Krishna Kumar of Eastspring Investments, who manages USD 4-5 billion across funds and products for the Indian market says: "The Budget has failed to address several structural problems with higher government borrowing and cuts in spending being key negatives for the market."
The finance minister has taken small steps in the right direction which the market has already started to price-in, Kumar told CNBC-TV18. "There is room for further reforms in next few quarters while the severity of the slowdown has been underestimated."
Below is the edited transcript of the show on CNBC-TV18
Q: Why are Indian markets suddenly so bumpy and what is troubling investors?
A: It is a combination of multiple factors. Globally, economies worldwide are at cross roads with currencies are flying all over the place. India has its own set of troubles which don’t seem to be resolved quickly or easily. There were expectations of a fair bit of runway from the existing scenario in the last six months on continued policy reforms.
However, that momentum will start building from now. The investor is a bit spooked post Budget which should have addressed more issues than it has. Though it is a slow start, I hope the situation will recover soon.
Q: Has the Budget disappointed investors?
A: Expectations were a bit high but we normally don’t expect too much from the Budget. For us it is more of a government income and expenditure statement, but it contained a few elements that have spooked the market. One is the higher borrowings that the government is looking for and the cutback in expenses. Cut in expenses directly relates to capex and that has spooked the markets. Increased borrowing of 4-5 percent means that bond yields don’t come off.
Though the finance minister has already demonstrated capability for fiscal prudence, the expectations regarding monetary easing and roadmap for further reforms was ignored in the Budget.
Q: Is the policy tailwind more or less priced in or will it continue to drive further rerating of the Indian market?
A: The reforms are irreversible and should have been done a long time ago. However any step in the right direction is always appreciated. I think the initiatives are being priced in. But I am not so sure if investors expect a follow through.
Q: Will any of this tailwind fade as the elections near?
A: The run-up to the election has already started and it is a surprise that the finance minister has managed to achieve this much. Chidambaram has a few quarters more to announce further reforms if the polls are not pre-poned.
Q: All of this has ramifications for the Indian currency as well. For a bit it looked like it was appreciating and it has come back to 55 again. It has taken away so much from foreign investors over the last couple of years. Do you worry that it may still be a headwind for investors like you?
A: We have been worried about currency. Currency has taken away and spooked a lot of our investors because we run a fair bit of overseas money and whatever returns that we got were taken away by the currency. Even now the way Current Account Deficit (CAD) is sitting, it is pretty precarious to say the least that it looks very vulnerable. The currency can go for a spin.
But the way the Budget has been presented is more in line with the thought that the government is worried. They are concerned about the CAD and keeping the fiscal prudence in players. If the considerations are currency, you will see that the currency does not slip away too much. 2008 was the time when I think the same Finance Minister presented the Budget and gave a farm waiver of Rs 72,000 crore.
That saw everything go out of the window and that is what we are suffering even today, if you want to think back and blame something for. At this point in time, if you see the run rate, we are clearly running at about 5 percent CAD. If you put gold under check and if you have a few more checks and balances, if subsidies get reversed the way they are, I guess currency could be more stable from hereon.
But, you must look at it from a point of view that there is competitive currency devaluation which is happening globally. But, here if there is a compulsory devaluation happening, then you have a different situation altogether.
Q: The other thing that people have started fretting about of late is the way growth is coming off. Last year the hope was that growth has bottomed out. It is just a matter of time before it starts jumping again and we got a 4.5 percent GDP reading just a few days back. Do you think people have underestimated the severity of this slowdown?
A: Possibly yes. The severity is not on the backdrop of something which has happened all of a sudden. Blaming it on global issues and global turbulence is one part of the story. It is our own doing I think. If you see numbers, they are staggering numbers. We have got about USD 180 billion of projects which have been stalled and it is almost about 7 percent of the total projects which are under progress.
If you do not put capex on the ground, if you do not have investments which are going to give you GDP in course of time, it is going to be very difficult. We are in a bit of a trap at this point in time. It is rather going to be a gradual but sure recovery. But, is it going to be a quick shot, fast rebound back to the high numbers we have seen in the past? I have my doubts, which is saying that we will possibly get back to 6-6.5 percent, but 4.5 percent was the worst in my view.
Q: Could it be a protracted troughing out period and not just a one-two quarter trough that people were expecting or might have been expecting and pricing in earlier?
A: This is not a V. The way it looks like, we have probably hit the bottom. Will it be a V-shape recovery getting us back to the numbers that we have seen between 2005 and 2007 where we saw protracted period of about 8 percent growth which was 12 quarters in succession? It is pretty unlikely. So is it going to be protracted, long-drawn, may not be as protracted, long-drawn? I think it is going to be a few quarters away before we see a recovery which is going to be back to 7-7.5 percent.
Q: Flipside to this is that a lot of people who are not as optimistic say that we may have bottomed out. But we will bob around 5 and 6 percent for longer than people think because the investment cycle is not picking up in a hurry. Do you think there is any grain of truth in that argument?
A: The investment cycle is what we expect to improve on the back of a couple of things. We expect that the government has taken the path of reforms very seriously. If project clearances are to come through, the reality is that on the basis of a couple of meetings that we had with senior officials in the government, they seemed to be taking the Cabinet Committee on Investments (CCI) pretty seriously and they want to put that one window clearance actively and not as a dummy window which is available once in a while.
If that window becomes effective and projects start getting cleared, I guess you might be surprised on the upside if things start happening now. The pipeline is really getting choked and there is so much waiting to get cleared up.
Q: Do you think the next election would be a crucial one in determining which kind of momentum the investment cycle assumes? Do you think it is partly contingent on the result?
A: Elections and politics are catalysts. Indian corporate sector has done things not because of politics, it is inspite of them. Indian corporate sector is very efficient. It is the policy bottlenecks that do not let them loose, but they have used capital very efficiently and they know how to get things done.
Most of the guys who were there in the system have got things done and possibly moved on in life and investments are happening. Election does not matter. It is going to be either A coalition or B coalition. We know that we are destined to have coalitions as we go along in the next few years and the way we look at it is, it just cannot get worse. The point is it can only get better and it is rather futile to be pessimistic now.
Q: During difficult patches in the economy it is blue-chip large caps which tend to do better and we have seen that in the earnings season. Mid-caps have performed far more poorly. Tactically, has it made you take a narrow stance on quality or have you focused on quality this time around?
A: We have a very strong bottom-up approach towards buying stocks and we are very conscious about the price that we pay to buy any business and we stay focused to that effect. If quality has become expensive and the jaw is widening as we talk within the last six months, we get more worried about the way things are. If they are expensive they are expensive for a reason and at the end of the day, you don't say that we will hold it inspite of whatever the environment is.
So we start looking for value elsewhere and quality has been expensive and tends to be as expensive as it is now.
Q: But do you worry looking at the kind of destruction which has happened over the last three weeks in mid-caps and the broader market, has your confidence in going down the value ladder eroded somewhat?
A: We don't worry too much. We love to play this Greed and Fear game. We have very strong long-term investment strategies. So we are a little averse to buying very expensive high quality stocks. However, there are several mid-caps which are good quality names, which get thrashed in this environment where risk aversion is so high that they get beaten down to really attractive valuations and it drives our process that effectively we will get down and buy those mid-caps. It doesn't matter whether they are mid-caps or large-caps. At the end of the day, if it is actionable, if it is cheap, it will be bought.
Q: Can you think of even two or three names that you may have accumulated in your disclosed portfolio making use of such aberrations or big falls in the market?
A: I can give you something which was prior to this reforms process, which commenced in the middle of last year and seemed to be a runway. We own a business called Mahindra and Mahindra Financial Services which is not known to be a large-cap, but it is supposed to be a good mid-cap.
The reason why we think it is a good mid-cap is because of the franchise that they have. The franchise is built around tier 3, 4 and 5 cities. It was a completely neglected piece which was lying around because people thought it was one more financial service and it is not going to be a well known business and it is fraught with risk. It has gone through a cycle of boom-bust because you make mistakes and learn from it over time. It was available for a good price and we own it and we continue to own it.
We are very happy investors there and we see that if this cycle beats it down because mid-cap is an aversion or if the gap between mid-cap and large-cap widens further, it will only increase our conviction levels to buy or look for more mid-caps in the space.
Q: A banking licence would be a bonus?
A: Banking licence doesn’t matter. Banking licence is also equally fraught with risk if you think about it. Banking licence means cash reserve ratio (CRR), Statutory Liquidity Ratio (SLR) and priority sector lending is also in a sweet spot. They have got priority sector lending and they are in a position to give out their portfolio to banks. They are in a very happy place and banking licence doesn't actually make a difference.
Q: I see stocks like ITC, HDFC Bank in your portfolio, they are high quality companies but, they are also not very inexpensive. You are happy paying those kind of valuations just to make it a good quality portfolio?
A: 52 quarters of 30 percent compound annual growth rate (CAGR) is expensive for a reason and if you are able to put the next 20 quarters for example, don’t think that I am giving you a number, and said that this company is going to grow at 30 percent CAGR for the next 20 quarters the book value, which you would have derived would have been about four.
So, the ability to value a business and the ability to see the runway that the company has is what makes us buy those businesses. The same thing would be valid for ITC as well. It is not about value growth, it is about volume growth, it is about business that they are getting into, it is a de-risking process and how they kind of manage the process and the ability to stay competitive over the industry.
Q: Have you taken large bets on the investment cycle, anything linked to infrastructure or is it a space that you generally tend to be leery of right now?
A: It is completely polarized. It is like there is one big boy on the left hand side and there are ten small boys on the right hand side. The ten small boys are possibly boys playing around the fringe and dribbling around the corners who are trying to grow the balance, which is not likely to grow very big and the big boy is expensive.
So, you kind of divide as to which one is going to be more representative and we are very fussy about valuations. We think about it and say that do you want to buy any business which is discounting the moon and say that we are buying too much into the future. We wait and we are very patient and we can be surprisingly or irritatingly patient.
Q: Let me ask you about liquidity because we have been hearing various kinds of feedback from large asset managers, some people who have run India focused funds are not getting too much money apparently, but emerging market funds have got money, ETFs have seen some money, what has been your experience?
A: It has been a bit volatile. A set of investors have been a little concerned, a set of investors have lost money because of currency. We have made money but effectively net-net what they see is what is not the reality. In the process, we have been a little volatile, we have not got a lot of money but, we have not lost a lot of money. We are standing almost like status quo.
The better part of the story is that we are getting a lot of enquiries, either through regional funds or gem funds. The enquiry has been building up in the last six months, more than it has been in the last couple of years on the back of the fact that the market has done well and the tendency to come when the market has done well is little higher than otherwise.
Q: Do you think these enquiries are coming in from quarters which will now be tempted to use a correction to deploy or do you think it was a factor of how well India did in 2012? It was momentum chasing money?
A: There is a fair bit of passive money which is already finding its way. The passive money is kind of a little dumb.
Actively what we look for is avenues to get into the market and we are also looking for active management. Passive comes in because that money is surrogate hedge as people give the money to hedge funds and they got the money back and did not get all of it. So they said that I do not want to put the entire stuff into active managers.
So to answer your question, I think it is not hot, it is stable, it is strong and it is pretty long. Given that India is in a sweet spot, think about it this way, what are your other options in the emerging market space? There are not too many guys who are willing to take the money that you will be able to allocate anywhere else. We are the tallest dwarf in the system and India will probably get more and more money.
Q: It has been five years of fairly up and down kind of movements, we have not seen a clean trend. There has been one good year, one bad year, a couple of bad years and economically looking at the macro, how long is it before we get a clean trend once again in the market, four-five years of good earnings, good market appreciation?
A: Hopefully, soon. The way one should look at it, India is not a macro story. India has been often mistaken to be a top-down story and you will never get India right. India is a bottom-up play. There are very strong companies, very strong quality franchises, very strong cash flow businesses which are available in the country. All pieces falling in place and you getting a runway which is going to be clear is not going to be very easy.
But, the point is if you have seen that you are the best man in the system, it is not the centre which drives any more growth, it is the states which have started driving growth. It is more like micro, it is like saying, it is Gujarat, it is Chhattisgarh, it is Madhya Pradesh (MP), Bihar, which are doing north of 10 percent GDP. So it is the constituents which are doing much better than the industry.
Effectively, bottom-up value buyers like ours will possibly keep getting winners and we will not be so worried about macro top down and say that here is a time to make money and here is a clean run. But, I know where you are coming from and that will we get a 2004-2008 kind of a rally. I think that will come when growth is not inflationary.