‘We can provide as much opportunity as the entire world needs’

In an exclusive interview with Moneylife, Nilesh Shah, deputy managing director, ICICI Prudential AMC, gives his perspective on the current market rally and where the markets are headed. Moneylife presents the first in a three-part series of the interview.

ML: Are we witnessing the start of a new bull market?
Nilesh Shah:
I can't categorise this as a bull market but if you ask me if optimism returning to investors as well as companies and regulators and government or fund managers, the answer is yes. And to some extent it is reflected in the valuations. Unfortunately I don't follow price patterns as much, but we are today probably standing at a place where crossing the previous high can easily be achieved, provided certain actions are taken and some reactions are generated. The world has lots of money and less opportunities. We can provide as much opportunity as the entire world needs. Our savings and investments can generate 5%-6% growth. But that's not good enough for us or the market to sustain this momentum forever. But if we can augment our savings vis-a-vis the capital flows from foreigners and convert that into meaningful investments, then suddenly that 5-6% starts increasing to 8-9%. The moment you put this kind of growth in any equation, then everything turns bullish. It's akin to what Japan delivered between 1970s-1990s, when global capital flows along with Japan's absorption capacity turned it into a developed nation. A smaller pattern was witnessed in Southeast Asian nations when some countries moved further, some moved a little later but overall they moved further up. And the latest example is China. With capital absorption, they have just kept on growing and growing. We today have the same opportunity. The world has lots of money. Virtually the entire world banking system is a safe deposit locker. You put money and don't get anything back on the interest side. So if we can position ourselves and use this to enhance growth to 8-9%, clearly the market has much higher level to go.

ML: How different is the current rally from 2004-06 or 2006-08 periods?
In May, June 2006 when the markets corrected, the economy was not correcting. While inflation and interest rates were probably moving up, they were just brakes in an accelerating car. They were not speed breakers. We were trying to stabilise the speed of the car on a curve, which we did and eventually the market realised that this is not a speed breaker, it was just a brake in an accelerating car, the car is still moving and the markets recovered pretty well. Surprisingly, the speed of the recovery then was also quite nice. And most importantly the investor confidence, barring a few instances did not really shatter. At 11,000 or 12,000 when the correction occurred, by the time it started reaching 10,000 and 9,000 and eventually just a shade above 8,000, domestic money kept on flowing. So there was huge confidence that this is just a temporary phase and will recover. If we go back to 2003-04, it was an end of a prolonged bear phase. From 2000 to 2003, it was a horrible nightmare, people lost tons of money and lot of people made a lot of mistakes, at the issuer level, investor level, probably regulatory level. Somewhere in May2004 when the correction came after the recovery from 2003 lows, it was purely on the event of election results surprising the market. While May 2009 surprised positively, May 2004 was a negative surprise.

But a lot of weightage was being given to the announcements which were being made in the media and there was a fear about how the economy would shape up. But the reality was that the economy didn't lose its momentum with change in government; in fact, growth picked up. The foreign capital flows continued, so did the momentum and growth of economy. In fact we sustained it all the way up to 2008. So May 2004 as well as May 2006 were, in hindsight, an opportunity to invest. It provided an overextended market a temporary break, but it was a break on a curve and the overall momentum continued. I think what we witnessed in 2008 was substantially different. It was driven by the exodus of capital from foreigners who were withdrawing not because we were doing badly but because they had certain other considerations.

The collapse of global financial giants pushed us into an unknown territory. We hadn't experienced this earlier and the economy did suffer. We were always highlighting that India is a different country, not depending on exports and the reality was that in the whole of 2008 we were falling more than the other counterparts and the decoupling story was flying in our face. We couldn't understand why that was happening. But courtesy the efforts taken by the RBI and govt, slowly and steadily we recovered. Today when we see our markets trading at the second-half level of 2007, we are just one year behind. Most of the developed markets are 10 years behind. The decoupling theory which didn't work in 2008 has actually worked in 2009. We are late by a few months but we are not wrong completely.

ML: Is the current market overvalued or fairly valued given that the market may be discounting the growth of 2010 and beyond?
The market has probably run up too fast, because a lot of investors wanted to participate and couldn’t do so. Has it run fast vis-a-vis the valuations and fundamentals? The answer is no. We were trading at a cheap and attractive zone at just 10 times one year forward earnings in March. Even though interest rates were coming down it didn’t really benefit the stock market in terms of change in valuation. But once the confidence started returning from March, April, May onwards, the markets have come back to fair value levels. Probably it is a little bit at the higher end of the fair value, but again that’s a reflection of optimism. People are bit more bullish about the future and it is reflected in the markets. {break}

‘We can support our growth from our own capital’
In an exclusive interview with Moneylife, Nilesh Shah, deputy managing director, ICICI Prudential AMC, gives his perspective on the current market rally and where the markets are headed. Moneylife presents the second in a three-part series of the interview.

ML: What are the key factors you would watch out for signs of significant reversal?
At the end of the day if 8% growth happens, notwithstanding small corrections, we can be reasonably sure that markets will continue to move up. At 8% growth rate even interest rates need not move up. We can have a virtuous cycle which can support us or we could have a vicious cycle which could derail us. The optimism is basically driven from the fact that we are generating about 25% savings and putting similar amount in investments. With that savings and investments we are able to generate just around 5%-6% kind of growth. If we can increase our productivity, it could easily become 8%-9% growth. The productivity is not going to increase overnight. For that infrastructure needs to be developed, deficit needs to be cured. For that certain real reforms have to happen in the real economy. I think all of that will follow, but at a slow and steady pace. The second shortcut is that we get money from overseas investors and convert that into capital. My feeling is that the world can give us that capital. People are talking about China and India virtually in the same breath, but the allocation is far more tilted towards China. We can bridge that gap. With that capital coming in, we can accelerate growth, which will accelerate government revenue, narrow down deficit problem, reduce interest rate pressure and reasonable liquidity becomes available.
With that jobs and employment will be created, more consumption will happen, optimism will prevail, corporate earnings will go up. The entire virtuous cycle will prevail for us, in which scenario equity markets will continue to move up. The vicious cycle could come is essentially because of two things. One, the real reforms don’t happen in the economy and hence the absorption capacity does not increase. Capital flows go towards asset price inflation, building up of bubbles, rather then building up of real assets. If that happens then we are back to the old story where eventually the bubble burst. So there have to be some real reforms in terms of improving the absorption capacity. We are seeing some improvements happening but it is not sufficient. We can do better. Like the ultra mega power projects announced some time back. None of these are moving at the speed they should. Same is the case with coal allocations. Bank credit growth has definitely slowed down in response to falling raw material prices, oil companies are not borrowing as much as before. But this slack of bank credit should have been absorbed either by the planned capex or infrastructure development. The slowdown in bank credit probably signifies that the real economy’s absorption capacity is not as high, so that we can be sure of that 8% growth on a sustained basis.

ML: Is there too much of complacency not only about global growth but also about the domestic growth situation?
I think what we are seeing is the difference in the return expectation of investors. The Japanese investors investing in India will probably be happy with 5%-10% return because he is comparing with a 0.1% return on his deposits. An Indian investor on the other hand is looking for 30-40% return because he is comparing with previous experience. So we are seeing participation from different sets of investors with different return expectations, time horizons and hence the shrugging off of certain short term economic issues.

ML: Domestic investors have poured more funds into the markets. Have we finally shrugged off our huge dependence on FIIs? If so, what are the long-term implications?
I think while we suffer from the limitation of long term investment on the equity side by pension funds and retirement funds, we are seeing the emergence of insurance companies and mutual funds as a major force. They are acting as a stabilising factor for the Indian equity market. Very recently Goldman Sachs came up with a research report that said that India can actually fund the entire $7 trillion worth of infrastructure investment from its own savings. We don’t need foreign capital. This is based on certain assumptions and projections, but it shows the enormous power of Indian savings. For us savings comes naturally. We still don’t have the American lifestyle of living on credit cards. We live within our means. So we have this ability to support our own growth from our own capital.

ML: At what stage would inflation and higher interest rates be worrying factors given the higher high liquidity in the system, rising prices and huge government borrowing?
Somewhere between 1997-2003, our fiscal deficit remained at an elevated level, which is why stock markets fluctuated. It went up because of certain reasons other than fundamentals. Overall it didn’t go anywhere. From 2002, fiscal deficit started contracting. Fiscal responsibility and budget management reduced the deficit from around 7% levels to 3%. This created the brand value of India. Our equity markets expanded almost 7 times in those four-five years. Then in 2008-09 again we saw an exceptional response from the government. It resulted in higher deficit and the market valuation corrected. Now there is hope, that though deficits are high, they are cyclical in nature, they will come down.{break}

‘Infrastructure remains a bottleneck for growth’
In an exclusive interview with Moneylife, Nilesh Shah, deputy managing director, ICICI Prudential AMC, gives his perspective on the current market rally and where the markets are headed. Moneylife presents the final part in a three-part series of the interview.

ML: What are your expectations regarding corporate performance and which sectors do you see outperforming?
I think the sectors which could create outperformance for Indian equity markets are the sectors related to infrastructure. We are lacking in infrastructure and it is acting as a bottleneck for growth. Infrastructure sectors will have to receive priority if growth is to sustain. During the Green Revolution certain areas were given priority such as hybrid seeds, irrigation and fertilisers. Suddenly the farm productivity went up. The same kind of approach would be required towards infrastructure sector. So, probably roads, towers, power transmission and such kind of things which actually create the building blocks for connectivity for sustaining growth, will receive special treatment. They will probably outperform. The second growth sector is consumption. At the end of the day we are a domestic consumption story also and while savings and investments will continue to give a fillip to the infrastructure side, the rest of the amount is going to be spent and hence the consumption sector will do well. The problem is there will sometimes be down trading. So company X which is at the higher end may not benefit but company Y which is at the mid-end could do very well.

On the other hand you could have newer trends emerging on the consumption side as people move up on the income curve. So per se, in consumption sector, you will have to identify the trend and identify the companies. Consumption as a sector will do well but you really have to focus on the companies also. The other sectors are difficult to evaluate. Earlier, life was very easy when you invested in a steel company; all you wanted to know was selling price. You could then have actually create an Excel sheet showing 10% or 20% growth rate for a steel or aluminium company without any worry and genuinely believe in it. Now, a mine getting closed in Zambia or an earthquake occurring in Sumatra has an impact on all these things. So, with so many variables, it is difficult to remain bullish on the commodities sector. Technology as a sector has run up significantly well and they are witnessing two contrasting trends. One, in their top-line they are seeing some revival, global growth is happening, financial institutions have started placing the orders and they are seeing some large orders. On the other hand, the cost cutting measures, which they had adopted are almost coming to an end. They have to actually increase salaries. I think their employee turnover will also increase as more and more people start chasing the talent. Third, the rental cost and lease costs will also start increasing. So we will see a good differentiator where top-line is improving but at the same time the margins are getting impacted because of the domestic factors. Since valuation appears rich and the currency has appreciated a little bit, probably in the short term there could be some impact on the technology sector. But overall one can remain bullish. However, a lot of technology companies are fairly large in size and hence the growth will not be as good as it was in the past. So we will have to price the growth correctly.

ML: With the markets back in full swing, IPOs are back in vogue. A big burst of IPOs is usually is a contrarian indicator. What is your sense?
Definitely, the supply of paper is necessary to balance the appetite of investors and ensuring that the liquidity does not end up creating a bubble. As long as markets are functioning efficiently, I think investors are smart enough to price the issues properly. There will be one or two issues which will fail because of over-pricing. The promoter’s need and investor’s greed will be balanced out. We haven’t yet seen a mad rush of IPOs. We could argue with the valuations for some of these companies but the fundamentals are beyond doubt. We have seen how some IPOs had to be extended even though they were reasonably priced. It just didn’t generate investor interest. So I think that IPOs should come in good quantum, of good companies and let the pricing be market determined. One or two issues may be priced aggressively. Somewhere Maruti’s IPO generated the trigger for the bull market to hit India. My feeling is that if we can see similar type of IPOs from PSUs or the private sector, it will enhance this rally, rather than curtail it.

ML: What is the direction of the market over the short-term, medium-term and
Long-term, I am extremely bullish. I think the virtuous cycle will prevail. We will probably move in true Indian style of two steps forward and one step backward. Over the medium-term also we are reasonably bullish. We have political stability, desire for growth, entrepreneurs, resources, consumers and now capital is available. We need catalysts in the form of reforms so that this entire process can be speeded up. The short-term is difficult to predict. The markets are no longer cheap or attractive; they are fairly priced. A small correction here or there is always possible. We will have to keep one eye on the liquidity factor as it can change colour very fast, but I would advise investors not to get deterred by the short-term volatility and keep an eye on the medium-long term. 



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