Sep 18, 2013 08:37 AM IST | Source: CNBC-TV18

5-6% GDP may be new normal for India: Amansa Capital

If there is a broad based redemptions happening across emerging markets (EMs) then foreign institutional investors (FIIs) don't have a choice because they cannot sell everything else and not sell India, says Akash Prakash of Amansa Capital.

Akash Prakash of Amansa Capital is of the opinion that there is a growing minority that believes 5-6 percent gross domestic product (GDP) is the new normal for India. So, unless there are significant reforms in terms of judicial reforms and the way bureaucracy functions, we may not get back to 7-8 percent growth. However, he does not believe that India's long-term story is permanently vitiated.

The finance minister will have to deliver 4.8 percent fiscal deficit number because otherwise there is a greater risk of a ratings downgrade. For that the FM will have to savagely cut planned expenditure and if he does so then there will be no catalyst for growth.

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If there is a broad based redemptions happening across emerging markets (EMs) then foreign institutional investors (FIIs) in India don't have a choice because they cannot sell everything else and not sell India. So, the  broad-based long-only fund selling is driven by EM redemptions and not driven by them deciding to underweight India or cut India, adds Prakash.

Below is the verbatim transcript of his interview on CNBC-TV18

Q: How is it looking? Just the darkest hour or do you think it could get even darker the way the news flow has been these last few weeks?

A: Hopefully we are somewhere near the darkest hour in the sense that it is difficult to conceive anything else further getting worse from here. In the sense that the rupee move has already happened, gross domestic product (GDP) growth already has been cut by most people, who estimate the GDP growth for the coming year around 4-4.5 percent.

The only thing I would say is that the markets have held up reasonably well. The large cap liquid stocks have actually performed okay despite all the headwinds. Midcap index is pretty much beaten down and probably is as bad as it gets, but for the large cap index you could argue that there is still downside.

Q: That downside might play out if global funds begin to sell. They have sold a bit but not lots. In your interaction with people do you sense that their patience might be wearing thin now?

A: The final capitulation if it were to come would be these large long-term, long-only money holders in India were to finally sell-out either because of redemptions or for other reasons, that shoe hasn’t dropped yet. More than the fund managers themselves I think the issue is people behind the funds – the investors or the limited partners, what is their level of patience and willingness to stick it out in India and there – there is a clear sense of fatigue setting in that people are just tired. The last five years most investors in India have not made anything in dollars. There is a constant question being asked that if you have made nothing in the last five years in a time when liquidity was very strong and flows into emerging markets (EMs) were very strong etc, how much longer are we expected to wait to make returns here. So, I think there is fatigue setting in. Combine that with the general sense of disillusion with emerging markets as an asset class more broadly. So, there is a possibility that some people just throw in the towel and say let me move my money back into the United States (US) or wherever that risk does exists.

Q: Has the basic confidence in the long term story also been dented because people have taken knocks in India in the past, they have gone through up's and down's but this time when we speak to people they seem to be almost suggesting that something is going wrong with the long term scrip out here which is not just a tactical correction of 20-30 percent in the market which happens quite routinely?

A: You hit the nail on the head. If there is the capitulation of the long term investors getting out it is exactly that – saying that I can no longer underwrite India growing at 7-8 percent for the next 5-10 years. Till very recently there was still a sense that this is a short term problem, its high oil prices or inflation or lack of reforms etc. I think there are people now who are more broadly questioning what you are saying, saying that may be this 7-8 percent growth for five years between 2003 and 2008 was actually the flash in the pan and that we don’t have a governance structure or infrastructure in place to grow at that level.

The very strong liquidity flows in that period of 2003 to 2008 disguised or papered over lot of our structural weaknesses. So, the jury is still out. I am not sure that it is right to be so bearish to say that the long term view on India itself is gone; I think that is still too strong a statement. I am not as bearish to say that the long term story is permanently vitiated.

However, there is growing number of people in the US who are taking the view that the new normal for India so to speak is 5-6 percent GDP. Unless there is very significant reform or a more grass root level type of reform in terms of police reform, judicial reform, the way the bureaucracy functions – very basic stuff, unless that type of basic blocking and tackling is done you are not going to get back to 7-8 percent growth and are going to be stuck at 5-6 percent. It is still a minority who thinks that but it is growing – the minority is growing.

The longer we keep cutting earnings and GDP estimates, the minority will keep growing who believe that this is a permanent or a structural problem not a cyclical problem.

Q: That is one part of the scary script - the growth problems that you spoke about. Tied to that is the basic structural balance of the economy which is the way the deficit is moving, the way commodity prices are beginning to creep up again and the fact that the fear of that downgrade which we sort of swept under the carpet for a few months is beginning to come back. Do you think on that side too, investors are right in being a bit more worried now?

A: Firstly, the rupee weakness -the 15-18 percent move has serious fiscal consequences in terms of the subsidy bill, oil and fertilizer specifically. Secondly, the government was building in near 6-6.5 percent GDP growth this year when they made their Budget arithmetic back in February. Obviously that is not going to happen. So, there is going to be significant consequences in terms of negative consequences on tax revenue and you are not going to get the 18-19 percent tax revenue or whatever number they budgeted in the Budget.

There is serious expense overshoot on the subsidy side and looks like a significant revenue undershoot on tax as well as they are not going to get the money they budgeted for the spectrum and the disinvestment.

Having said that, the finance minister is very clear that the 4.8 percent fiscal deficit is a line in the sand and he will have to deliver that because you run much greater risk of a ratings downgrade if he cannot deliver the 4.8 percent on the fiscal deficit. So, he will be deliver 4.8 percent which means he will have to savagely cut planned expenditure again, which is what he did last year to make the budget arithmetic work.

If you savagely cut planned expenditure, I don’t see where you will get the catalyst for growth because one of the assumptions people were making was the government would come in, the public sector companies would make serious investments in kick starting the capital spending cycle. The government will spend money, that doesn’t look like it is going to happen. I think you are stuck with the current constructive of growth, which is reasonable consumption growth which is still slowing but still reasonably okay and almost non-existent fixed capital spending in investment because the private sector doesn’t have the capital or the confidence to make investments and the public sector or the government won't have the money if they need to cut the fiscal deficit back to 4.8 percent in the construct we have just talked about.

So, the imbalanced growth or the skewness of growth in India is entirely consumption driven and very little on the investment side. Unfortunately, I don’t see that changing for some time. You need to get that to change if you want to get a significant recovery in the economy. I don’t see where that thing will come from in the short term because the private sector doesn’t have the confidence or the balance sheet to make the investments required.


Q: Just to get back to this foreign institutional investors (FII) problem that you spoke about, do you think FIIs realize that it is not easy to sell even USD 5-6 billion of stock in this market without hurting their Net asset value (NAV) disproportionately, in a shallow market like ours - could that also be staying their hand or do you think at some point disgust might creep in and they will sell regardless of what damage they are doing to their existing portfolios?

A: For anyone who is trying to sell significant stock in India, if you are not in the top 10-15 stocks then obviously the price damage is quite significant in any attempt to sell anything below that top 20 stocks. If it is a redemption that they are getting and it looks like some of the large players in emerging markets are getting some redemptions out of emerging markets, as there is a general reassessment by lot of investors whether they want to be in EM equities at all or to this extent.

If there is a broad based redemption across EMs, then frankly they don’t have a choice because you can't sell everything else and not sell India because India is not the only market where these liquidity problems remain, even South East Asia, ASEAN, you try selling billion dollars of stock in Indonesia or Thailand or Malaysia it is even worse than India or as bad. So, firstly India is not the only place where significant selling or even small selling can cause significant price damage.

Secondly, you can't skew your asset allocation or country allocation because you are trying to protect one country vis-à-vis the other. So, if it is with a broad based redemption I don’t think they have a choice.

If it is a tactical move in the sense they are going underweight India or reducing their overweight in India and moving the money somewhere else, then they may have more time, they may be little more tactical about it. They may try to sell only when the markets are up and stuff like that but the flows out of India right now are more in my view are happening more because of broad-based redemptions not so much out of the long-only cutting allocations.

There are two categories of selling going on, one is the redemptions by large investors, second are hedge funds or other people shorting the market. So, people who are shorting the market want the market to go down, so that is a different kettle of fish altogether. But the broad-based long-only fund selling is driven by EM redemption it is not driven by them deciding to underweight India or cut India.

Q: How is the relative India story looking when you compare it with other markets like China, Brazil, Russia? A few months back while EMs did not look great atleast people were saying that India is not looking as bad as some of the other peer markets. Has that also begun to turnaround?

A: A little bit because there is a sense developing that China is not as bad – China is still split camp, there are lot of people who are very bearish on China however if you look at the last data – the last couple of months the data on China actually seems to be stabilising. Also the new regime in China seems to be fully in control, so, there is a sense developing among some investors that China will not be as bad as people initially anticipated. One of my friends in Singapore keeps telling me that everyone was playing for a China hard landing but the hard landing has happened in India unfortunately and not China. So, China is still growing at 7-7.5 percent and it looks like it will be able to stabilize and maintain that type of growth rate and they have enough degree of flexibility at the fiscal side and they can do things to buffet any slowdown.

The last couple of months the delta has been that China people are little less negative and people are more negative on India. So, three months ago people were saying that India is not great but China is worse and because China is so bad Brazil is also bad. Brazil has its own issues and Russia etc and Turkey. Brazil people are still worried about other issues, but delta is that people are more positive on China. The so-called hyper bear case on China seems to have reduced probability by most people now. It is no longer seen as a very high probability event.


Q: That is an interesting point because it could have ramifications for the commodity universe as well and in the last few days crude at USD 115 per barrel not because of China but could that add to our problems, the fact that commodity prices improve and inflation which is not the top of our worry list right now also comes back into play?

A: Yes. I wrote about that in one of my articles. I think that is the ultimate nightmare scenario for Indian policy makers that you have the rupee where it is, you have oil unfortunately where it is because of geopolitical reasons and you have China trying to recover in which the whole commodity complex as you point out – from steel, copper everything starts going up again and then India has a real problem because then you will have a real inflation bogy which takes away any scope for the Reserve Bank of India (RBI) then to significantly cut interest rates. That is the problem that you could have – the government if they want to maintain 4.8 percent on the fiscal doesn't have much capacity to spend on planned expenditure atleast. So, they can't really kick start the economy.

If this nightmare scenario of commodity prices going up were to play out then the RBI won't have much space to cut interest rates to kick start the economy. Then you start scratching your head wondering what will kick start the economy because it is not going to be the private sector. The private sector pre-election I don’t think is going to do anything, it is not going to move at all in terms of starting new projects because they don’t have the balance sheet, they don’t have the confidence and everybody wants to wait for the new elections to see what the contours of the new government will come. So, I don’t see how the economy will really kick start because if the government can't spend and the RBI can't cut interest rates very aggressively and the private sector can't or doesn’t want to invest and spend then the only sliver left is consumption which is already reasonably robust or has been for some time, it is unlikely to accelerate from here. So, that is the problem, you kind of wonder how you solve this equation.

Q: How do you position your portfolio now? In such a difficult scenario where people don’t like banks because of the obvious issues, people will not buy industrials before they see some turnaround in the investment cycle and consumption is slowing down. Do you think that crowded trade of just flock to IT or anything linked to export will just keep getting more crowded?

A: To certain extent yes. It depends on your horizon. If you are looking at a 6-9 month more tactical horizon then that crowded trade will probably get more crowded in the sense of IT and pharma. Consumers we have said for a long time we think the valuations are too expensive. So, may be that sector will also may not come down but will do okay. However IT, pharma, exports that trade will continue doing well because it is unlikely rupee will strengthen dramatically from here. I hope it stabilizes and it will but I don’t think it would strengthen dramatically.

So, the only part of the market which would probably have a significantly positive earning surprise will be the exporters basket because the reality is most analysts are not yet putting in 60 or 65 because today an exporter can hedge at 70-71 if they use the forward markets. So, to assume they can lock-in 65 for the next financial year I don’t think is an outlandish assumption at the moment.

No one seems to have built-in those type of dollar-rupee assumptions into their models for the exporters. So, you could have positive earnings surprises there. On a short term tactical basis that exporter basket would continue doing well. Longer term if you take a 2-3 year view and if you take a view that this is not a permanent downturn, this is not a secular reversal of India's growth fortunes, it is more cyclical then areas of the market where there are clear divergence is – one is large cap and midcap.

Midcaps have just got decimate in the last 12-18 months and there is lot of opportunity there especially compared to the top 20 or 25 stocks where valuations are still quite expensive. So, that is one divergence you should play. Probably move more into midcaps stocks compared to large cap stocks. Second is that this whole defensive versus cyclical trade has gone to almost an all time extreme as well. So, if you take a short term tactical view that it is not going to reverse, if you take a 2-3 years view the opportunity will be in more cyclically oriented names but you have to be careful there in terms of are you betting on companies which have decent balance sheets, will survive another 12-18 months potential of slow economic growth, have decent entrepreneurs, decent businesses. There are decent companies in the cyclical space as well.

So, if you take a 2-3 year view you got to play medium sized companies, more cyclically oriented. If you take a 6-9 month view then probably the exporters basked is where you have to remain even though that trade is overcrowded already but there is limited visibility of that trade reversing atleast pre-election.

Q: Let me come around to the billion dollar question which nobody has an answer to but everybody is talking about. The fact that over the next couple of years may be global liquidity is tightening, emerging markets have been an underperforming asset class and therefore there is disenchantment. So, if we don’t get as much liquidity as we have got used to even in the last two or three years is it possible that India gets stuck around this 5 percent kind of a growth for another couple of years in which case it becomes a 8 year down cycle which will be so painful to handle for investors or anybody doing business in India?

A: This government or whichever government comes in power post elections unless they undertake genuine structural reforms to address the supply side issues we have in terms of investing in physical infrastructure, investing in human capital, improving India the destination to do business, reviving business confidence more broadly, unless we take those steps which are required to do that we are going to be stuck at 5-6 percent GDP growth. So, days of wishing this away as we have to do nothing and if we just sit on our hands and do nothing, this is just a cyclical downturn, it will automatically reverse on its own and we will get back to 7-8 percent growth without doing anything, I think that is not a realistic assessment of the situation. You will have to undertake genuine branch and root reform and improve the way we as a country function in terms of our economic governance.

If that doesn’t happen I don’t think we are going to get back to 7-8 percent growth.

Q: Where does this leave the Nifty? What is your bull case and bear case scenario say between now and the next elections?

A: Between now and the next election, lets make the assumption that the market doesn’t come to a clear verdict pre-election because the market may start discounting a particular election outcome as the polls start coming in, as one coalition breaks out over the other. I am saying under the assumption that the market doesn’t have a clear view as who will form the next government, if you make that assumption at the moment which may be till two months before the election or till the election itself depending on how the polls are – if you make an assumption the market doesn't come to a clear view on the next government I don’t think there is significant upside beyond 5700-5800, may be 5900 on the Nifty. I think you are stuck in a trading zone.

The market recognizes that you have to have genuine changes in the way we do things, if that doesn’t happen then there is limited upside and they would want to see who the next government is before they make a judgement on who that is. So, I don’t think there is any dramatic upside till the market is very clear who will be the next government and what they will do. Downside may be 5000 on the Nifty – difficult to say because you could have events around the US Fed tapering, Europe stuff like that, it could go to 5000 on the Nifty, it is possible depending on global events but I think you are in a broad holding pattern. I don’t see the upside because there are going to be negative earnings revisions and I don’t see interest rates coming down dramatically in India in short term atleast.

So, I don’t see what would drive the market up, I don’t see positive GDP revisions. Downside you could argue at 5000 the market will get quite cheap – the broad market will be quite cheap at that level and stuff like that. I don’t have a precise answer. I think you are stuck in a range or a zone until the market makes up its mind as to what the next government will be and what they will do.

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