In a special series 'Asian Tigers', CNBC-TV18's Udayan Mukherjee travelled to Hong Kong and Singapore to chat with the biggest FII voices to get a sense of how they are now positioned on India. He had a conversation with Amit Bhartia of GMO Emerging Domestic Opportunities Fund and asked him if India's slowdown is structural or temporary with the moves like demonetisation and goods and services tax (GST).
“I think the large part of India’s growth is structural. We are in a medium-term growth slowdown,” he said.
Below is the transcript of the interview.
Q: India has slowed down over the last few quarters and there is a huge debate back in our country on whether this is a structural one or it has happened because of moves like demonetisation, GST and we will be off to the races once again, what is your view on this? Is it structural or is it just temporary?
A: A large part of India’s growth is also structural. We are in a period of medium term growth slowdown. While the debate is, the government is to blame, I don’t think government itself cannot take the responsibility irrespective of any government is in power. A lot of blame also goes back to the private sector.
If you look at it there are two groups of entrepreneurs I would say who have caused this slowdown in some sense. One group is the entrepreneurs in sectors like power, infrastructure, who took way too much risks which impacted their balance sheets and have indirectly impacted the banking systems in India and we know what has happened because of that.
Another group I would argue which is not well thought about is the companies in software and pharma sector for example. India has a huge competitive advantage in software and if you look at for example, 10 years back the market cap of the top 3 Indian software companies had a market cap 15 times bigger that the top 3 Chinese software companies. Now it is 1/15th of these three Chinese companies because what really happened was unlike China, Indian companies did not want to innovate. They were too focused on stock prices and preserving margins.
So, software sector for example which was the biggest job creator in the country and I would argue resulted in this growth boost in India’s economy has significantly slowed down and will continue to slow down and that will also impact long term India’s growth.
Q: Too late for it to turn around? You think in the sense the IT sector might have missed the bus?
A: Absolutely, because the dominant companies as we are aware, the Google’s and Amazon’s have become so globally dominant and unlike China, India has effectively given them a free entry in these home markets. So, you have a significant competitive disadvantage compared to them. However there are lot of areas where you can actually participate, maybe new set of growth drivers in healthcare technology or some of the other areas in artificial intelligence or robotics. I think it is time Indian companies also take some risk at least in the software sector and that can have a multiplier effect on India’s economy.
Q: Would you say the same of pharmaceuticals? That is another sector which has got derated over the last couple of years. Do you think the story is similar that we did not make enough investments when we could have?
A: Absolutely. Again, they were also infected with the same problem – too much focus on margins, too much focus on stock prices. If you look at two years back, the Indian pharma sector peaked out at a market cap of about USD 100 billion. So, investors were ready to give these companies a high multiple but again these companies were also focused too much on short term issues, didn’t invest in quality control, didn’t invest in hiring some of the best talent globally and today they are paying the price. As you can see, stock prices have halved from there, you have enough FDA issues and lot of these companies have serious crisis.
Q: Do you think the derating which has happened in the export sector – IT and pharma, is it of a more permanent nature? There is a group of investors who believe that multiples will start moving up once again, once these stocks bottom out. Do you think that will be difficult?
A: Stock prices are a function of two things, one is earnings and second is PE multiples. High multiples are given to companies who can innovate, who can think longer term and who can build businesses that can be there for the next 10-20-50 years for that matter. So, I don’t know about the latter part, whether Indian companies can still think like this but it is possible in a year or two some of the cyclical part of the earnings do come back and some of these stocks do well.
Q: There is one school of thought that in a couple of quarters we will rediscover growth and quickly bounce back to 7.5 percent kind of growth rates once again, how likely is that in your book?
A: In my opinion it is difficult but it also is a function of government policies. If you have certain sectors that the government focuses and targets, they can have a multiplier effect on the economy. For example I like some of the initiatives the government has done in power sector, in regional airports for that matter, in low cost housing, these are good initiatives and if implemented properly they can make an impact on Indian economy and have a multiplier effect.
Q: Is there a lot of enthusiasm globally about India or India is just another market and people are not as enamoured of it as we think back home?
A: There has been a fair amount of enthusiasm about India, especially with the new government in power in the last two years. However I see that increasingly changing, we are getting headlines for all the wrong reasons. If you look at recent articles, whether it is in New York Times or Washington Post or even the Economist for that matter, these are widely read by global asset allocators and opinion leaders, so that is significantly impacting India. Recently for example we had a lot of calls from some of our biggest clients who are the pension funds and sovereign funds who have cancelled their trips to India because of pollution in Delhi and some of the issues.
Increasingly when I talk to such investors, there is talk about freedom of press, some of the social issues which lot of investors are increasingly focusing on and will impact their long term decision making or allocation in India.
Q: That is interesting you say that because people in the stock market believe these are peripheral issues and they should not matter in the lives of an investor – this pollution issue, the social issues that we are talking about. However you are saying that, as a fund manager too you need to be cognizant of these issues?
A: Absolutely. There is a lot of research being done globally and in fact there is a very interesting statistic – for every one degree increase in temperatures globally, GDP gets impacted by about 0.9 percent. Countries such as emerging markets which are significantly dependent on agriculture will have a huge cascading effect on GDPs and corporate earnings because of climate change and environmental issues. India obviously is much more vulnerable as we are all aware given that 15 percent of India’s economy is dependent on agriculture. India is the most globally impacted country due to rising climate issues.
Q: Let me turn to the first point that you started off by speaking about, which is the part of the market or part of corporate India which took big risks and sort of destroyed their balance sheets and could not participate in driving growth again. Do you think the recent recapitalisation that is being done towards public sector banks in anyway brings those kind of companies back on the table so that they can play a role in reviving growth?
A: It will help but again it will depend upon lending standards, how do the state owned banks again lend? The private sector banks historically they have worked closely together with state owned banks to fund long term infrastructure projects. So, whether that will happen.
Second, you have a context of way too much over capacity in a number of different sectors. So, even if you have very low interest rates or you have recapitalised balance sheets, the question is how much does private sector step up and take loans again, especially in infrastructure sector.
Q: You have actually in the past have invested in private sector financial stocks in India, do you see this as a turning point? Some people are saying that now public sector banks will come back into the play and private banks and NBFCs who have had a great ride over the last couple of years will actually see some market share erosion. Is that a possibility or you think these fears are overblown?
A: I think both can co-exists together. I think the private sector banks and the NBFCs also need a vibrant state owned banking system to survive and grow because if the economy doesn’t grow or if credit doesn’t grow, sooner or later the private sector banks will have serious problems. It cannot be a situation that this group of companies continue to do well whereas the other 80-85 percent of the banking system is in serious trouble. Actually I am delighted that this has happened and it is a win-win situation for both of these groups.
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