Policy paralysis and various imbalances have been plaguing the Indian market for a while now. Amit Bhartia,Portfolio Manager,GMO-EM's equity team. GMO,a global investment management firm, feels the country can easily go back to 3-4 percent growth because of lack of stability. However, he is quick to add that the nation can grow 8-10 percent if policymakers do their job right.
He believes the growth that was witnessed in India between 2004 and 2007 was an aberration. The US during that period was running huge current account deficit and as a result the dollar devalued. But over the last few quarters, the US has corrected a lot of its imbalances, he adds.
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Bhartia says he's cautious on India as he continues to remain worried about the imbalances building in the market. He believes emerging markets as a whole is losing its attraction as an asset class. He explains that the US is growing at 3-4 percent and if EMs too show similar growth, then investors are likely to concentrate more on the US market.
He does not think India or even the emerging market needs to worry about the US Federal Reserve tapering. "Fund flows in emerging markets are more dependent on the country’s growth and the risks in that particular country," he adds. It is his belief that if good policies are in place then there is no need to worry.
Bhartia says IT and pharma can outperform on the back of economic revival. He has invested significantly in export-oriented stocks, but does not wish to invest in domestic companies with 3-4 year horizon.
Below is the verbatim transcript of Amit Bhartia's interview with Latha Venkatesh on CNBC-TV18.
Q: As I read your report, the first thing that hits is that you expect that India would slip to the 4 percent Hindu rate of growth yet again. We haven’t seen such a bearish stance just yet but 3-4 percent you think is possible?
A: Absolutely, there is no God given right that India has to grow at 7-8 percent. Policy makers have to work hard just like both of us have to work hard in our businesses. What is worrying is if you look at the period 2004-2007 was an aberration in some sense in which the US was running huge current account deficits (CAD) and they had a dollar depreciation policy. So nominally, an average emerging market grew at about 16-17 percent during that time. Obviously those periods are over. We are now in a period of tightening monetary environments and if policymakers don’t work hard or if the right policies are not set in place, we could be back again to 3-4 percent GDP growth rate. What is the big deal? Let us not forget two years back, everybody was talking about 7-8 percent growth rate.
Q: Is that your base case or are you just saying that is one scenario?
A: I think that is my scenario but again it is a function of policymaking. If you have the right set of policies, if you have the right set of people running the government who are committed to nation building and growth, India can very well grow at 8-9-10 percent even so it is all a function of policies and policymakers in my opinion.
Q: You have not just a cautious view on the growth situation but on emerging markets as a whole, I was going through your note where you point out that more than 50 percent of emerging markets are growing less than 4 percent while the US GDP is growing at 3 percent so imbalances in the US may have been corrected but they continue to be built up in emerging markets, so are you foreseeing a situation where in 2014, the emerging market slowdown could exacerbate and could drag India with it?
A: Absolutely. As I just talked about that the periods earlier were in some sense an aberration and what has happened is US has behind the scenes corrected a lot of its imbalances. So you have a situation where the US economy is growing at about 3 percent and in nominal terms about 4.5 percent. If you have about 60-70 percent of emerging markets growing at similar growth rate of 3-4 percent, obviously the attractiveness of emerging markets as an asset class does come down and not to mention about some of the vulnerabilities that have built up across emerging markets. So that is why if you see fund flows continue to be negative in the asset class and what will happen in my opinion is you will see increasing differentiation between countries, sectors within the asset class itself. So if you have growth, if you have the right set of policies, if the risks are low, that country or that sector could have disproportionate amount of fund flows.
Q: Where does India figure in your pecking order within emerging markets?
A: For the last couple of years, we have been quite cautious about India. We have been very worried about imbalances that have built up and the currency overvaluation, so that, in some sense, has come down. However, you can think of India as not one market but maybe two markets; one is the export oriented market which is the software and the pharma which has done quite well but again that is a function of the US economy. If you look at, for example, the software stocks then earnings upgrade cycle has pretty much tracked GDP momentum in US or in fact just tracked NASDAQ. However, the domestic oriented sector is again a separate decision. It all depends upon policies, what is the economic growth momentum and again, I think, we will take a call on that after elections on the domestic sector.
Q: We have seen a lot of money being made in export sectors like IT while rest of the Indian markets have been very downbeat. Do you think this aversion to domestic cyclical sectors like capital goods and materials will continue or is there at least some bottoming out?
A: It is possible. In India, there has been a lot of imbalance that has built up over the last couple of years. The economy, in some sense, is come to a complete standstill.We are effectively seeing stagflation in the country right now. So, in this environment where interest rates are high, inflation is about 7-8 percent and industrial production is effectively growing at 1-2 percent, the intrinsic value of most of the domestic stocks has come down significantly. So, again re-iterating the same point, if you have right set of policies and if market participants think over the next three to five years India’s economic momentum has come back then maybe funds can go into these stocks. However, I think it is too soon to say right now on these stocks.
Q: What would your investment choice be now? Would you want to stay with the export oriented IT, pharma sectors?
A: No, while we have invested significantly in the export oriented sector but that is a result of us worrying about the domestic economy. So, if we think that things are falling in place and some stocks become reasonably attractive, we will play these names but I don’t have the guts right now to basically take a three to four year call on some of the domestic stocks. We will see what happens, who are the people running the country, what kind of policies they have and then take a view after that.
Q: Before we get to more general issues what's your view on what's happening with Maruti Suzuki? There has been so much angst over the Gujarat-Suzuki deal, the fact that manufacturing unit has been setup a in a Suzuki arm.
A: It is difficult for me to comment on one particular stock but what is encouraging is, in my opinion, leave aside issues of corporate governance and things like that, I really can't comment on that. But what I think is relevant, which people are not discussing, is Japanese corporates ready to invest in India. Again from my perspective that's in some sense a hope for the country because Japan, in some sense, wants to see an alternative to China. India is a large addressable market if the right set of policies is in place. So, Japan can pretty much invest USD 50-100 billion in India going forward and I think that is something one would watch out for.
Q: To come back to more global issues should investors in India be worried about tapering now that with each successive month USD 10 billion less is going to be available to move into global markets?
A: I wouldn't actually worry about it because historically fund flows in emerging markets and countries have more been dependent on country's growth and the risks in that particular country. Let me give you few examples, in the last five years, so much wealth has been created in different pockets in the world, so, for example one Chinese internet company Tencent today has a market cap of USD 130 billion. The Chinese gaming sector that didn't really exist, I am talking about the casino’s today have a market cap of more then USD 200 billion. India's market cap as a percentage of the world market cap is back to decade lows that is about 60 to 70 basis points of the worlds’ market cap. So, my point is if good policies are in place – we could be worried about excessive funds inflows coming into the market and not outflows. My point is, if there are growth opportunities in India why can't investors sell USD 15-20 billion from just one stock in China and put money in India. I wouldn't worry about it. I would worry about the right policies.
Q: How are you positioned once the new government comes to power and if it is an NDA led government how much of incremental move do you think you could see on economic reforms and therefore on the market itself?
A: Again, it is very difficult to say right now. The consensus view is that you will have a rally if BJP government is in place and it's possible, it happens. However, investors have been burnt so badly over the last couple of years that a lot will depend on execution. Who is the team running the country, what kind of policies they have and can they execute investors will watch out for that? So, my point is you could have short-term rallies here and there but the big money is always made in economies where you have visibility from three to five year perspective about businesses that will do well for a long period of time and it's a function of what policies they will put in place and whether execution is truly good.
Q: We spoke a lot about export sectors and cyclical. What about your take on consumer goods? Would that be your favorite set at all considering there is a huge consumption economy out there?
A: I don't believe that, again that's a consensus view that India is a large addressable market but in my opinion the data doesn't really support it. Just to give an example, today if you look at profits of MSCI consumer staples plus discretionary as a whole group in India, that is about USD 8 billion. Just one company in US - Home Depot makes about similar amounts of profits. So, if both these groups are growing at about 3-4 percent, it's not such a large addressable market. Addressable market is a function of growth; it's a function of inflation and so on. At this moment with 4-5 percent growth and such high inflation the domestic consumption market is not as big as it's commonly perceived.
Q: Let me come to your view of some macro issues. What have you made of the new RBI Governor and his determination to go after CPI or the consumer price inflation? Does that influence your view of Indian markets?
A: One thing is for sure, India needs lower inflation because sustained inflation of 7-8 percent basically has eroded India’s competitiveness significantly. That is why so many things in India today are more expensive than for example US. Food prices are about 40-50 percent higher than US in spite of such huge income differential. So, inflation has to come down but again there is a trade off between growth and inflation in my opinion.
Q: Is the new Governor’s policy influencing you to invest more in India or to invest in a particular fashion?
A: Absolutely, good economy in my opinion is an economy that grows reasonably, doesn’t take a lot of risks and inflation is low and sustained. That is an ideal economy for you.
Q: What will be the main issues that you will watch out when the new government is formed? Will it be their tackling of the fiscal deficit or will it be something else?
A: I think infrastructure is the key because if you have infrastructure and that means roads, power and all these things, what that will result, in growth coming back. When growth comes back a lot of problems that the country is facing today will automatically come down. One of the reasons why fiscal deficit is increased is also because growth is completely collapsed. So, the critical question is growth coming back and a lot of other problems will be solved in my opinion.
Q: One consensus trade has been to buy Indian private sector banks; your thoughts on that sector?
A: What is shocking in my opinion is today if you see the entire market cap of state owned banks in India is less than USD 50 billion which is tragic in my opinion. I understand State Bank of India (SBI) couldn’t even raise USD 300-400 million in equity from foreign investors. So, that tells you about how much investors are worried about the state owned banks. Again, it is a function of economy also because banks are nothing but a play on the economy. So, if the growth revives you will see NPLs coming down and some of these state owned banks actually doing well on a shorter period.
Q: So are you saying you are unimpressed by even the private banks not just the public sector banks?
A: Private Banks have done well and basically again, one of the reasons they have also done well is because the state owned banks have not been fierce competitors and not to mention private sector banks, the managements have been very diligent in what they have done and avoided NPLs. So, they continue to do well but the question is what happens to state owned banks because you can’t have the state owned banks at a market cap of less than USD 50 billion.
Q: Any surmise industries that you may like in India say like Just Dial or even in the unlisted space there are companies like bookmyshow.com, lots of digital shops as well?
A: These look like exciting businesses and if you look at what has happened in the internet sector in the rest of the world they all have had fancy market caps. I just talked about Tencent being a USD 120 billion company. However, in India another thing one has to watch out for is a lot of competition from some of the foreign players. So, Amazon is there, Google is there compared to a country like China when where some of the foreign players were not allowed so that is why some of these companies became so dominant. So it is very difficult to say what happens to these players in India and again as I said it is also a function of the domestic economy. You can’t have the internet sector doing very well if you have a period of 3-4 percent growth rates.
Q: How about the other consensus trade? IT companies, are you worried about the valuations of the big IT companies, do you see them rising further or would you prefer any of the promising midcaps?
A: Right now we are sticking to the top tier IT guys but again one also has to watch out for tighter immigration rules or other issues for example relations between India and US again. They also will play a critical role because you can’t have an environment where let say if US and India are at loggerheads with each other and the software sector continues to just do very well – it is only then a matter of time before some kind of constraints are put even on the software sector too.
Q: Finally back to a story which we can’t get away from, elections. Do you see the BJP coming to power as a slightly higher possibility; is that a scenario you are working with and therefore will you go long before the elections?
A: Modest speculation can be done. That is what we have done, basically increased our exposure to India anticipating favorable election outcome. But let us see, in politics it is very difficult to say what happens. My view is that if you have stable government with the right set of policies even if I miss the first 10-20 percent it is okay. We are not here to make money in one quarter. Then the question is how do you invest in India for the next three to five years and that’s when you make the most amount of money.
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