India Better Placed For A Taper Tantrum, Sharp Tightening Unlikely, Says JPMorgan's Sanjay Mookim

There are two fundamental questions in investing at the moment I think one of course is the growth or economic outlook, and that is where the conference is centred, we've named it as- ‘The Growth Imperative for India’, that's the title of our summit this year and that is where you can have a lot of debate on what the economy holds for us in the next three quarters the next three years and the next 10 years and there on. There are multiple timeframes, and you can have intelligent conversations or a very lively debate on the outlook for various themes and structural changes in India. The second fundamental question is the marketing investing question, which I would argue, on your question on what I personally think there are a lot of returns that have been made have been made on a falling cost of capital. This sounds like a very boring answer, but it is the qualitatively correct answer to my mind that since the GFC, it is the falling cost of capital, the abundance and liquidity everywhere in the world that seems to have driven a majority of the returns for equity. It seems to continue at the moment, which is why the stance is taken by central banks over the next few weeks, and thereafter will be very important to determining equity returns. Our year headpiece in January, if I may point to it was titled, ‘The Icarus Trade’, Icarus, the Greek mythological character who has wings of wax and flies towards the sun, rises as high as he can and then collapses under the heat. That is where we think the market is today, it continues to fly higher based on liquidity until that liquidity stops

Frankly, this is imponderable and the only way we can think about it, is to think about the various scenarios of central bank action. If central banks say that liquidity injections go to zero, so that the asset size or the balance sheet size of central banks remain static, then you should not see a very large correction in asset prices. You may see a diminishing incremental return, but you shouldn't see a very large correction. However, if central banks are forced to start tightening liquidity, pulling back the supply of money from the markets, then you can imagine scenarios where asset prices continue to fall meaningfully That is not my base case, economically, I think it's very low probability that central banks will be forced to tighten dramatically in the current economic situation. So, yes, you may kind of get to a more stable asset price environment, but I don't really, at least in my base case, don't really anticipate significant correction.

Not so sure that will happen, I would love for that to happen because we've all been trained in colleges on DCFs and capitalising asset pricing models that doesn't seem to be working at the moment, at least in the traditional sense. If you go back in history and look at investing from 1970 to 2010, in total returns has always outperformed growth, apart from brief periods of volatility. It is only post GFC that you see sustained growth outperformance and again goes back to the original point I was making that it is the cost of capital that drives these valuations or these ties differently. If you think of equities as a cash flow stream, a growth equity has a higher duration than . That is why when cost of capital falls growth does better than . So, it makes complete arithmetic sense, in a way and if you think of it that way, only environment or only the reason why s start outperforming growth is if the cost of capital starts to rise, then duration will get sold off or growth equities will get sold off and apart from little bit of normalisation, I don't think global economies is a place where you will see significant increases in cost of capital for the next few years.

First, I think that premise is entirely correct that global correlations are very strong, decoupling is very rare. In the last few months, India has outperformed EM by about 25% but I would argue that's largely to do with North Asia specific issues, and not because India is looking much better than the rest of EM trajectory. So, the decoupling is rare so if either EM taper-tantrum happens, or the U.S. multiples starts to correct, then India will also face that same headway. Now, there are two other arguments—if you do see taper tantrum, India, at least from a currency perspective is reasonably well placed because the RBI over the last two years has built significant amount of reserves. So, the currency is more defensible now and even if dollar liquidity were to tighten, at least in total dollar terms India should not disappoint EM investors. It should not do worse than other EM countries. That way, it is reasonably well placed in the short term. I think the debate needed for investors or EM investors in the longer term is India's growth potential over the

next 7, 8-10 years and that's when you get into questions on the demographic dividend, the structural urbanisation, the reforms that have been conducted and the benefits of that, the use of technology in the country. This whole environment or this whole vision that India goes from a $2000 dollar for capital to a $4000 capital or thereafter and therefore the increase in the total consumer buy. That is the excitement for longer term investors, that is the reason I think India trades at a significant premium to other emerging market countries because that growth is considered a little bit more assured in India and therefore people are willing to pay up a little bit.

That question can have an hour-long answer, frankly, and we've done a lot of work highlighting the structural positives in India. Let me try and summarise it in a few minutes now. We are confident that India will deliver steady growth through a variety of endogenous processes that are happening in the country. So yes, people focus a lot on the China plus one, the shift in manufacturing, but there has been steady growth in India on a lot of parameters, irrespective of the shift. The shift will probably add a little bit of beta to growth if it does, but the core growth is still very intact in India. We've argued that this happens through a process of transfer of labour and transfer of labour from agriculture to services and manufacturing in India, largely to services in India. This is because agricultural productivity is always very low everywhere in the world, and you shift these people to manufacturing or cities that productivity output per capita goes up a lot. You look at 75 years of Indian history, this works like clockwork. There's a lot of headroom for this to happen in India still, and our argument is that over the next 10 years, you with great confidence imagine that India's standards of living will only continue to rise. We can take that in detail about why we think that assurance is high. However, what this means is, that you have great pie of demand or consumption in India growing, then the only variable for a company to succeed is execution. For my longer-term investors, we put it in this way, that look you should buy domestic facing businesses, but the evaluation criteria should be execution of management, the execution of a company to capture the growth in its addressable market locally. So, domestic facing businesses, good quality management, good execution, brands, company strategies, those are the filtering criteria. I am slightly less fast about which sector within the consumer space or the financial space I'm chasing, it needs to be domestic facing, it needs to be a quality company. The shorter-term question is a little bit more complex, to my mind. While everybody believes that India, post-Covid gets back into super strong growth, 8-9% and at least that's what the earnings forecast suggests, we are not so confident of that. Our view is that the economy today is very two-faced, there is a section of society whose savings have gone up, who have this pent-up demand and will come through and are already coming through as the economy re-opens but the lower end where the masses are, with a bigger population chunk has lost savings, and has lost income during Covid. We have done a lot of proprietary surveys over the last year and a half, and our surveys confirm this assertion that consumer confidence or risk appetite in the lower end of India is actually pretty poor. We do not expect that on reopening you're going to see super strong activity levels and super strong growth. Therefore, the question lies, what drives growth in December, March and June next year and there's only one thing happening in the economy or one major thing in the short term, which is the monetary stimulus. The abundance of liquidity, the collapse in interest rates, that this can be very powerful in driving demand. So, in the

near term, we are actually very positive on a relative basis of course on the rate sensitive sectors. The financials, autos depending upon timing if you want to time it and real estate The rates sensitives of what we like for a near term play whereas longer term we'd like anything that focuses on Indian consumption.

Just to imagine, India is segregated into two distinct buckets and that these buckets don't interact with each other in anyway is not correct to my mind. You can argue that the incomes of the top bucket are derived from the activity of the lower bucket as well. There is a lot of interconnection and it is difficult to be precise in modelling it but I would assume that arguing that these two are entirely separated, does not make sense.

So, the concept is look, India may not emulate the strong growth of China, the investment-led growth of China because there are a variety of reasons. One of them being that we are a bottom-up country where local governments have far more sane activity levels and for the right reasons as well I would argue but that means is that we will have simply slower growth in China, but steady growth over the medium term. So, you would still get that compounding effect in India as well and at least in the EM context that is now a rarity. So, there are not too many countries of this size where you could argue that you have this assurance. When India goes from the $2,000 per capita to 4000 in 2028 or 2030 or whatever, you’ll get two effects. One is the expansion by itself, so you'll have more consumption of everything, but you also have J-curve effects in many commodities with a prior tipping point where will have sudden accelerations in category growth. You will see growth in newer consumption patterns along the lines of the per capita GDP growth. So, that is where I think bottom-up PNL modelling, bottom-up company analysis needs to be focused on what are those categories where I can a, get the expansion of the market, b, where I can get some J-curve effect as incomes start to grow and that's what I think investors at these valuations particularly need to look at. It is easier than done but frankly, but I think that's where effort should go