India’s Growth Is Bigger Issue Than Tax Relief For Foreign Investors, Says Enam Holdings’ Sridhar Sivaram

India needs serious reforms to revive investor appetite and materialise equity returns, according to Enam Holdings Pvt. Ltd.’s Sridhar Sivaram.

The government thinks it is the foreign-portfolio-investor issue leading to outflows, but unless the growth comes by, foreign investors’ outlook towards India is unlikely to change, Sivaram told BloombergQuint on a special series—Navigating Through Uncertainty. “I don’t think it is the FPI that is the issue. I think it is the growth that is the bigger thing.”

Comparable economies, some of which were also a part of the ‘Fragile Five’, have done much better reforms than India, he said. “From the lows of 2016, Brazil is up 125 percent, Russia is up more than 100 percent, but India is up barely 40 percent.”

India had a great opportunity during this period because the country’s macros were great, but for various reasons, the nation hasn’t capitalised on that, Sivaram said.

Sivaram, however, said he is hopeful that the liquidity measures announced by the government and the Reserve Bank of India will aid in reviving the economy. A large stimulus is already being anticipated by the markets and the rating agencies and this will not be taken very negatively, he said.

The broader market, according to Sivaram, is throwing up some good investing opportunities. He, however, said one needs to have the patience and the ability to sustain price corrections. This a once-in-a-decade opportunity to invest in companies as some of them are trading significantly below their historicial price or market capitalisation.

While autos are not structurally weak, select auto ancillaries and metals provide an interesting opportunity, Sivaram said, adding that staples and information technology stocks can be avoided.

Watch the interview here:

Here’s the edited transcript of the interview

A year ago when we did this on Navigating Through Uncertainty, we thought it will probably end on the domestic side with the elections out of the way, the global uncertainty may remain. What keeps you awake at night?

No, I sleep quite well so it doesn’t matter if there is global uncertainty because a lot of these things are not in my control. So, what is in my control is my portfolio and typically, I don’t take the portfolio back home otherwise there is no end to it. Having said that, looking at the Indian macro, it is looking quite fine. So, if you would have told me a year ago inflation would be, say, in the three handles, your current account deficit is broadly stable, you’d get absolute majority government. If you had told me all of this a year back, I would’ve lapped it up with both hands. But what is currently more uncertain, is the global environment in which there are the trade issues as we are seeing, there is a global slowdown across emerging markets, and we are seeing a part of that reflecting in India. So, I think it is always important to keep things in perspective. Having said that, if I look at India’s performance within emerging markets, they are not too out-of-the-line with emerging markets. So, if you take a year’s performance or a year-to-date performance, India is broadly in-line with emerging markets. So, there is a general belief that India has under-performed, that’s not the case because in the last one month, because of the commodity fall, most of the other markets have corrected very sharply. So, I would say that India’s performance is broadly in-line, but having said that, given the way Indian macros are right now, it should’ve significantly outperformed but that is not the case.

But let’s face it, from the peak of June 3 and 4, maybe we have done a lot worse as compared to some of the other markets and speaking a lot on the world being uncertain, a lot of question marks about whether due to the tax changes, or the slowing economy or the consumption hitting some bit of road blocks, there seems to be at least on the foreigner’s side, outflows that are happening. I don’t quite find mutual fund investments coming in as a sign of a market call, it is more of that SIP money that is coming in. The informed investor is not necessarily gung-ho right now in India, Sridhar.

Yes, so, if I look at emerging markets in general and put things into perspective for India, most countries are facing some sort of a slowdown, some sort of issues and many are fighting it in various ways. So, as I mentioned to you earlier that China has done a 2 percent fiscal stimulus for this year. 2 percent for an economy of that size which is five times our size is fairly significant. Now, they are doing this because they are facing a significant slowdown because of trade issues. We saw Jokowi come back in Indonesia and he has immediately announced tax cuts for corporates. There are some reforms for FDI in Indonesia, so they are also facing slowdown, they are fighting on whatever best they understand. We’ve seen significant reforms in both Brazil and Russia. I mean it is not very well documented and it is so far away that people don’t write about them. But these are comparable markets for India. I mean, for India, investors for emerging markets, at least the sense we get is that the Indian bureaucracy fees is TINA factor for India. Because India is the fastest-growing economy, so where will people invest? But that is not the case. So, that is the delta we invest in so where are we going from here and how will we be in the next 12 months? Many of these economies, some of them were also fragile-five. As part of fragile-five, as India was part in 2013, in the last three-four years, they have done much better reforms than India.

So, from the lows of 2016, Brazil is up 125 percent. Russia is up more than 100 percent; India is up barely 40 percent. So, I am trying to put things into context that we had a great opportunity during this period because our macros were great but for various reasons, we haven’t capitalised on that. And I don’t think its too late. I think we can still capitalise because the macros continue to be good, but the point I am trying to make is that, unless you do something different or unless the incremental delta is improving, FII has other opportunities to put money which is why we are seeing the FII outflow. I don’t think it is the FPI that is the issue. I think it is the growth that is the bigger thing. Unfortunately, the government thinks that it is the FPI issue and thinks that they’ve solved it, and everything is great. Unless the growth comes by for people, generally they come to India for growth so I think that is missing and I think many of the other markets are offering that growth right now and despite the challenges that they are facing, I think that’s why we are seeing this FII outflow.

Some baby steps, if you will, they look much bigger than compared to what was done post the elections but some baby steps last Friday, by the finance minister. It was a long one but in terms of market impact, some moves being taken, there is promise of more, maybe real estate, maybe some other moves coming in the next week as well. Does that revive sentiment? I remember a conversation I had with somebody who said that some of the markets will start doing well if the government is listening to what the markets want. Are they trying to listen to what the markets want?

So, I would say that is a very positive step that has happened last Friday. I would actually go back to the monetary policy before that, that for the first time, the central bank sort of admitted that there is a sort of a problem with the HFCs, NBFCs and they would do anything to ensure that we don’t see a crisis there. You go back to October 2018 when there was actually a big crisis. We had the deputy governor come for a press conference and come and say that NBFCs and HFCs have messed up their balance sheets, their asset liabilities are all messed up. These are not the things you come and say in a press conference, but possibly in a closed-door meeting. I see a big change after the new governor has come and at least, one, what I hear is, they are listening to people and they are trying to do and they have done many measures for NBFCs, HFCs which I think are steps in the right direction and along with that, what we heard from the finance minster on Friday. I think what was announced was too little but there is a promise based on body language and what she communicated so one will have wait and see on what they are up to. They have to take a little more risk if India has to come out of the slowdown.

The central bank seems to be trying to do that. I remember a conversation that we had the last time and you were saying that, why is that, that the bank is not doing enough? This is under the new dispensation that is happening, I reckon just the follow up to that, I reckon this whole transfer from the RBI to the government would actually embolden or actually strengthen its hand to do more as you think?

To start with, I completely support what the new governor is doing. In fact, what the frustration was that the previous governor, when we should’ve been doing a lot of rate cuts, actually changed the policy stance to calibrated tightening for reasons best known to him. So, we lost a golden opportunity because transmission takes 12 to 18 months. So, we’ve already seen signs of that, and I am hoping that the government and the RBI and all the liquidity measures that they are putting in, we’ll see transmission which helps in reviving the economy because that’s one of the issues with the economy that the real rates are very high. If a corporate has to borrow at say, 10 percent, and say inflation is at 3 or 4 percent, we are talking at 6 percent for a real corporate rate. There is no business sense to make that sort of rates. Along with that, with the transfer of reserves, I think it was more technical, it was expected that it would happen, so I think it helps the government because they have got some additional Rs 50,000-60,000 crore because they have already pencilled in a lakh crore in the budget. So, I think it is an additional Rs 50,000-60,000 crore. Keep in mind that they are short on revenues. So, it isn’t as if this immediately brings down the fiscal deficit. Keep in mind that the previous year numbers are Rs 1.70 lakh crore short so the budget numbers also had questions attached to it. In all, I think this will help bring the fiscal deficit to the target that they already have, and I don’t see any issues if they hypothetically were to do a fiscal stimulus of say, 50 basis points. Anything short of Rs 1 lakh crore won’t make an impact on the economy or the market. I don’t think any rating agencies or bond markets are going to take that very negatively because that is a broad expectation that the government will do a fiscal stimulus, but I hope that, it does happen.

To borrow a line from one of your previous answers, “where will we be going?” and “where will we be somewhere 12 months down the line?”: Should there not be dole outs? Round one seems to suggest that this is a revenue-neutral policy change or measures or stimulus that the government has given out. If that doesn’t change, what happens? Who brings the money to the table to fund and kick-start what looks like slowing down?

So, as far as the dole out is concerned, there are mixed views within the market itself and also if the dole out should be for a particular sector which is ailing right now or a broad dole out is better? My broad view is, if it is a cyclical slowdown, then there is no need to give a dole out for a particular sector. Like auto in particular. And within auto and the champions and the CEOs and the promoters of auto, there are split views. So, in my view, given that we’re going to see a structural change in autos like the BS-VI transition which is going to happen from April 1, 2020. And the price of vehicles in general will go up. The rough number given is about 10 to 15 percent for two-wheelers and commercial vehicles at least. So, the government is going to get a higher revenue because of the going up. So, there is an argument that along with BS-VI, because it is structural in nature, you can do a reduction and the loss of revenue to the government would be much lesser by doing that. But does it mean that you are doing that for autos, you have to do it for a biscuit industry or for any other industries or in my opinion what the government is directly indicating is a right approach; which is, you cannot be giving out dole outs every time there is a cyclical slowdown but there are other ways of doing it which is a general stimulus mechanism. In my view, the best thing to do would be a cut in petrol-diesel prices. So, roughly, a rupee adds to Rs 15,000 crore to the government. But keep in mind, that is taken away from the consumption basket of people. And if you argue using the same government argument that 2 percent or 3 percent of India’s population is rich, and most of the others are sort of middle-income or low-middle income, it is actually the masses which are paying these Rs 15,000 crore.

But the counter to that is, that Re 1 deduction on my petrol bill or a Rs 2 deduction on my petrol bill will not really make me go out and try and spend on maybe not the soap yes but not on movie tickets, not on articles, not on goods and artefacts.

So, it can’t be one rupee, right? So that is the whole point, if you look at the budget, the whole narrative of the budget was taxing the rich so they can pay. How much did you tax? It is about Rs 12,000 crores and you did a Rs 2 rupee petrol-diesel increase, that’s Rs 30,000 crore annualised revenue. So, you’ve actually taken more money from the poor and middle class than what you would’ve taken from the rich. I would’ve understood if the narrative was, “I am taxing the rich, I am getting Rs 12,000 crore I am reducing Rs 2 from petrol and diesel that’s Rs 30,000 crore given to the rest.” But we did exactly the opposite so at a time when consumption is slow, you’ve actually taken Rs 30,000 crore more away from the system. It doesn’t happen on a single day but over a period it adds up and it hurts a truck driver to a taxi driver or anybody else. So, my point is that it’s an easier way of transferring or doing a stimulus. Along with that, you could do measures like a corporate tax cut is something that has been discussed for a long time. How much do you lose by a 3-4 percent tax cut? So, a broader stimulus is something I’ll be more supportive of rather than giving sops to any industry which goes crying to the finance ministry.

So, let’s assume that we don’t quite know what will happen, lets assume some of the measures get done, some don’t, and let’s assume its sector-neutral but more consumption-oriented maybe petrol, diesel something else. What happens over the course of six to 12 months? For the first six months, we are on the back of a very beaten down, broader end of the spectrum, on the cusp of, which is arguably a good month of this festive season, how do you think markets navigate through that?

If I just go back to what the finance minister said, I think the biggest delta or impact will happen if the government pays its dues. I mean that is something which she mentioned not only for the GST but even for others. The talk about other 75 percent to be paid in case of arbitration, this was there even before the prime minister’s office had come out with a sort of a diktat or a circular about two-three years back but a lot of them didn’t go through because of some corporate guarantee or a bank guarantee issue. But in my view, if this is sorted out, it is close to Rs 1 lakh crore stuck in the system. Many others from the market have also highlighted this in the past month that the government has not been making their payments on time especially at a time when liquidity is very poor especially for SMEs and smaller companies. This makes a big delta. I would be very happy if the government actually makes it transparent. Today, they have announced but we don’t know if the money is actually going or not. So, if they make it very transparent, put it on some website, disclosing what was struck, names of the people for whom they released cheques from NHAI or some other company, BHEL or any other company; If we make it transparent then I think, it’s easier to track it because that makes it a huge delta, that whole process. If those things were to happen and even if we have a reasonable festive season, I am not expecting it to be a blockbuster based on whatever we are hearing on the ground. So that’s what we have to keep in mind that from October-November, we’ll have the base effect ticking off the previous year. So, my broad view is that, as we enter the next year, a lot of these numbers will be in the base and some of these measures that have been taken and will be taken now, will start to show results. That’s how I am trying to be optimistic right now. Things can’t get worse from here, maybe in terms of auto numbers, the worst may have come but I think the worst is ahead of us, but the market’s already pricing right now, that is my view.

How do you approach investing in such a scenario? I am just using banks as an example right now, The last three-five months have shown that people talked about how polarisation is not that great and why investing in 4 -6 price books? Invest in a lower price book. One bad quarter in one bank or the fall that we’ve seen in other private sector banks over the last one month shows that even if the quality of the manager isn’t great and the intent might be great, due to unforeseen circumstances, the price correction is so serious that it takes away all the gains that you would’ve thought of making. Would you believe that, that phenomenon and that fear in the minds of the investors will still keep them polarized toward large-cap safe names or will they, at some point, see return of the mid-caps and small-caps?

So, we are taking the riskier approach right now. One, we don’t have a benchmark to report, we don’t have an investor to speak to. We can hold across cycles, I am not sure how many people, especially people who have benchmarks, many of my friends would not be in a position to take such approaches. But we do think that the broader market is certainly offering some opportunities, but doesn’t mean that the returns are going to be front-loaded. They may be back-loaded. It depends on how much patience you have to wait and how much price damage can you sustain? So, we are treading carefully in this segment, because we think this a once-in-a-decade opportunity that you will get, because cyclically, some of them are down but if you look at the historic price or price to book, they are way below maybe one or two standard deviations lower. So those are the type of approaches that we are taking, doesn’t mean we have discarded or sold-off some of the large-cap, blue chip positions in the financial space or in any others. It is just that, incremental money is going into the broader market where we think the opportunity is very good.

Is this in the companies that are already displaying or showing the impact, or this is more in the belief that the good times that might come back?

So, in many cases, it isn’t that the improvement in the performance is very visible right now but the price destruction is so severe that you are getting companies that may be 0.2 times sales or 0.3 times sales. So, you look at historic averages where you know that the management is reasonable, the business is reasonable, they are going through some sort of cyclical slowdowns you have to take those calls. As I said, it is easier said than done but that’s where we think the opportunities are right now.

You started off by speaking of one space, if you believe its cyclical then great, if you believe its structural its great. What do you think? Is auto slowdown cyclical? Is it structural? What about the suppliers as well?

It is cyclical. It is not structural. So, take two-wheeler for example. It is not like EV is going to come tomorrow and the government has announced that they are not forcing anyone to make the switch and disruptions don’t happen by force, they happen by choice. If the choice for an EV is much better than say the choice of a normal vehicle, so the customer will do that. We saw that in case of smartphones versus traditional phones or digital camera versus old camera or say messaging versus WhatsApp. You don’t need to do that. It will happen. But we do think that it is sometime away but possibly the first disruption will happen in two-wheeler but that is at least three to four years away if not more. Both can co-exist for a period. Then the customer will take an informed choice at that time. But at this time, I think it is cyclical. So, maybe along the BS-VI or maybe along the bottom and then things move from there.

Is this for suppliers as well? Because there the price damage has been very severe.

At the supplier’s part it looks more interesting right? Because the damage is much more and if this is only cyclical, then when the cycle turns, they will also benefit from the turn. So, the investor has to be careful in seeing what type of supply am I investing in, do they significantly lose out when the transition happens to EV because not all suppliers, not everything will be going to zero. So some of them look very interesting. See, one of the issues with auto was that, they were trading consumer valuations. But they are actually discretionary because they go through a cycle. And the valuation differential between a staples and a discretionary is there because of a cycle. Unfortunately, we were trading at a consumer staple evaluations for a discretionary. So, we were maybe one or two standard deviations over what they should be. So, now a lot of that has corrected. So, where we are seeing the long-term average, it is much lower and many of them are cash rich companies. I mean, they don’t have any debt, they have brand so, that is an interesting space to look at.

Okay, so since you mentioned staples, what about that? A biscuit makers is saying people are not buying, soap makers have cut prices arguably by 20-30 percent even if it is in select SKU, but having said that, it has happened. Maybe we will see more signs of this as well? Is there a worry on the valuation front even if not on the growth front?

So, I am personally not a big fan of staples at the valuation they are, but back in 2009 in my previous firm where we had taken up large positions in staples at that time, we were coming out of the Lehman crisis and the market was gung-ho and cyclicals were flying. The premiums of staples to the market were possibly the lowest in 2009 and based on that macro view, and we had done fiscal stimulus at that point in time, our view was that, that will play out in consumption. So, that was a time when we really went overboard on consumer staples and that was like the perfect trade because you don’t get such trades because some of the stocks my previous firm is still holding and there were 20-30 baggers from there because not only did they get earnings growth they also got multiple re-rating. It is very difficult to argue for a multiple re-rating from here because you are really talking of earnings growth and that also is looking difficult. At least, to get a strong double-digit growth it looks difficult. I think the risk reward is not there. So, I think I am getting so many other companies which are domestic oriented at points of sales in market cap, I don’t need to pay multiple of sales to buy staples. So, that’s my broad view. I could be wrong.

Everybody says that before the trade war is over don’t even touch metals. We did a study wherein as per the valuations right now it is comparable to at least the Ebitda or price-to-book to 2016 or 2009 as it is in some cases.

Price-to-book is a very safe multiple to play as far as metals are concerned and typically between 0.5 and 0.7, metal stocks tend to bottom out but keep in mind that 0.5-0.7 is a fairly significant fall for the stocks so people who have the ability to take losses in this, because it’s not like these things turn overnight. But when they turn, they give multi-bagger returns. So, these are very interesting times for metals in general.

Are you looking at metal very seriously right now?

Which is why we exactly know where the price multiple is booked at right now.

One word on the globe since we mentioned that right now. How do you think the impact would be on Indian shores with regard to FY interest because if you see almost everybody goes to China, every fund manager goes to China and tells me there is a revolution going to happen out there, and they are doing stuff that India is not even thinking right now. Will larger portions of money get driven towards China and some of the other countries in the wake of what’s happening?

So that’s kind of a big disappointment as far as Indian IT is concerned. We just missed a decade, by just being after this offshoring, I would call it more of a labour arbitrage or anything. We haven’t created any IP. 78 years ago, in the top 20 there were hardly any Chinese companies there. There were possibly some Indian companies there. Today, it is a split between the U.S. and China. Obviously, the U.S. is a bit dominating there, but there are like four or five Chinese companies there and lndia is completely missing. And what we have created, this can vanish overnight with AI and all sorts of changes that are happening. So, I think my biggest disappointment, as far as Indian IT is concerned, is that we’ve just missed the bus and look at the people who are leading it overseas. They are all Indians. So obviously, it is really sad that we haven’t done anything whereas the Chinese have really taken over. So, yes, if you ask me where the people are putting money in China, it is the new China. Because that’s where the innovation is happening. that’s where the exciting companies are. So, I do think that China has a big advantage because they’ve done much more than India could do potentially. So, I think that’s the biggest disappointment as far as the Indian IT sector. So, I am not a fan of Indian IT. It is a place to hide but look at the revenue growth, it is 6 to 8 percent, at best 10 percent and even that is dwindling. So, doesn’t excite me.