 "India is now a low-beta market: Ridham Desai")
Indian equities are up 20 per cent since February, which has triggered the usual debate about valuations and bloated multiples. This has got shriller as earnings have not revived as estimated by strategists two years ago. In an interview, Ridham Desai, Morgan Stanley's managing director - research, tells Malini Bhupta why Indian equities are nowhere near bubble territory and why markets are now a defensive play for global investors. Edited excerpts:
The government seems on course to roll out the goods and services tax (GST) next year. How are markets viewing this?
This is one of the biggest and much-awaited reforms since 1991. From a short-term market perspective, it is probably priced in. However, its long-term implications will take some time to be discounted. The new law, when it is enacted, will eventually reduce the cost of doing business in India, improve the ease of doing business, improve government revenues by reducing leakages and likely increase growth. The delay in its passage is not necessarily a bad thing, because the draft law is much cleaner than the first proposal 10 years ago. Indeed, the government has an execution challenge, with multiple steps to take in the next few months to meet the April 2017 deadline.
Our database shows that only a third of the companies have reported earnings. Of these, there has been an improvement in the surprise breadth, one out of two companies has surprised positively. Another continuing trend from the previous quarter is that domestic businesses are doing better than global ones. We see strength in three sectors - retail banks (lenders to consumers/businesses), discretionary consumption (small household equipment from air coolers to kitchen appliances to automobiles) and select industrials, which are beneficiaries of government spending on infrastructure.
We have seen a big recovery in steel production since the government imposed an anti-dumping price. The industry's response has been to increase utilisation rates. Cement production is also up, so there has been some activity in infrastructure.
The weakness is still visible in corporate banks and staples are struggling a bit because the tailwind of lower raw material prices are ebbing and volumes have not picked up as rural India is sluggish. The effect of a good monsoon will be felt in a quarter or two.
Do you think the government's attempt to stimulate consumption through higher revenue spending and other measures will work?
The government has attempted to stimulate growth through infrastructure spending, rather than consumption spending. The Pay Commission award was not a choice they made. If you go back to the Budget, the government's rural expenditure stands unchanged as a percentage of gross domestic product (GDP). The only item gaining share in government expenditure is infrastructure. This is visible in roads. Last year, the government finished 6,000 km and issued orders of 10,000 km. This year, the target is to issue orders of 25,000 km and finish 15,000 km. These are aggressive targets and even if they achieve 80 per cent, it will be a mega jump over the trailing 10-year averages. The step up in infra spending is a large.
The constant refrain is that nothing has changed on the ground. What is your view?
Everybody assesses ground reality on the basis of manufacturing. You have to ask how the services companies are faring - insurance is up, retail banking is growing and hotels, airlines and travel are doing well.
What is the biggest challenge to India's growth?
The biggest challenge is global growth, as we are not in an era of five per cent global growth. Between 2004 and 2008, world GDP growth averaged five per cent and today we are around three per cent. It is not conducive for India's growth. There has been a turnaround in our external financing. India has been heavily dependent on global capital flows to fund its external account. The ratio was typically 3:1 - for every $3 of portfolio funds, we got $1 of foreign direct investment (FDI). So, whenever there was a problem in global capital markets, India did poorly as flows got threatened. Today, ratios have changed. For every $4 of FDI we are getting $1 of foreign portfolio investments, which lends stability. India is now less vulnerable to global capital market cycles and this has not been the case for 20 years. India is now a low-beta market.
Thanks to the recent run-up, are Indian equities in bubble territory?
Markets are up 20 per cent since February, but if you compare it with last August, they are down one per cent. We are looking rich compared to emerging markets (EMs). In 2007, India traded at 2.2 times the EM book multiple. India's own book multiple was 6.5 times and the rest of EMs was at three times. Today, India is trading at 2.2 times EM book multiple but India's own book multiple is 3x, which is half of what it was in December 2007. Other emerging markets have their own structural issues, which is why their book multiple has collapsed.
In the past few months, other emerging markets have done well, but India has underperformed. India is the 17th best performing emerging market out of a list of 24. We may have done well on an absolute basis, we have not done so in relative terms. We are sitting at the bottom of the pile. The reason is that we are a low-beta market. We are a defensive play now. The perception of the world is that we have a superior growth outlook and it is widely accepted. We have been on a strong wicket since 2013.
Can corporate India revert to double digit earnings growth?
Double digit growth is quite possible. I think we can look at a combined annual compound annual growth rate of 15-17 per cent earnings growth over three years. I am optimistic about the next 12-24 months. The stock market is a discounting machine and share prices reflect the turn in corporate earnings. Share prices have discounted some of the earnings growth. Also, this is a nascent bull market, which is always created on doubt.
The government seems on course to roll out the goods and services tax (GST) next year. How are markets viewing this?
This is one of the biggest and much-awaited reforms since 1991. From a short-term market perspective, it is probably priced in. However, its long-term implications will take some time to be discounted. The new law, when it is enacted, will eventually reduce the cost of doing business in India, improve the ease of doing business, improve government revenues by reducing leakages and likely increase growth. The delay in its passage is not necessarily a bad thing, because the draft law is much cleaner than the first proposal 10 years ago. Indeed, the government has an execution challenge, with multiple steps to take in the next few months to meet the April 2017 deadline.
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How are you interpreting the earnings season?
Our database shows that only a third of the companies have reported earnings. Of these, there has been an improvement in the surprise breadth, one out of two companies has surprised positively. Another continuing trend from the previous quarter is that domestic businesses are doing better than global ones. We see strength in three sectors - retail banks (lenders to consumers/businesses), discretionary consumption (small household equipment from air coolers to kitchen appliances to automobiles) and select industrials, which are beneficiaries of government spending on infrastructure.
We have seen a big recovery in steel production since the government imposed an anti-dumping price. The industry's response has been to increase utilisation rates. Cement production is also up, so there has been some activity in infrastructure.
The weakness is still visible in corporate banks and staples are struggling a bit because the tailwind of lower raw material prices are ebbing and volumes have not picked up as rural India is sluggish. The effect of a good monsoon will be felt in a quarter or two.
Do you think the government's attempt to stimulate consumption through higher revenue spending and other measures will work?
The government has attempted to stimulate growth through infrastructure spending, rather than consumption spending. The Pay Commission award was not a choice they made. If you go back to the Budget, the government's rural expenditure stands unchanged as a percentage of gross domestic product (GDP). The only item gaining share in government expenditure is infrastructure. This is visible in roads. Last year, the government finished 6,000 km and issued orders of 10,000 km. This year, the target is to issue orders of 25,000 km and finish 15,000 km. These are aggressive targets and even if they achieve 80 per cent, it will be a mega jump over the trailing 10-year averages. The step up in infra spending is a large.
The constant refrain is that nothing has changed on the ground. What is your view?
Everybody assesses ground reality on the basis of manufacturing. You have to ask how the services companies are faring - insurance is up, retail banking is growing and hotels, airlines and travel are doing well.
What is the biggest challenge to India's growth?
The biggest challenge is global growth, as we are not in an era of five per cent global growth. Between 2004 and 2008, world GDP growth averaged five per cent and today we are around three per cent. It is not conducive for India's growth. There has been a turnaround in our external financing. India has been heavily dependent on global capital flows to fund its external account. The ratio was typically 3:1 - for every $3 of portfolio funds, we got $1 of foreign direct investment (FDI). So, whenever there was a problem in global capital markets, India did poorly as flows got threatened. Today, ratios have changed. For every $4 of FDI we are getting $1 of foreign portfolio investments, which lends stability. India is now less vulnerable to global capital market cycles and this has not been the case for 20 years. India is now a low-beta market.
Thanks to the recent run-up, are Indian equities in bubble territory?
Markets are up 20 per cent since February, but if you compare it with last August, they are down one per cent. We are looking rich compared to emerging markets (EMs). In 2007, India traded at 2.2 times the EM book multiple. India's own book multiple was 6.5 times and the rest of EMs was at three times. Today, India is trading at 2.2 times EM book multiple but India's own book multiple is 3x, which is half of what it was in December 2007. Other emerging markets have their own structural issues, which is why their book multiple has collapsed.
In the past few months, other emerging markets have done well, but India has underperformed. India is the 17th best performing emerging market out of a list of 24. We may have done well on an absolute basis, we have not done so in relative terms. We are sitting at the bottom of the pile. The reason is that we are a low-beta market. We are a defensive play now. The perception of the world is that we have a superior growth outlook and it is widely accepted. We have been on a strong wicket since 2013.
Can corporate India revert to double digit earnings growth?
Double digit growth is quite possible. I think we can look at a combined annual compound annual growth rate of 15-17 per cent earnings growth over three years. I am optimistic about the next 12-24 months. The stock market is a discounting machine and share prices reflect the turn in corporate earnings. Share prices have discounted some of the earnings growth. Also, this is a nascent bull market, which is always created on doubt.