Saurabh Nanavati: Corporate margins will be down almost across the
globe. I think, the market has factored in a portion of this but I think there
is another 10% downside. The government has gone completely wrong on the policy
front. If you take all the subsidies cumulatively, and the deficits at the
state and the central level, you are looking at a fiscal deficit of 9%-10%
which is serious. My biggest worry is that general elections are one year away,
so you are not going to see the right policy steps and financial health may
worsen. India runs the risk of getting downgraded like Vietnam – from the
investment grade it enjoys now. If that happens, it will have a significant
impact on the market.
Tushar Pradhan: Rising crude price doesn’t affect the Indian market in
any way. The impact is felt by the refining companies, which are made to sell
products at a lower price. Also, each barrel is about 159 litres which means if
you are paying Rs50 a litre at the pump, you are actually paying $200 a barrel.
So where does the money go? To the government – in excise duty and sales tax.
So, in totality, it does not hurt us. Coming to inflation: in India, inflation
is weighted heavily by food. Food constituted around 40% of the rise in
inflation. But the point about agriculture-based inflation is that, at best, it
is a 12-month phenomenon. Higher prices in one year lead to higher production
next year and prices fall. I think, this time we are expecting a record food
grain production. We are placed in a very unique situation where the world is
short of food grain because we did not sow enough – partly because in the West
a subsidy is given not to plant! Next year, that will get corrected. However,
in case of materials like minerals, iron ore or bauxite, the expansion in
capacity or supplies doesn’t come quickly. The larger companies of the
world have gone in for expansion and this supply will hit the market in a year
or two. So I think it is a cycle which is peaking. Demand will also slow down,
and it is already showing up in GM shutting down four plants and airlines
reducing routes. Then you have to incorporate the speculative element in
commodities. The minute this speculation starts unwinding, prices will go down
sharply. People are talking about inflation because of its short-term impact.
For example, a manufacturing company which has to provide for multi-quarter
projects will say that in the first quarter they will not buy anything, which
means there will be a lower top line growth and you will see the media saying
that there is a slowdown. But that is temporary. The markets are very dynamic.
Demand, supply and prices adjust quickly. So, while there is some slowdown now,
it won’t last long. There is a noise in the market. If you look at
FY07-08, most street expectations for the Sensex companies were between 15%-18%
of earnings growth. The actual earnings for the 21 companies that have
announced annual results so far were 21%.
Sanjay Sinha: The concern comes not from the extent of the spike that we have
seen until now but the uncertainty related to how long will these prices remain
strong and whether there will be any moderation in the latter part of the year.
This has created a serious current account deficit to deal with – at a time
when the rupee has also depreciated. Plus, we do not have significant capital
flows. The other problem is that the government chose not to resort to
market-discovered prices of petroleum products. If they had done that, demand
would have come down. But if you subsidise prices, obviously, demand will not
be affected and prices will remain higher for longer. So it becomes a
self-fulfilling cycle of inversion. I believe the decision to hike prices will
moderate demand somewhat. I do not see a reason for crude prices to remain so
strong for very long. This is for two reasons: (a) the fact that India and
China have been growing strongly has now been known – not in this year but for
the past three to four years. And (b) the Chinese and Indian economies
collectively account for $ four trillion of GDP whereas the US accounts for $14
trillion; so I would not expect that the growth in these economies would not
compensate for de-growth in the US economy. Fundamentally, these prices will
not sustain and I expect them to start declining in the second half of 2008. We
will probably have to live through a phase in which inflation would be high or
commodity prices may be high.
N Prasad: While rising crude prices and inflation are worries, the biggest
worry for the market is the reluctance of the government to pass on the rise in
fuel prices to the final consumer. This is leading to a fiscal deficit of 8%.
India had this kind of fiscal deficit number in 2004. You know where the stock
market was at that time. I do not think inflation is as much a worry as oil.
All the sectors that are the cause of inflation today like steel, cement, real
estate, etc, have moved up in the past two years which means the market
anticipated it. While unmanageable inflation due to excessive demand and money
growth is not welcome, I do not think India is at that level of inflation where
it can cause excessive worry.
Mihir Vora: Inflation is calculated on a YoY basis so, at some point of time,
in the next 9-12 months, the base impact will start showing up and inflation
will start declining. Equity markets discount the future and so the markets
won’t go down too much because of this news alone. There may be other
factors which can drive the market down but not necessarily crude oil and
Madhusudan Kela: We have been bullish on the India story and the biggest risk
factor which we highlighted is the crude price, to which India is very
sensitive. Higher crude prices lead to higher subsidy, to higher borrowing by
the government, higher interest rates and higher inflation – everything is
linked. If the crude price goes to $150, obviously, sentiment will be bad and
bottom-up ideas do not really work in that kind of environment. However, it is
not an India-specific problem. It is starting to hurt the whole world – China,
the US, Korea, etc. The impact is so well publicised that people are looking
for options and how to cool it off. Also, this price is largely speculative.
The total commodity exchange open interest in 2003 was something like $13
billion-$15 billion and that has gone up to $280 billion with a lot of money
coming from pension funds and large institutions. This is a very small market,
compared to equities. I think, what we saw in commodities was partially because
of this speculative activity. Now this is something that is coming to the
notice of all government agencies so I am hoping that, at some point of time,
it will get curbed. I am hoping that the crude price will cool off and, if it
drops to $100, we are fine. We will obviously be worse off than we were two
years ago but, of course, all the fears about inflation and fiscal deficit will
Ajay Bagga: We are concerned about commodity price-led inflation, huge subsidy
burden on oil, fertiliser and food, high fiscal deficit and high current
account deficit. It is a grim picture for the Indian and global markets and
economies for the next two quarters. We expect a slowdown in the Indian
economy’s growth rate and a lowering of corporate earnings growth rates,
which will have an impact on valuations.
2. A 9% growth rate is
history. What is the 2009 expectation?
Saurabh Nanavati: I am looking at a 7.5% growth rate. A 9% rate can be
achieved over a longer period of time, but we need significant policy actions
to achieve that. I see a lot of infrastructure projects getting delayed and
reworked and that will also contribute to the growth rate going down. Of
course, a 7.5% growth rate is not insignificant. We will still be in the top
quartile, globally. The US is experiencing negative growth now. At 12% nominal
growth (7% plus RBI’s targeted inflation rate of 5%), means that the more
efficient companies will grow at 30%-40% which will mean an overall earnings
growth of 16%-17% – that is very good from a global perspective.
Psychologically, a slower GDP growth rate is a damper and you are seeing that.
If you ask me what is the fair number for the Sensex, I would say
14,500-15,000 is fair, which means a PE multiple of around 13 at Rs1,000 EPS
for the Sensex companies in FY08-09 and around Rs2,000 as embedded value. I
have reduced the embedded value because, having come from the insurance
industry, I know that insurance valuations are way out of whack; I would not
attribute 3,000 points to that. However, the market does not behave in that
manner. When it turns for the worse, it will go much below fair value.
Tushar Pradhan: I don’t know why everybody gets worried about a 9%
growth. When India’s GDP was growing at around 4%-5%, on an average,
stock markets returned 18% compounded since 1979; that was not a problem. So,
that 9% is not going to be achieved, is barely a problem. We are a
trillion-dollar economy for which even a 7% growth is amazing. That alone will
make us the second fastest-growing economy in the world among the larger
countries. Also, I don’t think India’s GDP number really captures
growth in this country. India is made up of 28 states. Are Bihar, Madhya
Pradesh, Rajasthan, Uttaranchal or Chhattisgarh growing at 8%? I don’t
think they are. Which means that the better states are growing at a much higher
rate than 8%. I think, we just get caught up in this average number. All you
have to do is to look around you. Today, if you are saying there is a slowdown,
try and find an apartment or an office for yourself or a discount on a new car.
These are signs of a slowdown. The government numbers are influenced by bias in
collection and information gaps in our system. I am not a great fan of these
numbers. India reports inflation on a weekly basis. Nobody else reports this.
Are our systems so much better?
Sanjay Sinha: In this year, yes, a 9% growth rate is definitely at risk
but 7%-8% looks achievable. Once we have a more benign outlook, this entire
vicious cycle actually turns into a virtuous cycle – commodity prices will come
down, inflation will come down and, therefore, interest rates will come down,
margins will expand and the economy will grow faster. So I have not given up on
the 9% growth rate for the coming years.
N Prasad: No, a 9% growth rate is not history. As per RBI estimates, it
could be between 8%-8.5% in the current year and, I believe, it would be so. We
have not yet seen demand erosion, though there could be margin erosion for
companies. Our guess is that by 2010-11, GDP could be in double digits if
agriculture does not disappoint. It is wrong to write off the story just
because there is a lull for one or two years due to adjustments of supply and
Mihir Vora: We could get 7%-7.5% growth, for which valuations are
attractive. Given the fact that we have a good RoE, corporates are still
sitting on cash, they don’t have leveraged balance sheets; even
households are not leveraged. So I think 7%-8% growth is positive for India
Madhusudan Kela: We should expect 7%-7.5%. But my worry is not 2009.
What the whole world was playing for was India’s potential to grow 8%-9%
for the next 10 years. And now there is a question mark there. Whether India
can have high growth for the next 5-10 years will depend on where crude and
other commodity prices go. If they continue to spiral up, growth will take a
beating and that will get reflected in the stock markets. But, for the time
being, I think the markets are more than adequately discounting the fears
visible for the next one year.
Ajay Bagga: There are positives as well, in terms of increased liquidity
being given to the rural sector (higher minimum support prices and Rs71,000
crore of loan waivers) and urban segments (tax cuts and Sixth Pay Commission).
The medium-term investment story is also very much intact. In this scenario, we
expect around 8% real GDP growth rate for FY08-09.
3. FIIs are selling
continuously. When will they turn buyers and why?
Saurabh Nanavati: If you put
yourself in the FIIs’ shoes, firstly, the fundamentals have deteriorated
and, secondly, the rupee has depreciated which was not anticipated by anybody
at all. A sharp depreciation – of 5% in a month – will basically knock an
FII’s portfolio out of shape, so they had to take corrective action and
that is the reason they have sold. What will prompt FIIs to come back again
will be appreciation of the rupee. But the bigger issue is: why should they
come in now, when they are not clear about the policy actions and when
fundamentals are weakening?
Tushar Pradhan: FIIs are not one homogenous unit. In the last calendar
year, they put in $16 billion net. This year, from January to now, they are net
negative of $ four billion. What made them bring that much money last year? I
don’t know. What made them take money off the table this year? I have no
idea. But that is what drives the market. If we look at fundamentals, what they
bought at last year was this year’s earnings at 20 times. What they are
selling is 15 times, nine months forward. It doesn’t make any sense. But
I am sure they have various reasons for doing what they are doing. They are
witnessing a global growth scare and they are reducing their equity positions
per se. This means they will reduce equity positions in any market. While India
has lost almost
$ four billion (net), Japan has lost around $14 billion and Korea has lost
around $16 billion. I think, in Asia, they are net positive in Indonesia and
Taiwan to some extent. I don’t think India is particularly hit because
there is very little domestic participation and most of the drivers for the
market always follow net FII numbers and that’s a sad fact. I was looking
at the newspapers today and I saw so many bold numbers of stock prices and bold
numbers here indicated 52-week lows. I think if you buy at 52-week lows, you
would make money. Clearly, that is an opportunity.
Sanjay Sinha: I think their selling is prompted by the fact that the
global risk appetite has contracted and we will need to restore it for them to
come back. They have sold 2% of their holding which is not so significant in
percentage terms. I am not pessimistic that they will be away from the markets
for too long. So, once the risk appetite is restored, I think, we will shine
N Prasad: I think the twin deficits of fiscal and trade are a concern
for any international investor. These deficits were not looking as ugly a
couple of months ago as they are today. As these fears wane, which could be due
to a combination of declining oil prices, pass-through of the oil price rise
and of fertiliser prices, the rise in software exports, decline in non-oil
imports and as capacity creation in India passes the hump, we should see FIIs
Mihir Vora: India is one of the large emerging markets and what we have
seen in the past few months is a shift away from markets like India and China
which are net importers and large users of commodities, to markets like Brazil
and Russia which are commodity producers and tend to benefit from higher
prices. So, when India is down 30%, Brazil is up 7%. I think it’s a
process of investors reacting to changing fundamentals and when commodity
prices peak, we will see money coming back to these countries.
Madhusudan Kela: FIIs are investors who are attached to returns. They
are not here because they have a patriotic feeling for India or any other
country. I think they are very clearly looking for better returns and there are
countries which are benefiting out of rising crude or commodity prices. We have
seen countries like Brazil and Russia doing exceedingly well compared to India
and China in the past six to nine months. As soon as the macro environment
improve; obviously, there is no problem in the India story and FIIs should
logically come back. What is worrying them right now is the macro environment.
You must not forget that India was a very fashionable market and lot of FIIs
got into India in the past two years very aggressively. I would not even say
that they are not selling aggressively as of now because what they have trimmed
may be just 2%-3% of their total exposure.
Ajay Bagga: Given the global risk aversion, credit crisis and
inflationary expectations, it looks highly unlikely that foreign investors will
take fresh exposures in commodity-importing Asian markets in a hurry. FIIs are
not one block of homogenous investors; they range from endowments and pension
funds with really long-term investment horizons to ‘long-only’ funds to
leveraged momentum players who are very short-term in their investment horizon.
The trigger for resumed inflows will be a global recovery in corporate earnings
and stabilisation of India’s domestic macro economy.
4. FIIs said they were
long-term players and found the Indian growth story very attractive. What has
Saurabh Nanavati: Nothing has
changed for them. India will figure more and more in their portfolios and their
allocations in the next five years have to go up. However, the economic
scenario is forcing them to withdraw funds and there is nothing wrong in that.
They are far more long-term players than the normal retail investors. The
retail Indian investor churns more than the average FII. India is an essential
part of their portfolio but, in the current scenario, if I were in their shoes,
even I would book profits.
Tushar Pradhan: Nothing has changed for them. India has a market-cap of
around $ one trillion, of which 40% or roughly $400 billion is owned by FIIs.
For this, they have paid $65 billion. Of the market-cap of $400 billion, they
have sold $ four billion, which is just 1%. But since it is $ four billion at
the margin in a poor environment, it has caused a big change. But if you look
at what they still hold, it is hardly anything. In fact, they can’t get
Sanjay Sinha: It would not be correct to say that all the long-only
funds have become negative on the country. FIIs will be of all varieties. There
will be some who will be opportunistic in nature and they may be the first ones
to sell in the event of emerging markets’ outlook turning slightly
cautious. Secondly, the P-Note rules have been revised and they are to be made
effective in the next 18 months, so some of the unwinding would also happen
from those quarters. I feel that of the long-only investors, if 98% continue to
be committed to India, that story remains intact. Also, the number of FIIs
registered with SEBI has gone up to 1,400 from 1,100, so there is now far more
participation by a larger number of investors.
N Prasad: FIIs invested $36 billion from 2005 to 2007. In the current
year, they withdrew about $ four billion which is 11% of their investment, not
considering the appreciation. Howsoever long-term you are, I do not think there
is anything wrong if you withdraw a portion of the investment in order to
diversify, especially when you have made so much gain.
Mihir Vora: What is long term? On the extremely conservative side, we
have pension funds, endowment funds and sovereign funds which are hugely long
term in nature. Then you have mutual funds, global emerging market funds which
are like us, investing with a view of three-five years and then you have hedge
funds which have a very short timeframe, say, three months. It is not necessary
that all of them are selling.
Madhusudan Kela: You are a long-term player till the time you have a
huge conviction in fundamentals. But if your fundamental conviction itself gets
shaken, then you cannot blame them. Subsidies on fertiliser, food and oil have
also gone up five times. Obviously, things have deteriorated as far as macro
fundamentals are concerned.
Ajay Bagga: Even though a $ four billion outflow has occurred in the
calendar year 2008, this represents a small portion of the total historical
inflows and portfolio stock of FIIs in India. The trigger could have been
de-leveraging elsewhere; it could have been the need to offset losses in other
markets and redemptions by underlying investors. The positive is that only a
very small portion of the total FII holding in India has flown out so far in a
very bearish market. And the strong purchases by mutual funds and insurance
companies have given some support to the markets.
5. Are domestic mutual
funds confused? They are neither buying nor selling.
Saurabh Nanavati: , put yourself in
their shoes. If they find that the market is overvalued by 10%, they will hold
on and if everybody holds on and there is no buyer, the market falls further.
But I think at levels below 16,000 they are buyers. If you combine insurance
and mutual funds, they form a significant portion of the market.
Tushar Pradhan: Mutual funds don’t have any option; nor do we have
any discretion. Suppose we launch a new open-ended equity fund, we have to
invest in equity as per the offer document. We are given a window of only three
months after the NFO to invest, after which I have no choice. So if you are
saying that mutual funds are not doing anything that is because we are not
raising any money. The money that was raised is already invested.
Sanjay Sinha: In the whole of 2007, they bought equities worth Rs6,700
crore and in the current calendar year, they have already bought more than
Rs5,000 crore. Also, we have not had too many large NFOs, so this is obviously
money which is coming into the existing funds from investors. There is now a
structural change in the way the fund investors behave. In 2004 and 2006 we saw
mutual fund investors either leave the market or become paralysed, but in the
fall since January, we have seen them coming into equity funds which shows two
things. One, that they are taking advantage of the fall in the market to
increase their equity ownership; and, two, they are not coming for a short-term
gain in the market; otherwise, they would have invested directly.
N Prasad: In India, we have not reached a stage where investors
invariably invest in equities as a discipline of asset allocation. And, as you
know, long-term money – like pensions and provident funds – is still
out-of-bounds for equity mutual funds. In the absence of these two critical
supporting factors, Indian equity mutual funds have to ensure that there is
enough liquidity to repay sudden surges of withdrawal. The inaction, if we call
it that, in spite of net purchases of Rs1,500 crore this year, is due to this
Mihir Vora: We are not confused. We have been actively churning sectors
and stocks. Late last year, we started trimming exposure to infrastructure;
later, we added IT, FMCG and also commodities. We have done a lot of changes in
the past six-eight months. You don’t see mutual funds coming and buying
vigorously because they are waiting for volatility to reduce. Mutual funds are
sitting on cash, so I don’t think money is a problem. Even if inflows are
not huge, there is no outflow from funds. It is just a question of trying to
find the right stock at the right time.
Madhusudan Kela: We have a very clear cut call. We have nearly $ one
billion in cash, which has remained constant all through the decline. We are
watching the fundamentals. There is no screaming reason for me to go and deploy
all my cash today and that should not be seen as confusion. Till the time I see
decisive signs of improvement in macro factors, there is no need for me to jump
into the market just because I have cash. Anyway we are 80%-90% invested in the
majority of our funds, so if the markets go up, we are going to make money.
Ajay Bagga: Mutual funds have been net buyers of $1.5 billion this year.
However, funds have been independent in their thinking and have realised this
is a bottom-up stock-pickers’ market which will test and differentiate
the mature, long-term value-picker from the momentum players who had surfed in
the raging bull market of the past four years.
6. What is the direction
of the market over the short, medium and long term?
Saurabh Nanavati: I am negative on
the short term. I think there is going to be another 10% correction from here
in the next three-six months. (The market fell sharply after the interview. –
Editor) I am neutral on the medium term. You can look at a positive 10% from
here, say, over a period of 12-18 months and 15% compounded rise over
three-five years. When I say 15%, people don’t realise it is huge. It
means doubling your money every five years.
Tushar Pradhan: I think, there is no debate about the long term. The
demographics, the infrastructure spend and the consumption story will create
growth for the next 15 years. This means being in equities. That is the only
view I have. I don’t have any short-term view. The intermediate view,
which covers the next 12 to 18 months, is of volatility partly because the
international situation continues to look gloomy. As an investor, if I have the
money, I should be very excited about the intermediate term because I know what
the long term is. But if I have already invested and don’t know what I am
doing and I am worried about reduction in value, then I am lost. Being an
equity investor, I think that the next few months will give us great
opportunity to buy very good businesses at throwaway prices and that is how you
make money. As long as you understand the opportunity, as long as you say that
‘look today at a company in India which has a 15-year future and is trading at
a 52-week low’ you know what you have to do.
Sanjay Sinha: Short term would be choppy; and, when I say short term, I
mean the next three months. In the medium term, which would be the period
between three months to 12 months, we would see the market once again coming
back to its upward trajectory. Beyond 12 months, I would expect many of these
clouds to clear and, therefore, the long-term picture is definitely more
N Prasad: We are positive on the medium to long term.
Mihir Vora: In the next six months, I think, it will still remain
volatile. This is because of all the uncertainties that we discussed earlier.
But even during volatile times, there are stocks which have given you 10%–20%.
Take the example of pharma, FMCG and other sectors which have done well. Beyond
a point, I am not too obsessed with market levels. I would be more focused on
specific stocks and sectors. If you look at a three-year or a five-year view, I
don’t think there is any change in the India story. What is different
about now and the early 1990s is that, earlier, capital used to be a
constraint. Now, if you are willing to raise money at a reasonable price, there
is money available and that is where the major difference is today. Between
these two, I would rather not give any view.
Madhusudan Kela: If you can tell me where the crude price is going, then
I can answer this one. My short-term view is that the market would be
range-bound. To get out of this range, you need a lot of air to be cleared at
the macro level which does not look likely to happen soon. Then, we have
elections at the end of the year. Medium to long term, we are hoping that just
as a lot of commodities have corrected in the past one year, crude must also
correct. It is a much-publicised problem now so some solution has to be found.
Our market call is clearly linked to the macro-economics of India. If this
story holds true, which we would come to know in the next two or three months,
then obviously we are more inclined to invest. However, we are India-specific
investors and always in search of good bottom-up ideas and we would buy
wherever we find deep value. We are basically not waiting for crude to
collapse. I think even if India grows at, say, 7% to 8% in the next five years,
you will still find a lot of investors around the world being very excited
about India because there are not too many markets in the world where you can
find this kind of growth. The other part is, we are still a very small fraction
of the world demand-supply of money; so, at the margin, I have no doubt in my
mind that India is certainly one of the more promising developing markets.
Ajay Bagga: Short term – range bound, volatile with low volumes. Medium
term – some recovery in select stocks and sectors. Long term – extremely