Customers talk to a banking officer in a HDFC Bank branch. (Photographer: Amit Bhargava/Bloomberg News)

Stronger Dollar And Demonetisation ‘Disaster’ Double Whammy For India: Madhav Dhar

This week on Thank God It’s Friday we spoke to Madhav Dhar, managing partner of GTI Investment on three key triggers - India’s demonetisation drive, what U.S. President Elect Donald Trump means for India and the interest rate trajectories of the Reserve Bank of India and the U.S. Federal Reserve.

Given the way the macros have been shaping up and the way the markets have been moving, the Street has been speculating on the U.S. and the Indian central bank moves both of which will have implications for the market. What are your expectations from these central banks?

The U.S. is ending a cycle of extremely low interest rates and the Fed is starting to raise rates after 6 or 7 years. And India luckily has been on a very different side where structural interest rates and inflation have been heading down. So we are expecting the Fed to hike and the RBI to cut which actually puts India in a fantastic position, relatively speaking. The markets in general tend to do poorly when the dollar is strong and U.S. interest rates are rising. But Indian macro situation, before demonetisation hit us, was shaping up very nicely in the sense that economy was starting to recover and accelerate. The impact of demonetisation will take a quarter or two to play out. I’m a little worried about that.

The U.S. markets are at lifetime highs and lot of people are of the opinion that Trump’s economic policies are going to be more about politics than data. What do we know, what do we not know, and what sort of implications will some of these factors have on policies which will affect the United States and consequently global equities?

What we know is that he has a predisposition for lowering taxes, he has a predisposition to reduce regulation and I think those two things are broadly what has lifted the markets which has confounded people who expected the markets to go down on a Trump win which never made sense to me because he, definitely in terms of his basic platforms,...they are market-friendly platforms. So we do know that. What we do know is also that he has gone way out on a limb to say that certain trade positions have to be renegotiated or revisited at minimum, whether it’s NAFTA whether it’s the Trans Pacific Partnership and so on. So in that sense the risk premium on what happens to America’s interactions with the rest of the world has gone up, that risk premium has gone up. We do not know what the action on that will be or how negative it will be. We do know that that is a concern. The third thing we do know is this is a an inexperienced man for the job, doesn’t mean that he will do poorly but we do know he’s inexperienced.

Okay so I am going to come to the issue of demonetisation. According to the last report we have about 11 lakh crore worth of old currency deposited with the banks. Should the government be worried about this number because we are only done with November yet. All of December is still left and in your assessment what are those numbers that will determine whether or not this exercise has been fruitful from the government’s point of view?

I think we are targeting just one specific thing. So you have to step back and say what are we trying to do. Are we trying to punish the existing stock of black money? Are we trying, separately, to create an environment where future black money creation will be difficult? Are we trying to create a situation which improves and hinders the funding of terrorism or are we strategically trying to push India to a more digitalised and a securitised platform? So those are four independent things. If your entire objective is vengeance or punishment at any cost, then the experiment is on and then we see what will happen. And if they get...pick a number...75-80 percent of notes come back, then I would say that even from that standpoint this would have been way too high a cost to pay for marginal vengeance on people who already have cash. So I think it’s a misdirected policy misapplied. The objective is very noble, so was gareebi hatao. Who can argue against that? Who can argue against elimination of black money? But how you go about it, what pre-conditions you out in place, what behavioural changes you seek so it doesn’t happen, those are the planks you have to put in place before the fact, and that that certainly hasn’t happened. So before you really put India in a different path altogether, both sociologically and economically, you would have said everybody has to get an Aadhaar card. When they get an Aadhaar card, they get an automatic bank account, then they get a debit card whether they like it or not. So that has to be the sequence. Then you say how political parties are going to get funded has to become transparent. Then you make it clear that tax laws are such that are three or four slabs with minimum changes and minimum deductions. And then you say, after all, that we will give you six months to get out of cash otherwise we are going to come down very hard on you. That’s the way to do it.

You are somebody who believes in buying at points of stress to get good value. Is India under stress currently and are you looking to buy right now?

I am structurally very bullish on India and I will continue to be bullish on India and yes I think conceptually every time there has been some stress in the system, I have stepped and bought and this goes back to 20 or 30 years. But usually you have to think that the stress is being over estimated by the market. So it’s not enough that there is stress in the system, you have to believe that the market is overpricing the stress and the stress will relieve itself. I have to say for the first time I am not against the grain. I mean there was a currency crisis in 2013, rupee went to 68 and the Congress party couldn’t do anything, we were at a standstill, there were scams in the system, I think there was a fantastic path time to buy because I was willing to take the other side, which is people are underestimating that the structural changes in India and stocks are too cheap. So every time that’s happened, I have had a differential view than the market. This time unfortunately, I don’t have a differential view. We are easily the strongest emerging market given our structural situation

Coming back to foreign flows, we have seen a little over $2.5 billion leave our markets since November 9. Before that, we saw another $1 billion move out leading up to the U.S. elections. On the whole, the Nifty was around 8,600 then, it is around 8,100 now, we haven’t seen a substantial correction. So how are you viewing foreign portfolio investors (FPIs) moving out and how are you viewing the participation of domestic institutions and retail investors?

Well to give a very quick and blunt answer, I don’t think at all about what FIIs are doing, ever. And I will tell you why. Those are not leading indicators to market action, those are coincident indicators to market action. FPIs have sold, not because the market is down. FPIs have sold because U.S. dollar is going up and people view this demonetisation move as a disaster. That’s why they have sold. So that’s a coincident indicator, it’s not a leading indicator of market action. So I think this is one of the big mistakes that the observers and the commentators make - trying to figure out what the FPIs will do. If you tell me what the policy changes will be, I will tell you what FPIs are going to do.

Since you are known for your value investing strategy and you said in the past, that you like to sell things which are over valued and where everybody is very enthusiastic. I am assuming that your portfolio before November 8 was not heavily weighed towards financials?

No it wasn’t, but I do hold public sector financials. I own some of the PSU banks and some of the capital goods stocks, the medium-sized companies.

Does the recent correction seem like an opportunity to buy anything in the private banking space or some of the non-banking financial companies which have done very well?

Not for me, too rich for my taste. I think that there is very little headroom for those stocks and they are great companies but I think you are going to have more and more competition, and especially with this thrust to a digital platform, creates even more competition, whether from smaller similar players, or even as PSU banks get their act together.