This week on Thank God It’s Friday, Arvind Sanger, managing partner of Geosphere Capital says the U.S. market will remain rangebound after the significant Trump rally that we saw since November last year. India, he adds, remains one of the best emerging market growth stories.
Here are edited excerpts from the interview.
Donald Trump has repeatedly spoken about tax cuts and trade wars which has led to a stronger dollar which is detrimental to U.S. trade. What is your outlook on the American economy, the dollar and do you really think that the U.S. equity rally is likely to pause now?
I think there are confusing elements to Trump’s economic philosophy. Clearly, on one hand wanting to have lower taxes and less regulations, especially rationalising U.S. corporate taxes, is a good thing. On the other hand, trade war is a dangerously negative thing that can spiral out of control. On the dollar, there has been some noise from the Congress on a Border Adjustability Tax which will put taxes on imports and give tax reports which would cause the dollar to strengthen. On the other hand, Donald Trump wants a weaker dollar because he thinks other countries are manipulating their currencies to weaken them to help their exports and their manufacturing inexpensive in the U.S. So I think this mismatch of mixed messages, I don’t think there is going to be some clarity in the inaugural address today. So those mixed messages are going to cause the market to remain somewhat rangebound after this really significant Trump rally that we have seen since the Presidential elections till we get clarity of what’s coming, in which direction is Trump and his administration and Congress, which areas are they going to emphasise on first.
Donald Trump is also been talking about outsourcing and bringing down drug prices both of which have negative implications as far as the Indian technology and pharmaceutical companies are concerned. How much of all this talk will materialise in terms of concrete policy action?
There is a Bill in Congress to raise the minimum salary for H-1B visa applications, $1,00,000 a year or somewhere in that range. That clearly would have some negative effect on I.T. outsourcing. Although it could accelerate more offshoring versus more onshoring. So the the results could be mixed. Similarly on the pharmaceutical industry, trying to talk down drug prices is a negative but one of the ways you get lower prices is to encourage more generics which would benefit the Indian pharma industry. I think the devil is in the details and time will tell as to how much of his Twitter-shaming of U.S. companies will continue. Because the reality is, if they put in place some policies, let’s say $1,00,000 for H-1Bs, that presents a framework within which companies can decide to outsource with more offshoring than onshoring and I don’t think it will necessarily have the desired effect that Donald Trump wants. Donald Trump is an unusual president in wanting to name and shame companies and that’s what creates a huge amount of uncertainty in investors which is what I think will worry the market. Is he going to be happy with policy action or is he going to micro-manage things that don’t give the desired results of what his policies are trying to accomplish.
Over the past three months, if you consider all the emerging markets, the rupee as well as Indian equities haven’t done as badly as some other emerging markets. What does this mean for fund flows in India? Should fund flows return to emerging markets, will India see relatively less allocation? Are you expecting fund flows in the emerging markets in general to remain subdued for at least some time now?
For sometime yes, the fund flows will remain subdued. The reason is that if there is a Border Adjustability Tax that could be very dollar strengthening and that would cause emerging markets to look less attractive. But if the Border Adjustability Tax fades – that I think would be the biggest concern in terms of dollar versus other currencies – if that possibility fades then we start to look at the emerging markets and eventually, emerging markets will come back into focus with or without a Border Adjustability Tax. But that’s just one major hurdle. But absent that or past that, I think emerging market fund flows would be driven by growth. At the end of the day, we as investors are looking for where we can find the best to growth opportunities and India still remains, notwithstanding the hit it’s taken in the short term from its own demonetisation decision, it still remains if I look at a 12-month perspective, one of the best emerging market growth stories. And you have got some catalyst. You have got budget coming up in India, you have got GST which is going to be rolled out hopefully by mid FY18. Those are all going to provide some positive reasons, provided they go the right way in terms of investors wanting to revisit the India story and take the money that has been going out starting to come back into the India market.
The Central Bureau of Direct Taxes has put on hold a circular on taxation of indirect transfer of shares. Can foreign investors expect to see statements/policies from the government that could cheer foreign portfolio investors? If not, will a status quo be a dampener? And worse, what if the government makes noises about more taxes?
That is one of the negatives, because every few quarters you have some statement from somebody in the tax department coming up with new ways to tax foreign portfolio investors (FPI). We had that instant a few quarters ago and then we had one in late December. It is unfortunate that there doesn’t seem to be better co-ordination and understanding or some kind of a panel that the finance ministry could put together to run ideas by investors to get their feedback. You can make your own decisions but at least get feedback before putting out half-thought out statements which cause unnecessary turmoil. The important part of the Indian investment scene is the FPIs and you cant afford to treat them like prize but I think that if there is some kind of long term capital gains tax coming and we already know the Mauritius treatment is going 50 percent in financial year 2018 and then going away completely - the tax differential. But if there is something coming then there is already the security transactions tax and some long-term capital gains. I would say that investors don’t mind stability and predictability. What investors dislike in India and India seems to specialise in this is periodic, arbitrary instability and that serves nobody’s purpose. It does not serve India’s tax collection and it serves no purpose in investors being able to make predictable investment decisions. So it is not so much that taxes are bad. A reasonable tax, as long as it is predictable and long term is good, keeping in mind that the U.S. is going to lower corporate taxes and lower capital gains, you have to compete in a market of global capital flows and corporate investments so India has to keep in mind that its tax policy cannot be ‘zigging’ while the U.S. is ‘zagging’ and that would make India potentially less attractive. So keeping those global constraints in mind, predictable tax policy is more important than whether or not there are some modern taxes in India.
Do you think we are likely to see a populist Union Budget given the upcoming state elections and probably the need to soothe rural economy post demonetisation?
Yes, that is one of the concerns. Frankly, a populist budget which either expands the budget deficit or invests whatever tax collections might be coming from improving growth into populism rather than into encouraging capital investment and encouraging more sustainable growth would be a negative from an investor point of view. So when we look at the budget which is only a couple of weeks away, we are a little nervous about how much populism will get in. Obviously ahead of an important state election, there will be some (populism). How much long-term investment and capital formation encouragement will be there in the budget will be the competing challenge that the government faces. How they address the challenge will determine corporate confidence. And investor confidence will follow because we know that corporate capex and corporate spending has been extremely weak over the last several years. So we would like to see elements that provide encouragement there and not focus on populist measures.
When it comes to quarterly earnings so far, earnings have not been overly upsetting, especially considering the demonetisation. But there are a few who suggest that earnings recovery will take more than just 2 or 3 quarters. In addition, you will also have companies adapting to GST once GST comes into play. Based on that, what is your outlook when it comes to earnings?
Yes, this quarter hasn’t been as disastrous or negative as it could have been given the demonetisation and its potential negative effect on demand in the second half of November and December. So in that sense it’s been a positive surprise. But I would say that as far as earnings recovery is concerned, March quarter is still going to be a transitional quarter because you could have some amount of inventory in the system which got pushed out in November but which stays slow. So that could be a negative. But on the other hand, GST will also create some turmoil. But I think we have been through several quarters of disappointing earnings before the demonetisation. So at this point, I think we are seeing green shoots in terms of things like auto demand coming back, short-term demonetisation notwithstanding. You have to see how electricity demand is doing, see cement demand recovers from whatever effect on real estate it has had. And other metrics that will suggest the economy is starting to recover and if GST causes a bit of a delay, that will cause a market recovery to be muted till we get the full effect. So that remains one of the challenges – earnings recovery in India continues to find reasons as to why its not as strong as we hope.
What are your preferred areas of investment in India right now?
Our preferred area of investment would be more bottom-up than top-down. We clearly are focused on domestic demand-focused companies in cement, NBFCs, also consumer demand areas. Whether it is in an FMCG-type of sector or be in the dairy area which is very interesting to us where there has been a lot of growth visible. So there are specific bottom-up companies which happen to fall into these buckets. But as a broad rule, we are more interested in India-facing than in U.S.-facing companies. So we are not interested in IT and other areas where there might be more headwinds. We are more interested in domestic demand-focused sectors, whether it is the auto sector – two-wheeler, four-wheeler or auto components or CVs which are other areas where we don’t currently have investments but we would look at with interest because those are domestic facing. Where we think again if you are taking a 2-3 year view, there is cyclical demand recovery that should be coming given how weak demand was for several years. We have had 1-1.5 years of demand recovery but we think there’s a lot more to go in the demand cycle.