Singapore: Venture capital (VC) investments in Indian start-ups more than doubled in 2015, but VC firms alone cannot solve the massive capital shortage in the country, says Roshan Francis Padamadan, fund manager and founder of Singapore-based Luminance Global Fund. “Money with an ability to absorb risk becomes capital. India has plenty of money, but not enough capital," Padamadan said in an interview.
Big picture—when you look at India sitting here in Singapore—overall, what is your take?
Four interest rate cuts by the Reserve Bank of India (RBI) set the background for a review of 2015. A falling oil price is a stimulus to India, but it is not a focused stimulus for any one sector. The Sensex is about flat for the year, and the currency is near lows for the year, and within striking distance of all-time lows. December 2015 saw my first investment into India in years—a toll road operator. Reform from the ground up will be seen when the GST (goods and services tax) bill is passed, bringing in one tax regime across the 29 states. Opening up more sectors to FDI (foreign direct investment) is not real reform—accepting foreign capital is fine, but doesn’t change the productivity curve.
So, you invested in India in 2015? How do you see the Indian equity markets in 2016?
Yes, we stated our first position in December. India does make it hard to get in. I can invest in over 30 countries, and easily India was the hardest to add to the mix. It is also one of the most expensive to access, perhaps reflective of how under-allocated it is.
I do not have a market view for Indian equities. My view of several Indian factors go into my stock picking, but to give you a view on the Sensex or Nifty, I need to put together a weighted average of 30-50 companies, and I have not studied all of them. Of course, giving a view on the market without bottom-up work on index constituents is the same as giving the view on interest rates and oil—India imports over 75% of its oil needs. India’s interest rates will tend to go down, and oil price might remain weak until the second half of 2016. Globally, cost of capital for oil names is now high, which will reduce supply. Oil in the ground is always free, you just have to spend money to get it out and pay taxes. So, the cost of capital is a key variable in the oil price. The former is going up, and it is a matter of time before oil price goes up as these are mathematically linked.
The next big leg-down for the Indian currency might be when oil starts moving up. It might be earlier if Indian corporates who have large maturities in USD find it hard to refinance, given a general aversion to emerging markets at present. To contrast: Nike—equal to 11% of India’s market cap—is able to extract remarkable growth in Greater China, 30% year-on-year in the quarter ended August. India presents a lot of work as an investment destination, where aside from government rules, a lot of work is needed on the promoter background, etc. Capital does take it easy and often moves to where it is easier to make up your mind. (Disclosure: My largest market is the US. I do not own Nike.)
Looking at some of the recent survey results in India, how can business sentiment be down if consumer confidence is up?
Consumers benefit from increased purchasing power from lower petrol prices, and rate cuts for home loans, while industry struggles with lack of adequate credit. Bank loan growth had slowed to three-year lows, from above 18% to below 10%, before ticking up 11% in December 2015.
The cost of doing business is still very high in India as inefficiencies in the supply chain make businesses choose sub-scale operations. There are many companies in India that choose to limit themselves to a city or region. I see several consumer brands—e.g. soft drinks, condiments—do this. I ascribe it to the “headache value" of confronting another state’s sales tax regime, plus the higher capex and marketing spends required. It will require a large infusion of capital, and this might not be available, given the propensity of the retail investor to choose property and gold over providing capital to businesses via the equity market. With less than 3% of India being income taxpayers, it has probably the slimmest tax base among large economies, leading to very regressive taxes on consumption, such as VAT (value added tax) and sales taxes, i.e. these taxes punish the poor whose effective tax rate becomes high. India’s participation in the stock market is still very poor—the demat service providers’ records show only about 1% of the country (have stock holdings). How can businesses raise enough capital in this context? It is quite a tough setting.
Be it listed or unlisted firms, what are your big bets for Indian corporate entities for 2016? You are also bullish on some of the private firms—why is that?
I initiated a position in a toll road developer and operator trading at a 40% discount to book. Usually, this is a boring sector as I have seen in Europe and Brazil. In India, due to policy uncertainty, it is not. The company is trading below the price of its rights issue that it had to do to relieve its debt burden. It will also have to do some asset sales to right the ship. This position is reflective of the kind of work needed in India—no easy “beta" plays, it has to be based on individual stock research.
While I cannot invest in private companies at present, they are part of my study of good businesses. A company should become public only for the right reasons. There are many prosperous companies globally which have never needed to become public due to the nature of the business and the timing of their capital needs. You won’t find private telecom companies as the nature of the spectrum sales leads to lumpy capex that can be quite hard to fund with internal accruals.
I look at companies like (confectioner) Haldiram’s—a private company—and admire how they have built up their franchise. They are not big by global standards, with $0.5 billion in sales. Despite the size, I believe it is a powerful brand. I see a strong runway for such a firm, having carved out a niche in the consumer’s mind. They have done such a good job with their distribution. I can find them everywhere Indians might go, at Indian stores around the world, I can even find them at Chungking Mansions in Hong Kong. I would like to find the next Haldiram’s.
Venture capital (VC) investments in Indian start-ups more than doubled in 2015. Was the FOMO factor—fear of missing out—at play here?
A lot of VC money is coming from abroad. India’s numbers—population, gross domestic product—demand a place in any top-down allocation. There is a lot of money flowing around in the VC world, as evidenced by the high valuation of several private companies in Silicon Valley. These two factors combine to give a good opportunity for entrepreneurs to strike while the iron is hot.
There are different types of entrepreneurs. There are ones who painstakingly build their profiles and are looking to build the next big thing, focusing on scalability. Then there are those driven by a creative vision, a passion to create something of their own. VC investments focus on the former. VCs alone cannot solve the massive capital shortage in the country. Money with an ability to absorb risk becomes capital. India has plenty of money, but not enough capital.
One issue that needs addressing, be it for entrepreneurs or for corporate entities, is the ease of doing business in India. Has the Narendra Modi government delivered on this so far?
Being an entrepreneur myself, I can tell you my experience. In 2013, I had to make a decision on where to base my investment firm, after leaving a global bank. I would have liked to come back to India... The market was not ready for the product, for the most part. A global hedge fund is two steps away for even very wealthy Indian families who don’t even own Coca-Cola. Indians can invest abroad using the Liberalised Remittance Scheme since 2004. I opened my first foreign broker account in 2004. I didn’t realize I was at the vanguard of something, I was naturally looking for the best opportunities and I became a global investor then. Eleven years later, with only 1% of India investing in Indian stock markets, there are less than 43,000 income tax assesses who show an annual income of over ₹ 1 crore. India’s luxury car sales for 2015 is expected to be around 38,000 units. So, either a lot of people are spending beyond their means, or the levels of unreported income is high. And unreported income stays in channels such as property—where real sale price can differ substantially from reported sale price—and gold. A hedge fund is very much a regulated product. Or more precisely, it has to meet regulatory criteria to be not regulated as a mutual fund.
The bigger hurdle was not the market potential. I thought of running the firm from India, while seeking customers outside India. Indian technology, business process outsourcing and pharma sectors have demonstrated how this can work, with the bulk of their revenue coming from exports to the US and Europe. I had experience in two of those three sectors. My issue was that India did not and does not have clear rules for running a hedge fund. Not allowing pooled trades meant I would have to run separate accounts for each investor, resulting in higher costs and inefficient capital allocation. I would have had to rely on interpretations of US laws even for things such as who might qualify as potential customers. For the sake of clarity on business rules, I chose to run my firm from Singapore. Entrepreneurs can accept many costs—higher costs of capital, poor logistics, time delays—but what they would find hardest is to accept policy uncertainty.
I am still waiting for the GST bill as the defining moment of a New India. It will be a genuine productivity multiplier. It will be (akin to) forming the European Union, in its economic impact. India already has political union, we just need economic union. Indian trucks waiting at state borders make me weep. Capital at a standstill is not good for anyone—not for the business owners, not for the government, and certainly not for the consumer, who ends up paying for all the extra costs in the product price.
As for big business, Modi does make it easy to get permission to come into India. For India, more capital would come in if it was easy to take it out as well. Allowing such capital might see more volatile moves. Remember the 1% who have demat accounts—they will not be able to effectively offset FII (foreign institutional investor) inflows and outflows. Also, domestic institutional investors (DIIs) are still not big enough. A low income tax assessee base means a low base of investors who can invest in regulated products. There are no large proprietary pools of capital—money with DIIs is again from the same pool of people. Between the choice of improving local capital efficiency by boosting productivity and welcoming more foreign capital to boost growth, it is quite clear which benefits India more in the long-term. If India does the former, the rest will automatically happen. There are very few avenues of genuine growth in the world. India remains very complicated for most global investors, and is massively under-allocated. India is under-allocated even in India. Just 1% own equities. This is the case even though long-term capital gains—held for more than 1 year—is tax-free.