Rupee’s depreciation over next year will be a positive: Nishith Sheth
The Narendra Modi government has implemented landmark reforms and overhauled the tax system in efforts to oil the engines of growth, but the results are yet to show, and the country probably needs some more concrete and tangible recovery on the job front and private spending, Nishith Sheth, vice-president, institutional sales, Kotak Mahindra (UK) Ltd, said in an interview. Edited excerpts:
How do international investors look at the whole debate in India on the slowdown or cooling down of growth over five consecutive quarters?
Listed fund flows to India were subdued in August and September. India received $383 million in August, compared with more than $1.5 billion of average monthly inflows over the past few months. This may be an early sign of international investors’ outlook of market turning cautious. Total India flows across India-dedicated funds as well as GEM (global emerging market) funds have shown a steady decline after its peak around April earlier this year. But at the same time, if you look at broader market performance, the trend doesn’t reflect a similar direction.
The Nifty has been up ~2-13% in the past six months. Moreover, the Nifty has returned ~20% over last one year; the BSE Midcap has performed even better this calendar year, giving returns in excess of 33% YTD (year-to-date). This brings us to the already over-emphasized topic of domestic liquidity, which apparently has become a justification to everything that numbers otherwise can’t explain.
I remember reading a story carried in your newspaper beginning of this year that was titled ‘Markets rally on liquidity surge, but will it last?’. It has lasted for three quarters now!!
Till a few months ago, the broad theme among international investors was ‘when will the earnings catch up with the multiples;’ of late, it’s become more of, ‘when will the multiples rationalize to reflect earnings.’ Another big factor for overseas investors is the FX. Usually, rupee depreciation eats into the market gains to the extent of 5-7%; instead, for most part of this year, the rupee has rather helped. The trend seems to be reversing for the last few days though.
Do you see a scenario where the Modi-led government will step up stimulus to reduce political damage ahead of a round of state elections beginning in December; and if it were to do that, will it shatter the confidence of investors worried about fiscal slippage?
If you ask investors to choose between no fiscal slippage versus stable, pro-reform government, I believe most of them would choose the latter. It’s almost like the government sprang into action as soon as they received some distress signals on the economic front, including the latest GDP (gross domestic product) growth or inflation shooting up. An advisory group of economic experts constituted by Prime Minister Narendra Modi has recently warned against breaching the fiscal deficit, potentially ruling out the possibility of a stimulus package to revive the sputtering economy.
Instead, the government is likely to go for targeted spending and nudge departments, especially those handling infrastructure, employment-intensive and rural India-specific sectors, to ensure allocations are yielding results. It’s a slight contradiction to come up with a stimulus package, when the country is enjoying one of the best macro environments ever, in terms of oil prices, rupee stability, interest rates, etc.
What can Modi do to revive the national mood and generate optimism over the economy?
In its first three years in office, the Modi government has implemented landmark reforms and overhauled the tax system in efforts to oil the engines of growth. But the fruits are yet to show. While he has already ridden the theory of “there is no alternative”, the country probably needs some more concrete and tangible recovery on the job front and private spending... You can’t really blame politicians to be populist, given that in India, voter turnout is linked to income. Poor people are far more likely to vote than those in the middle and upper classes. This ideally should have the effect of incentivising politicians to engage with the country’s grassroots, including in predominantly rural areas. But more often than not, it’s very difficult to not be populist and still win elections, or generate optimism among the entire strata of demography with uniform unbiased measures. I think, the presence of no credible opposition has been the current government’s biggest asset. This may not be the best thing for the country in the longer run. It’s very important to have a credible execution team of ministers and bureaucrats. In the absence of them, even the most well-intended efforts will not yield the intended benefits.
If you look at India’s reserves, it is about $400 billion. Should it hold on to this large amount of forex reserves? Instead, if these funds are used to finance, say, infrastructure projects, won’t the returns be much higher?
In addition to paying foreign debt and other obligations, forex reserves are usually used to keep the value of its currency at a constant rate and to administer if the economy is volatile. The economic costs and benefits of higher reserves for a country like India are complex. It gets even more intricate if one brings in external security and strategic issues. As a central banker, RBI (Reserve Bank of India) has been able to manage the volatility in rupee reasonably well, and a large part of it would not have been possible without the kind of FX reserves that the country has built. The reserve number may sound huge, but for a country of our size, it covers ~4 months of imports. At around 20% of GDP, the number doesn’t look out of proportion. At some level, the high forex reserves are making up for the absence of any established sovereign wealth fund, which most other major economies tend to have. We can probably afford to have some illiquidity at the benefit of better returns. Having said that, I don’t think RBI’s half-yearly or annual reports disclose any meaningful information pertaining to portfolio or risk management of forex reserves.
Global and Asian funds with a part India allocation had been viewing India as a relatively safer bet, given that all the macro projections look encouraging. But with India’s macro numbers faltering, how do these investors look at the country now? Do you see money flow going towards other markets? If so, which are those markets?
Any meaningful weakness in the INR is likely to result in the perception of macroeconomic weakness and negative sentiment. On the currency front, at least, the recent depreciation is no reason to worry as yet. In fact, continued depreciation over next year or so would be a positive, given the high share of companies with US dollar-linked revenues and profits in the overall revenues and profits of the Indian market.
It’s crucial for the for the profits of global commodity, information technology (IT) and pharmaceuticals sectors, which contribute a significant portion of the market. The other macro factors relating to growth certainly seem to cause some worry. That, coupled with the chances of global central banks reducing or removing their accommodative monetary policies, can have some adverse impact. India is already seeing a decline in foreign fund flows, both from a product perspective—ETFs (exchange-traded funds) and non-ETFs—as well as geographical focus—India-dedicated funds and global emerging market funds. If we break up the data further, the 12-month flow was one of the highest for India among all emerging markets, but the same flow for the last one month and three months, India is lagging behind other emerging markets like Taiwan and Korea. Although most of the emerging markets showed a negative FPI (foreign portfolio investor) flow in August, India was relatively high on the outflow number, as compared to Indonesia, Korea, Taiwan and Thailand. Overall allocation to India by Asia ex-Japan funds showed a decline in August, as compared to July or even August last year, whereas the trend was reverse with China. What remains to be seen is how long can domestic liquidity support the valuations.
Can the Indian markets continue to rally the way they have been this year despite slowing economic growth, high valuation and lacklustre earnings growth?
So far, domestic liquidity, promise of reforms, recovering global macro have helped the markets soar to newer heights. The markets can continue to rally till the time investors keep finding one such reason. By the time we run out of these reasons, actual earning growth may be revived or economy may be back to 7% growth. Hence, it’s difficult to put a time-line to this rally. Unfortunately, sitting on cash in the past 12 months or so has proven to be a very expensive strategy, irrespective of asset-class we speak about. This brings us back to the topic of domestic liquidity-driven markets. But in my view, retail investors, when they suffer, it’s primarily for two reasons—first, they wish away the problem and, second, use recent historical return from any asset class to determine the expected future rate of return. In a healthy supportive macro and growth environment, these concerns are undermined; but if the theme doesn’t continue, then they would be in trouble.
Specific to India, which are the investment themes likely to stand out going ahead?
If capital raise is any indicator of growth to come, the trend has been extremely broad based. Last 12 months have seen investors showing overwhelming demand for primary issuances into sectors across the board like consumer, manufacturing, financials (both banks and non-banking financial companies), auto, real estate, etc. Hence, it’s very encouraging that the up-cycle has been quite secular in nature. Additionally, there has been appetite from investors for companies across the market cap spectrum. Notwithstanding the valuations, any consumer-linked segment shows a lot of promise. Infrastructure is another segment that hasn’t performed to its potential. At a country level, for large scale infra projects to be awarded and executed, the stability of government is extremely important. Now that being reasonably addressed, we may see a renewed interest in that segment.
When do you see a broad-based earnings recovery happening in India?
Top India funds have given dollar returns of 20-25% compound annual growth rate (CAGR) over two years with current earnings…. why do you need an earnings recovery? But on a more serious note, with the delayed implementation of GST (goods and services tax) and more execution issues surfacing with time, the earlier envisaged window of 4-6 months may now extend further, and it may well be the third quarter of next year before we see any meaningful revival across the board.
For the markets to rally till then, we just need the domestic liquidity card to play out... or find some other proxy in form of a favourable regulation.
The views expressed in this interview are personal and may not necessarily reflect the opinion of Kotak Mahindra (UK) Ltd.
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