We are at the cusp of the greatest ever economic expansion in India’s history, says Bharat Shah, executive director, ASK Investment Managers. And this is not merely in terms of the rate of growth compared to the rest of the world, or compared to past growth rates, but also when measured by the quality of growth, its sheer breadth and scalability, he says.
“India’s challenges are mostly external, not within. We managed to emerge from the pandemic well but over the last year, the hurdles have been mainly in the form of the Russia-Ukraine war, and the resulting impact on supply chain and commodity prices, pandemic-related disruption in China, strong dollar because of repeated rate hikes by the US, and recently the turmoil in the banking sector in US and Europe,” he told Moneycontrol in a freewheeling chat. Shah spoke on monetary policy, banking crisis interest rates, preferred sectors, how to deal with information overload, and his filters for investing in companies. Edited excerpts:
On Fed’s dilemma
I don’t think we have seen the worst of the banking crisis yet. That is because real interest rates are still negative because of high inflation. The western world, the US in particular, is now paying for monetary policy sins of the past.
Previously, one of the defining features of the developed world was the maturity and foresight of its (financial) policymakers. They would respond to problems with long-term solutions. But for quite some time now, they have been resorting to lazy economics.
When the pandemic broke, they tried to boost demand through cheque writing, when the real problem was on the supply side. Earlier the problems began by cheap capital, and during the pandemic, it worsened by flooding capital rather than carrying out real supply-side reforms. The result was the misallocation of capital into unworthy causes and the eventual degradation of capital efficiency.
The Fed is now in a bind. If it does not raise rates, it will be hard to tame inflation, and if it does, it could create fresh problems like the ones we saw at the Silicon Valley Bank and the Signature Bank.
Interest rates in India
So far, the recent rate hikes in India have been to match those by the US Fed. But we have now come to a point where our interest rate decisions don’t need to depend on what the Fed does. We have perhaps reached a point of departure from the Fed's interest rate behaviour. Our inflation is pretty much under control, and as things stand, it will come off faster than inflation in US.
One, commodity prices will start easing, two, our policies post-pandemic have been to address the supply-side issues and they are already beginning to yield results.
This is not to say that we will be completely independent of what happens with interest rates in the US because dollar strength affects our trade balance and capital flows. Still, rate hikes need not necessarily be the only way to address issues on that front.
On banking
Over the last eight-nine years, the cost of capital in India has been declining. Interest rates have risen over the last year but the cost of capital has materially declined over the last decade. This will have positive implications for new capital formation, improve the business profits and lead to better lending volumes as well improved asset quality and better asset values in the long run.
This has happened in a systematic manner, thanks to fiscal discipline and better management of the current account, leading to better inflation management.
Balance sheets of lenders are now in a good shape, thanks to sustained high NPA recognition and write-offs and also, thanks, in part, to regulations such as the bankruptcy law. There is better discipline and a vastly improved credit culture among borrowers now. Their balance sheets, too, are in good shape. There is rising diversity of financial instruments such as REITs (Real Estate Invest Trusts) Invits (Infrastructure investment Trusts), green bonds, which did not exist earlier.
The supply side has become robust, thanks to the proliferation of private equity funds and venture capital funds, and there is strong demand from the infrastructure, exports, real estate, general corporate expansion and working capital demand. I expect credit growth to sustain at 15-16 percent over the next few years.
On insurance
The insurance sector should do well. Penetration is still in single digits and even many of those who have taken insurance are under-insured.
In addition, industry practices, too, have improved over time and the regulatory environment, too, is now quite supportive. The rise in income levels will underpin rising insurance penetration over time.
On manufacturing
The PLI scheme is likely to turn out as a big boost for the manufacturing sector. I see opportunities in industries like specialty chemicals, active pharmaceutical ingredients, agrochemical manufacturing, digital goods and electronic products.
On consumption
Within consumption, I see luxury products, discretionary consumption and consumer durables becoming a bigger portion of the basket because India is as much an aspirational story about the middle class as much as it is about robust physical infrastructure and growing exports with improving the diversity of export baskets.
On cement
In the last 20 years, cement has grown by 7 percent annually. Over the next 20 years, it may grow at 8-9 percent annually, given the strong demand drivers of rapidly expanding public infrastructure and real estate.
The industry as a whole has become very efficient over the last few years. Also, cement prices are not very different from what they were 20 years ago when adjusted for inflation. There is a scope for improvement in pricing, even if it may not happen immediately.
Lastly, cement is not a global product and hence there is no fear of price distortions due to global dynamics, as is seen to happen with other commodities like metals.
On information overload
There is just too much information overload right now, still rising and much of that is noise. You can’t beat markets with mere voluminous information, early access to it or with the speed of your response. Because of information overload, the market is constantly egging you to act and often it is the market’s way of snaring you into making a mistake
There has to be a fine balance between sobriety and agility. Not responding at all can hardly be a solution but overreacting is clearly an even bigger problem.
You should be able to intelligently interpret the information that comes your way and have the discipline to respond to the derived insights. For example, change in fundamental value. The mindset should be to be governed in a disciplined way by any changes in the intrinsic value estimates of the business.
Intelligent patience, combined with curious agility remains key.
Being thoughtful, disciplined, having a good idea about the likely real value of the business and acting upon such knowledge with agility are the four most important traits that an investor must have in this age of information overload.
On filters for investing
I look for the character of management, not just in terms of capability and innate value, but also in terms of foresight, execution, capital allocation and capital distribution.
They should have skin in the game, resilience and the ability to last through tough times, with good risk management capability.
Next comes the character of business. It should be able to create meaningful value and the size of the opportunity has to be large enough. There is only so much that good management can do with an inferior business.
The business should have good cash flows, and predictable growth in the long term, after adjusting for the highs and lows of a cycle.
It should have a good Return on Capital Employed, Return on Equity, and the ability to withstand the vagaries of competition and regulations. All that is to be followed by an adequate margin of safety, disciplined portfolio management and backed wisdom of realising the true value of the long run, without compromising on intelligent agility.
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