With Prime Minister Manmohan Singh taking up the Finance Ministry portfolio, market expectations are rife about key economic policy changes taking places in the near-term. Business confidence in the country has taken a thumping for a host of reasons – threat of a downgrade from ratings agencies, policy paralysis within the central government.
If India doesn't curb current spending and if weak GDP growth causes revenue shortfalls further, it could lower both domestic and foreign investment levels even more.
In an interview to CNBC-TV18, Peter Elston, head of Asia Pacific strategy & asset allocation, Aberdeen Asset Management Asia Ltd says that while there remain good reasons to remain bullish on India, in the short-term, the economy will struggle until its issues are urgently addressed.
He confirms that Aberdeen AMC has pared down its exposure to India slightly and sees us underperforming for a while. “Inflation, fiscal deficit and lack of reforms are the key domestic risks,” says Elston.
Getting sector and stock specific, he says that despite near-term worries plaguing India’s IT space, he remains upbeat on the sector and continues to hold positions on bellwethers Infosys and TCS.
Below is an edited transcript of his interview to CNBC-TV18. Watch the accompanying videos for more.
Q: You have been an old India hand. How have you approached the very poor and negative newsflow out of India over the last many quarters? Have you pared down your positions and do you continue to do that?
A: We pared them back slightly. It’s always easy with the benefit of hindsight, isn’t it, but with the benefit of hindsight we wish we had pared them back a little bit more. We still remain very confident about India in the long-term. We think the investment case remains extremely strong. India’s growth trajectory for the long-term remains a very high one. There remain very good reasons to stay bullish but of course short-term there is a lot of issues that the economy is struggling with at the moment.
Q: In the near-term, do you also sense there is a greater degree of risk-off generally amongst global investors and that may cause India to suffer or underperform some more?
A: Absolutely. There is no doubt that risk appetite around the world is very weak at the moment and that has also affected India. India has been battling things on two fronts - one is with respect to its domestic issues such as elevated inflation, fiscal deficits, and issues relating to a lack of reform and then on the external side of course with the global economy weakening that has also affected things. It’s been a tough time for India.
Q: What’s your view on Indian IT companies now? Performance has become quite disparate. Is that one of the spaces where you had to pare down positions?
A: It was one of the sectors where we pared things down slightly. We didn’t sell out of any holdings in the sector. Our main holdings there in our regional funds continue to be Infosys and TCS. TCS has actually been a pretty good performer. It’s Infosys that’s been a little bit disappointing. The way we look at any sector really is to assess the long-term competitive advantages. In that context, the sector remains a very attractive one. India continues to have a very strong competitive advantage.
Given the weakness in the currency, the competitive advantage is even stronger than it was before. Yes, it’s being affected by weakness in its key markets which of course are the major developed economies, but the weakness there won’t last forever and at some point demand will pick up. So we remain bullish on the sector.
Q: You have also held HUL for sometime. Do you continue to be confident about the Indian consumer staple story or do high valuations begin to worry you now given that they have outperformed so well?
A: We have taken a bit of money off the table in Hindustan Unilever certainly. As you point out valuations in this sector are extremely high. Although we continue to retain our belief in the quality of these companies, when they get overstretched in terms of their valuations to the extent that they have, it is sensible to take a bit of money off the table.
Previously you might have been looking at multiples in the region of 20-30x, you are now looking at multiples in the region of 30-40x. Whilst on a very long-term basis that probably remains quite good value, I think it’s going to present a short to medium-term headwinds for the stock prices.
Q: What do you hear from your end investors, particularly from the European space? Have they been withdrawing funds from emerging market funds like the one that you run in India or are they staying put for now and the turbulence in Europe has not led them to think of paring down risk with their emerging market investments?
A: That’s a very good question. We certainly haven’t seen outflows to the extent that we saw in 2008. In some ways I suppose you could look at that as being a bullish sign. In some ways perhaps it’s more of a bearish sign and that is just around the corner. But on the whole our clients have kept their positions. We haven’t seen huge inflows, but nor have we seen huge outflows. So I think there is a sense that we are not going to get a repeat of what happened in 2008 and people are relatively positive about the medium to longer term.
Q: How are you approaching the second half? Do you think it’s likely to be a continuation of events where developed markets outperform or do you believe there is going to be a switch in performance because of the growth concerns that developed markets are now facing?
A: You are absolutely right to point out this issue with developed markets. Emerging market stock markets are a geared play on developed markets. When we saw the recovery from 2009-10, emerging markets were outperforming whether you are talking about the stock markets or their economies. Basically, over the last couple of years, emerging markets in terms of their stock markets have been underperforming.
The question is what is going to happen to developed markets’ growth? Is that going to continue to disappoint or is that going to turn around and I suspect right now we are sort of more on the pessimistic side. We do see this structural trend of private sector deleveraging in many developed market economies. Governments are trying to support economies, but the private sector remains very weak, whether you talk about companies or individuals.
Of course, there are many consumers who are still overleveraged and not in a position to spend and the companies that do have strong balance sheets are also holding back, because they sense that governments and central banks are supporting things artificially. It does mean that there is this real problem with respect to private sector demand and that’s going to continue to affect emerging market economies and stock markets over the next two to three quarters.
Q: You have also traditionally held a lot of the private sector banks in your India portfolio and this morning there are reports that large investors are actually looking to sell out large sized chunks in these banks. Are you concerned about either valuations or performance or do you think this remains a safe space in India?
A: We have big holdings in HDFC and ICICI Bank. Like all our other companies in India we know them extremely well. We don’t tend to worry too much about the non-performing loan cycle. You are always going to get that with banks. In our view, it is just not worth worrying about that too much. What we do find attractive about banks is that the barriers to entry are very high. You can’t just go and start a bank. You can’t just go and setup a bank.
It takes all sorts of things to be able to do that and years and years of building up trust. But once you have done that and build a bank, you have got a competitive advantage there which allows you to generate pretty good returns on capital and unless you are really stupid and start to do things outside your area of core expertise then you will continue to produce decent returns on capital. We are very comfortable with our two holdings there and I don’t imagine that things are going to change on that front.