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Singapore: Even if the Bharatiya Janata Party (BJP) were to suffer a setback in the Bihar state assembly election, it will not derail the national reform process set in motion by the BJP-led central government, said Sanjay Guglani, chief investment officer, Silverdale India Equity Fund, and chief executive officer, Silverdale Capital Pte. Ltd, Singapore. The measures taken by the government will have a massive multiplier impact on the economy with a lag of two to four quarters, Guglani said in an interview.
Finance minister Arun Jaitley said India should have been ranked much higher in the latest World Bank’s ease of doing business index. Do you agree? As an investor looking at India from outside, has the country done enough to have gone higher in the rankings?
Well, 10 indicators determine the World Bank’s ranking on ease of doing business, which in turn colours foreign investors’ decisions in terms of return expectations. If in country A it takes one year to set up a business versus one month in country B, clearly return expectations from country A, other things being equal, will be higher. Hence, if the return expectation from country A is not commensurately higher, foreign investments will shy away from country A.
However, all macro reports should be taken with a pinch of salt. For instance, the biggest improvement in ranking is due to saving of 14 days in getting a power connection. It is well known that the time taken to get a power connection in Pipili village in Odisha is much different from that in New Delhi.
As foreign investors, while we acknowledge the steps taken by the Indian government towards a simpler FPI (foreign portfolio investment) regime and the gradual opening of the Indian G-Sec markets, it has a very long way to go as compared with other countries. For example, a PCC (protected cell company) or SPC (segregated portfolio company) fund is an accepted norm globally, while India doesn’t accept investment from a SPC fund, which, in turn, significantly increases cost of operations of an India-dedicated fund. It is difficult to comprehend how the Indian government can target long-term funds while perusing short-term policies, such as deferring GAAR (general anti-avoidance rules) by one year, non-ending policy flip-flop on MAT (minimum alternate tax) from $6.4 billion demand to $100 million to nil to no-but-yes depending on the PE (permanent establishment); now what determines a PE is left to future flip-flops!
How do you see the Indian markets react to Bihar state election results? Will a BJP defeat impact reforms going forward?
As foreign investors, we find the Bihar elections interesting for two reasons—first, the key opposition augmentor Nitish Kumar was a political ally of the BJP till 2013 who knows BJP’s election tactics; and second, because of the deployment of cutting-edge technologies and strategies, and last-mile logistics. A Modi victory in the Bihar elections would not alleviate the government’s lack of a majority in the upper House; and they would still need to learn the art of consensus building to pass landmark bills such as the GST (goods and services tax), land acquisition bills, etc. We do not believe the loss of Bihar elections would derail the reform process since many of the steps taken by the Modi government anyway have a long gestation period of two to three years such as DBT (direct benefits transfer), DFC (dedicated freight corridor), and inland waterways. Also, after Bihar, the UP elections are due, which, incidentally, contributes the largest number of seats to the Indian Parliament.
Are domestic investors feeling uneasy as earnings have not come back, making the valuations look expensive? When do you see earnings coming back? In this scenario, why is India still among the most favoured destinations by emerging market investors?
Structural reforms are painful and take time to manifest, which slows the economy; hence, slowing of the economy when it is at the juncture of a turnaround is natural, as seen with Thatcherism in the 1970s, where the UK growth rate plunged to negative 2% in the first two years, and later picked up to over 3%; even in Indonesia, post-Asian crisis, reforms resulted in drop of gross domestic product (GDP) to negative 6% in the first two years, to eventually recover to over 5%. Hence, muted corporate earnings in India are expected. But for the softer commodity prices, the reforms in India would have been much more painful and prolonged.
It is to the credit of the Modi government that it has taken the onus to kick-start the investment cycle. For the first time in nine years, government projects have overtaken private sector projects under implementation. The railways’ capex for the next five years is more than the entire capex done by the Indian Railways since the independence of India.
These measures have a massive multiplier impact on the economy with a lag of two to four quarters. We would see the effect starting with baby steps in the current quarter, and building over the next four quarters. The freight volume in the last quarter is already up by over 14%. We are also seeing second-degree effect in terms of higher utilization of freight fleets, uptick in consumption of auto spare-parts, uptick in LCV (light commercial vehicle) and MCV (medium commercial vehicle) demand. Hence, the earnings nudge has already started.
Talking about valuations: the Sensex trades at price-to-earnings of 16.2x which is slightly below its 10-year average of 16.4x, with price-to-book of 2.6x, which is near its 10-year average of 2.7x. Hence, Sensex valuations are not expensive. Yes, the premium of MSCI India over MSCI EM at 81% is significantly higher than the 10-year average of 43%, but that is more to do with the fact that many emerging economies, like Russia or Brazil, are commodity exporters hit by falling commodity prices.
Most analysts agree that India is relatively insulated from the US rate hikes. Yet there will be an outflow when rates are raised, and in this scenario, where do you see the rupee? Also, big picture, where do you see the rupee?
Looking at the big picture, since 1991, India’s GDP per capita has increased five times, while its forex reserves have increased almost 50 times. At current foreign exchange reserves circa $350 billion, covering about 10 months of net imports, India is no longer among the Fragile Five. As RBI governor Raghuram Rajan pointed out, India’s growth is its best insulation against externalities. Historically, it is observed that when the Indian economy has been robust, a Fed hike doesn’t impact India adversely, as witnessed in 1999 and 2004. Hence, in the current environment of benign inflation, relatively high growth rates, and fiscal discipline, we don’t expect any significant impact of a US rate hike on the Indian economy...
Some temporary bumps are, of course, expected as over three-fourth of all funds investing into India are global funds with India allocations, which, by definition, are sensitive to global flow of capital. However, we see contraindicative positioning by dedicated Indian funds, both domestic as well as foreign. In the current calendar year to date, FIIs (foreign institutional investors) invested $3.6 billion, against $16.2 billion last year, while domestic funds invested $9.1 billion, against $3.9 billion in the last year.
With regards to the Indian rupee, it is marginally overvalued based on REER—real effective exchange rate. However, we don’t consider it to be materially significant. The RBI’s proactive steps to avoid perverse rupee appreciations are commendable with meaningful intervention in the currency markets to keep INR range-bound. We expect marginal and gradual depreciation of INR in the coming months, which will have a salubrious impact on the Indian economy, both for investments and exports.
Your take on China?
We see Chinese policies to have a much larger impact on India than the US Fed rate. The slowdown in China, coupled with the speculated Fed rate hike, has reduced the risk appetite of global investors, leading to outflow of portfolio equity from EM (emerging market) economies, including India, as seen during August-September. With the improvements in India’s fundamentals, its share in global FDI (foreign direct investment) flows has been improving in recent times. In the first half of 2015, India has attracted the world’s highest amount of FDI of $31 billion, ahead of $28 billion of China and $27 billion of the US.
The slowdown of demand from China has also resulted in the softening of commodity prices, benefiting India, which is a large net importer of commodities. The flipside of low Chinese growth is potential dumping by Chinese companies, hurting the Indian companies and still further deteriorating the already adverse India-China trade balance. In the international markets, India doesn’t directly compete with China in the Top 5 items exported except for machinery exports; however, the long tail of Indian exports could be hurt if the yuan is devalued.