India’s Rural Economy May Have Bottomed Out, Says Enam’s Sridhar Sivaram

If you see the overall performance of emerging markets this year, most countries have given at least 15-20 percent returns. If you look at China, it’s up almost 45 percent this year. We have seen a broad-based rally and also barring India where the GDP numbers have been coming down, most economies are seeing a marginal uptick in their GDP growth. Most emerging markets have seen good GDP and earnings performance. I don’t see that faltering too much. Maybe given the strong rally, we could see a pause in the rally itself.

Lot of it is well documented. That India is going through some structural reforms. In the past, we have heard complaints from many market participators that we haven’t seen reforms. Very often, when you see such structural reforms, it does have its own pain which comes along with that, which we are seeing with GST and demonetisation.

I believe that tax rates should be lower. I am very happy that the government has reduced the excise duty on petrol and that has been our constant request whenever we meet bureaucrats. When indirect tax is very high – it is a very regressive tax because the rich and the poor pay the same tax. On prices of petrol and diesel, the taxes are so high that it does have an impact on overall consumption in the economy. This is the easiest way of transferring wealth. If you reduce Rs 2, then in a 6 months period you can transfer Rs 15,000 crore of wealth to people who are using petrol and diesel, which is almost to everybody, starting from a taxi guy, autorickshaw guy, truck driver or a middle class. We think this is very positive. One of our suggestion was that it should be reduced even more and you can offset this by selling some of the assets that the government has, which is the SUUTI stake they have.

I think that we need some booster because what we have done with the two structural reforms is, we have shaken up the informal economy – both demonetisation, and GST. And keeping in mind that they were a large part of the consumption economy, we do see a slowdown in consumption. Which we have seen over the last six months. It will continue for a while, if the government had not given some fiscal stimulus which they have already done. We think that a monetary stimulus would have also helped but the RBI needed to do this much earlier. In fact, in February when they changed their stance based on an average inflation number of 4.5, we made the point that the number is so outlandish that we can never reach it. We almost needed 12-15 percent month-on-month inflation to reach that number, it was so absurd. I believe the RBI needs to give an explanation as to how they got the number, now that they have reduced it. So, instead of changing the stance, the time to give the monetary stimulus was sometime in February, March or April. We saw inflation coming down to 1.9 percent. Now the scope and room is much lesser because we are going to head towards inflation closer to 4.5 percent. Even then, I believe monetary stimulus is possible because RBI has given a range, which is 4 percent +/-2 percent. So, it is still within their range. When growth is lower, the central bank has the leeway to stimulate growth along with what the government is doing. But that’s best decided by the central bank.

It is reasonably clear from the government’s policies that they are not looking at the election or election-related moves. Demonetisation and GST hurt some of their core constituency which is small traders and people who are in the business community. It’s very clear at this stage that the government is looking at some structural long-term reforms and I am very happy that they have done that. We will have to wait and see how it progresses as we reach closer to 2019.

Doubling of farm incomes by 2020 seems like a very ambitious target and they really don’t know what the roadmap is. For that they will need to do multiple agri reforms which include pushing the state governments since a lot of these are state subjects – the APMC and the mandis and the way they operate, prices that farmers get, building of cold storage as there is wastage when it comes to fruits and vegetables, and how the government addresses many of these things.

We saw some early signs of recovery in earnings in the second half of last year, which is just before demonetisation. The fourth quarter saw earnings growth of 15-16 percent. Then we had GST and we had a sharp earning downgrade. We are hearing that a lot of it is because of destocking and some of this has played out in the the current quarter. Because there was destocking, we are seeing some restocking and earnings would pick up in this quarter.

It has to be seen in the context of where the interest rates are. The cost of capital right now is much lower so people are giving a much higher market multiple. I may not completely agree with all valuations of companies that are trading right now. There are pockets where we see valuations are quite stretched. It’s a balance that one has to maintain at times like this, where liquidity is strong, earnings are at best average, but the market is pricing in a lot of growth. I am not very bearish on the market. I don’t see market correcting too much. Given the strong upmove and far from buoyant earnings, we could see sideways movement for a period. We have seen the market hit 10,000 in July and we are still in and around that. If in another  4-5 months, the market is trading in the same area, we would start discounting next year’s numbers. Hopefully, by then GST and other factors could stabilise. That gives us an opportunity to get good earnings growth.

Consumption, commodity, capex.

Not all NBFCs. But I have concerns about housing finance companies in particular. Because these companies are no longer mortgage companies. Almost 40-45 percent of their loan book is now to builders, to LAP [loan against property] or to corporates and only about 60-70 percent is mortgage. And you can’t make money on core mortgage because banks are very aggressive there. If you can get mortgage at 8-8.5 percent, it’s very difficult for an NBFC to make money. So they make more money by taking higher risk. If this was the portfolio for a bank, the market wouldn’t have given a one-time price to book and we are seeing the market giving 5-6 times price-to-book because it has very stable NPA portfolio. My own belief is that with GST and demonetisation many of these housing finance companies will face issues, especially on LAP. People say they lend based on cash flows which are not there in the books and they are very good at analysing some of this. This is a challenge and I would be very careful, especially with the ones which do not have enough mortgage.

Demand is not great. From the reports we get and the available reports in public domain on the vacancy of finished houses, it is very clear that demand is poor. Along with the Real Estate Regulation Act, there is also a GST element to real estate now. Maybe it is not very well documented but there is an anomaly here. If you buy a finished house, there is no GST. If you buy an under-construction house, you have to pay GST. So, I as a consumer am better of buying a completed property because I save 4-5 percent on tax. If I am a real estate developer, I want my investor to come in when the construction is on because I get offsets. But there is a conflict of interest here. The real estate builder is not always passing on all benefits to the customer for the offsets that he is getting. The smart buyers are waiting out, not wanting to buy when it is under-construction because he has to pay 4-5 percent more.

It’s a consensus that you are better off with the private sector but we are looking at some state-owned banks. We believe that the entire bankruptcy procedure currently underway will have significant impact on the banks because it will have a time-bound program where you have to finish the restructuring of an NPA within 6-9 months or it goes into liquidation. Many of the banks were hesitating to sign on the dotted line because they were worried what would happen – CAG audit, CBI inquiry and stuff like that. Now, that this is a very documented regulatory process, and we have an RBI Oversight Committee for this, I think the process is much more streamlined. Closer to January-February we will get much more clarity because by then we would complete six months with the first 12-13 cases which went into bankruptcy. We think that banks have already provided in the range of 40-50 percent for many of these cases. We don’t think too much more is required to be provided, especially on the steel companies, they may have to provide for some others. But the good part is at least we know what the loss is. Otherwise we are all guessing. Everybody has their own numbers on how much loss the banks have to take.

I will give you an example. In 2007 and early 2008, there were two blockbuster IPOs and we didn’t participate in either of those. The first was around Rs 500 which went to around Rs 1,200 in six months, and in a years’ time it was in two digits. So, markets can be irrational for a period of time. It can test the investor’s patience and his ability to analyze and rationally think. And one doesn’t have to participate in everything that is going up. If you get stuck in some of these IPOs that are coming are massively overpriced. I can’t even imagine why I have to pay these valuations when I am getting similar and slightly better companies at a much lower valuation in the listed space.