I had the privilege of attending a fascinating event this week, where, on the occasion of a market legend reaching a personal milestone, a unique panel discussion was organised to discuss and debate the outlook for Indian equity markets. On the panel were four of the smartest minds involved with Indian equities, three being individuals running their own capital, and one a large Indian institutional investor. In the audience was a veritable who’s who of the Indian equity market. I have never seen such a large gathering of the so-called smart money at a single forum, and the quality of the turnout was a reflection of the respect and affection market participants have for the individual in whose honour the discussion was organised.
The panel was quite uniformly bullish on the long-term prospects for India and Indian equity market. All the panel members were convinced that the trend rate of growth in India was somewhere near 8 per cent, and in an environment where western economies were under huge fiscal pressure and struggling to grow at even 1-2 per cent, India would stand out. The group felt that India’s time had come, and the quality of our growth and our domestic consumption-based economic model were starting to get recognised. The strong end-consumer demand we are seeing across sectors was seen as sustainable, and a sign that India had hit an inflection point.
On valuations, while everyone agreed that India was not cheap, 16 times March 2011 earnings was not outlandish, given a sustainable corporate earnings growth stream of 16-18 per cent and 20 per cent return on equity (ROE) with limited debt at the corporate level.
On the fiscal issues, one panelist felt that with the introduction of GST and DTC, the tax-to-GDP ratio would improve by 150 basis points over the coming five years. Taking a nominal GDP growth profile of 14 per cent, tax revenues should compound at 18 per cent (as tax-to-gdp improves), and this type of revenue growth would bring our fiscal deficit to 3 per cent, and enable the government to meet its public debt targets. This task would be helped by the recent decisions to tackle fuel and fertiliser subsidies, the possibility of freezing these subsidies at current levels was a significant positive. If we can bring the fiscal deficit down, that should enable a gradual reduction in interest rates and further boost consumption and investment. There was a clear feeling that India had always been a good micro story with weak macro, but given the deterioration in the macro indicators in the West and our expected improvement, macro can no longer be held against us.
On the issues of governance, there was a strong feeling that given our stage of economic development, our institutions are actually quite robust, with enough checks and balances. Parallels were drawn with other BRIC economies and with the quality of governance in the US at a comparable stage of GDP per capita. Most were heartened by the younger lot of political leaders, the use of RTI and the gradual maturation of the electorate. The panelists felt that there was hope for serious improvement in governance over the coming years through the use of technology. The Unique ID project was seen as a game-changer, plugging leakages and improving effectiveness of public expenditure. Examples were given of Gujarat, the rise in both crop yields and the water table, the transformation of Ahmedabad, the effectiveness of the bureaucracy, etc. Why cannot this be replicated in other states?
There was optimism on Indian manufacturing, especially with the introduction of GST, and many felt that high-end engineering was an area in which India can dominate. One panelist was quite optimistic about the scope for another agriculture revolution. He pointed out the scope for yield improvement, giving the example of how cotton yields have tripled in Gujarat from 220 kg to 660 kg in a matter of a few years with the introduction of BT cotton. Yields in India are below Pakistan and Bangladesh in many crops, but the economics of farming have improved sharply in the last three years, and thus the capacity of farmers to use and pay for better quality inputs.
There was a belief that power capacity additions will surprise on the upside in the 2012-2017 Plan period, with the entry of the big boys from the Indian private sector. One panelist even felt that we could see upwards of 110,000 Mw of capacity being added. If true, this would crash merchant power prices, reduce power outages and give a huge fillip to economic growth.
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On the question of large upcoming and ongoing equity issuance, one of the panelists made the point that there was approximately $30 trillion of money held by institutional investors in the world of which India had less than $75 billion. India should continue to attract large sums of money going forward, as we are under-represented in the relevant indices and, by default, in institutional portfolios. The quality of issuance was also the key, if we bring to the market good quality papers, buyers will emerge. The panel felt that large issuance, especially of good quality, would not derail the bull story, but attract new investors.
In terms of needed reforms, the panel felt that land and labour were the key to enable an adequate supply-side response to handle 8 per cent growth and unlock our mineral and low-cost labour resources. We need to handle land acquisition in a fair and transparent manner to enable all stakeholders to get a fair deal.
Inflation was seen as a temporary problem, with a clear view that assuming monsoons are normal, inflation will come down to 5-6 per cent by March 2011, perceived as an acceptable level for our rate of growth. There were no takers for the view that our inflation was more structural, as the panel felt that one should look at inflation over a longer period, and if you adjust for the monsoon failure, and last year’s 1 per cent inflation number, today’s double-digit print is less threatening.
There was concern on the short-term outlook, both due to global factors and the feeling that earnings in Q1 may disappoint, with year-on-year growth slowing from 30 per cent to 18-19 per cent. India’s relative outperformance was also a concern, with China down more than 25 per cent year-to-date, and India basically flat, though one panel member felt that India’s cycle of outperformance has just begun, and while this may be a concern in the short term, it will eventually pull in money as global investors chase performance. A correction was unlikely to be severe, and most likely in the range of 10-15 per cent.
In terms of sectors, the panel was uniformly underweight on commodities due to global growth concerns, and strongly overweight on the end-consumer facing business. There was also a positive bias towards agrochemicals and certain technology-oriented auto ancillaries. Some expressed concern around tech, given global growth issues, the rupee and valuations.
While broadly agreeing with the above, I tend to be a little more cautious in the short term, especially on the fiscal and quality of governance. I think we run the risk of the government spending away the gains we realise from tax buoyancy as populism continues to win elections, and governance, to my mind, remains weak in many key areas. I also worry about the supply side across education, infrastructure, etc. being geared for 8 per cent growth. Global concerns could still cause a flight of risk capital, and I am surprised about the lack of concern around our current account and trade deficits, which have worsened markedly in the last 18 months. Despite these issues, I do agree that India could break out, and the long-term bull scenario has a reasonable probability of coming to fruition.
On the whole, it was a fascinating discussion, and an honour to be able to hear these gurus in person.
The author is the fund manager and chief executive officer of Amansa Capital