gumashta: The challenge is that promoters have to see resolution. Today, if I talk to a promoter, he doesn’t know what’s in store, nor does the lead banker! Till we have some credit resolution playing out, there is likely to be uncertainty. The other big worry is: if the government continues to spend, can the fisc sustain, and what would it mean for interest rates? The big positive is that, both in fixed income and equity, 90% of the pain is in the price. Interestingly, there are good opportunities in equity. For example, quite a lot of PSUs are trading near distressed valuations. If at all one has to take a risk, then it has to be with equity.
Iyer: From a long-term view, lower cost of capital and lower inflation are good for equity as an asset class. From an opportunity perspective, we will again focus on quality. The next 12-18 months will be a good time to build a portfolio from a three- to five-year perspective. On the fixed income side, I believe, investors overseas are looking at emerging markets, especially India. On the risk side, the trade war is creating a lot of uncertainty around companies’ investment plans. And that’s a big global risk.
This is part three of a three-part series. Read part one and part two here.