Elections 2019: Privatisation Only Way To Meet Fiscal Targets, Says Manish Chokhani
Manish Chokhani advises against missing fiscal targets. And to provide much-needed capital, he advocates privatisation.
India needs land and labour reforms in the next two months and must step up urbanisation to solve the agrarian crisis, according to Manish Chokhani, director at Enam Holdings.
“Most economies have less than 10 percent of their population directly involved in farming and everybody else moves into secondary and tertiary sectors,” he told BloombergQuint in an interview. “India can’t be the only country saying that in a commodity sector where prices are structurally trending down globally, we not only want to support them and give them higher prices, but also want to let it remain fragmented instead of consolidating the sector. That should change.”
Also, interest rates must be lowered, he said. “In a world of negative interest rates, India can’t afford to pay such usurious rates.”
But he advises against missing fiscal targets. And to provide much-needed capital, Chokhani advocates privatisation.
“We are holding assets of a trillion dollars on one hand, which barely yield 2 percent return, and paying interest which aggregates to roughly one-third of the total revenues. This completely foxes me,” Chokhani said. “If India were a company, you would have sacked the CEO and the CFO.”
On Equity Markets
Chokhani said while the markets have remained narrow of late, if India can boost exports, industry and consumption, the boom will be more broad-based. If not, then investors will fall back on the income J-Curve of India, which would lead to consumption-oriented stocks being bought.
Watch the full interview here:
Here’s the edited transcript:
What happens next after this decisive mandate? Is it continuity of what has happened in last five years in terms of reforms and decisions? Or do you think there is mandate and opportunity to do something bigger?
I do believe that the mandate which has been delivered by the people of India to the Prime Minister is unprecedented. I only remember when Rajiv Gandhi had 400 seats. Even then he had 150 people in opposition. I don’t think in the current dispensation when National Democratic Alliance looks like 350 seats but YSR Congress, the Biju Janata Dal or others are going to be supportive. The mandate is unprecedented. Given the way the composition of Rajya Sabha is going to be changing within the next 12 months, the control that the administration will have of upper house sets the stage of very, very deep-rooted and substantive reforms possible in the country.
Whether you should expect continuity of reform on a linear basis or can it go non-linear and be a little deep rooted than what we had and go into second generation of reform, my hope and expectation now is that it is possible. If you would have asked me before the election results that if the mandate had been like 230-240 seats to the BJP and coalition and so on, may be the answer would have been no. But seeing the scale of the mandate and stature of the PM is not being lifted up and the aspiration which seem to have been unleashed in the country, I think that very deep rooted reform is likely to happen.
Also, when I put logically on what they are trying to do with the old manifesto which the BJP released saying that they will do $1.5 trillion of infrastructure spend in the next five years which is roughly $300 billion a year which stands at 10-12 percent of GDP. If that’s the level of investment which has to be done for infrastructure and let’s not forget we have to add it for education, healthcare and also social spending, the fact is that government doesn’t have the fiscal space to do it. As we approach the budget, we will see that the spend we have been doing in union budget is 3 odd percent of GDP is being spent only on interest. Given that the collection of government is barely 9 percent of GDP, it is unsustainable.
One is, the come back of the word “privatisation” which was there in the first Atal Bihari Vajpayee regime. It seems to me inevitable and it has to happen. The previous administration has in fact put 88 companies out for complete sale. But because they were very minor and people din’t really notice them, we felt that privatisation is off the agenda. I think it has to be back and central to the agenda of this government.
Second is, what happens to people in rural distress. What happens to jobs? Again, it is the reality of life that you cannot wish away the fact that agriculture is a commodity and employment and agriculture of low paying and income levels are not easy to lift up. So, you can do your best by increasing value addition by doing food processing or you can improve distribution change to ensure that the farmer gets the lot more. The reality of life is you cannot have 60-70 percent of India employed in farming sector and there is no alternative but to pull them away from the farm into cities and higher-paying jobs. Only way to do that is to create lot more urbanisation, industrialisation and service sector jobs which will also then require a lot of investment in the cities. It is counter intuitive but if you see the agrarian crises you have to urbanise a lot more and lot faster. I would expect a lot of that as well.
Third is, when you get this industrial engine going with the way the trade set up is globally and people want to move away from a single source of China, India should be a natural beneficiary of it. We are currently losing that trade away from Vietnam, Bangladesh and others in textile. It cannot come to India until we fix our land as well as our labour sector which has been very inflexible in the past.
We have to addresses these three-four major areas within the next couple of months. And then of course it plays out over the next five years.
You mentioned strategic privatisation. May be the government will give the list and act on it quickly. A lot of people speak about how if it had happened effectively and on time with Air India, it could have been a different thing altogether. If you look at numbers closely, would you reckon that one big income stream could be streamlining GST in a way that the monthly collection is higher than what it is right now? One would assume that they went through this exercise not just for having a patch which was anyways coming through tax methods. The ambition would be much higher.
There has been too much focus on GST rates. I don’t think the rate of 18 percent is the correct rate. I think the rate has to trend down. The finance minister already said even before going into the election that his aim would be to bring down from five slabs to 2 or 3. Eventually, we have to move to one slab.
The focus should not be as much on the rates as much as on velocity. The issue is that we have put a spanner in the works of a number of things by trying to be acute on what the revenue neutral rate is as opposed to saying that we can increase the velocity of trade. Then the actual collection becomes higher even with the low tax rate. They have accepted that reality in direct taxes by putting rates down for individuals and saying that with lower tax rates people will become more compliant and therefore our tax collections go up. They haven’t accepted that logic when it comes to GST because presumably, they have to take all the state FMs and bureaucracy aligned. But it seems unnatural, for example we pay 28 percent GST rate on cement which is going to be building block of infrastructure and housing boom that lies ahead of us in India. Similarly, while it sounds very cute that how can I charge a Mercedes car owner and Maruti car owner the same tax rate, but the reality is if Mercedes car is sold at a crore even an 18 percent tax rate means Rs 18 lakh collection. As opposed to saying, if I keep the rate at where it is currently which is north of 50 percent, there is no sale of that car anyway. So, you have zero collection of it. Would you rather have Rs 18 lakh and sell 10 cars or rather have zero by selling no cars even if you keep the rate higher?
GST needs to be fixed and made simpler and hopefully that’s the direction which they will move.
Three areas of immediate spend money that one can think of when they see what this government needs to do. One is, rural reflation because that is urgent and pressing need. While urbanisation and industrialisation will solve this issue over the long term but in the near term it will see the rural inflation and may be some spending there. Second is, NBFC and liquidity issue which seems to have gripped and some amount of intervention is necessary. Third is, infrastructure spend which you alluded to which is very high number. How does a government which is already stretched on its balance sheet meet all of this in the near term? GST rates is not in government’s hand and strategic privatisation will not happen in next two-three months necessarily.
It is not a question of two-three months. The thing with financial market is, whether it is rupee, equity market, debt market, is what you believe is possible and those rates will start aligning very rapidly. Illustratively, if government does not put Rs 80,000 crore disinvestment number, but we say over next five years we want to sell $800 billion worth of strategic assets which were sitting on and will include public sector units, departments of government, lot of land which we are sitting on, and so on. The capital is actually sloshing around in the world. Even if you look at it, I would not imagine somebody saying that we will buy into the Reliance refinery or petrochemical business and pay $10-15 billion for it. The reality is there are people who are looking for economies like ours where there is growth when there is certainty and profit of return of capital, along with return on capital because there are not many opportunities of that scale available in this world. If indeed we have to go down that path, then privatisation becomes the center point of what we have to look at accompanied with labour reform and so on.
The point you made for distress in the farm sector is counter-intuitive to think. That whatever the government will do to push money into farming sector is going to be counter productive in a way. Because if you do agriculture product price support which the earlier UPA did then you end up with inflation which then gives you higher interest rates and weaker rupee and it’s backs to inflation cycle again. So, it became self-defeating. If you do minimum income support, you came back to same vicious spiral of inflation, interest rates and so on.
The reality of life is, and we have to accept it, that farm income is the lowest form of economic activity anywhere in world which is why most economies of the world barely have 10 percent of the population employed directly in farming. Everybody else moves into secondary sector which is industry or the tertiary sector which is services. As we go more and more into the knowledge economy, the skill level has to be greater. India cannot be the only country against its grain and saying in a commodity sector where prices are going down globally, we not only have to support them and give them higher prices but we also have to let it remain fragmented where in every industry and every sector in the world when you have that level of commoditisation, you get consolidated and become two-three large players who can then afford and hold on to drive efficiency and cost down.
So, there is no escaping this and you are just making short-term band aid fix by putting some money in the rural sector for a couple of months but I don’t think if you are going to measure this government over the next five years, then that’s the only approach which we can bring in the farming sector by putting money into the farming sector, trying to clean up distribution chain and trying to encourage more food processing. Without moving 80-90 percent which is dependent on farming to get of the farms, I don’t think we will achieve what we get to.
Also related to this is when you want to increase the per capita income of India, that per capita income only goes up when there are better paying jobs. That’s why you have to be that much more competitive with jobs with the rest of the world whether it is in industry or the services sector. Remember, we are staring into the abyss where the world is going into robotics and artificial intelligence. So if you have to employ over a billion people and they’re all coming of the working age right now, with the skill level that we have currently sitting on our farms - and becoming at best delivery boys or security guards - you may notionally have employment but that is not the right level of employment for these people. So that massive skilling, industrialisation, urbanisation has to be thought through and our aspiration has to be to compete with China, not with the previous administration of the UPA.
As we approach the budget and the RBI policy is slated to happen in the next 10 days, would you think two of the things might happen? One, would there be further easing? Lot of people argue against quality of expenditure worsening off and in favour of consumption largely. Second, would you believe that there might be a need because the global economy and growth is shaping up to have a slackening of fiscal prudence that they have stuck to right now? Purely, because it might be the need of the hour.
In a country where 80 percent of population doesn’t touch the organised sector, whatever you do in interest rates will not solve the supply-side problem. When we have agriculture price inflation and when we put interest rates up, I don’t think your demand slackens because your interest rates are up. I don’t know what you achieve, except eventually the rates are up, your economy on industrial side slows down because no one on that cycle are to borrow at those rates. The rupee collapses and you import inflation through higher oil prices and higher commodity prices from overseas.
If your industrial indices are slowing down, exports have done nothing for five years, the consumption side of the economy is slowing down, and the government balance sheets looked stretched, then what are we achieving by keeping interest rates up? Interest rates have to tend to much lower level than what we have today.
In a world where $13 trillion of government securities are sold at negative interest rates, where the world is just happy to get the money back, they are willing to take loss on interest. We are the sixth-largest economy in the world and hoping to be third-largest and continue to pay this kind of usurious rates of interest to people. While capital needs to be more productive in India, but the rates in India completely fox me of where we are heading with this.
If you turn through the government balance sheets, the myth that we can let go off fiscal prudence and because every year we will have a crises in India, then we should live with 3-3.5 percent...it is a wrong policy because you are holding assets of a trillion dollars on one hand—which barely yield a return of 2 percent—and you are paying interests on the other side which is aggregating to the third of your total revenues on a real basis on what the government collects.
It foxes me that how this country runs its finances. If you have to look at this as a company, say this company earns 9 percent of its GDP, it spends 12.5 percent of its GDP, and its borrowing is therefore 3.5 percent of GDP, and its interest cost is 3.5 percent of GDP, then you would have sacked the CEO and CFO of this company.
Fiscally, there is no alternative to government getting out of business. When we started off it was trillion dollars of assets, if you add up where are we running. Not only Steel Authority of India but why can’t we have capital available to railways, life insurance? Why can’t we sell and monetise the government land? Why they just sit on this building and why can’t they rent and pay for administrative charges? Why can’t we reduce the administrative—of what we call SGA a burden—of having fewer employees and better use of technology? That kind of deep-rooted reform is the pressing need of the hour.
To me, the first steps of it should be shown in the next 100 days. There are already committees headed by Bimal Jalan on administrative reforms. There are committees set up through DIPAM on what assets can be sold off.
So, the information and knowledge are all there. I think it was political will that was always questioned, and now that the political space is available through this mandate, I can pray to god that India finally delivers on its potential and we can match up to the expectations that the young people of this country have.
Let’s take the assumption that some of these were to take place. What is it for somebody who is looking to invest in India: would there be growth, which is broad-based because benefits of such moves percolate—not only to a few things but larger portions of the economy—and therefore may be more companies and more sector would come back to growth? Would that happen and is that great for the economy and markets?
You admit that every single time we see highly valued companies, they add another 10-15 percent every single year. HDFC Bank is a case in point. Now Bajaj Finance has taken that step. Do you think market continues to remain polarised on valuations and returns? Or do you think it will become more broad-based?
I am hopeful that it becomes more broad-based. To put things in context, while the Indian markets is about $2 trillion in valuation, it is very narrow because top six companies are 25 percent of this—which is $500-billion valuation. The next 18 companies are worth $500 billion. So, among 23 companies you have covered 50 percent of India’s market cap. Then there are 45-odd companies in the next quartile. So, roughly 70-75 companies and you have covered 75 percent of India.
For a country of this size which is aspiring to become the third-largest economy in the world behind the U.S. and China over the next decade, it cannot be so narrow, and it needs to be more broad-based.
Because this “broad-basing” of the economy has not occurred due to issues, which we had of not going through reforms that were unleashed 20 years ago. In some sense, we have remained the shriveled economy compared to, say China, while we were equal 30 years ago. Now, China has become six times our size.
If the right things happen and we can broad-base between exports, industry and consumption, then naturally the boom will be more widespread. If things happen incrementally and sector by sector, probably there could be more rotational moves over there.
If nothing of this sort happens, then people will fall back on the good-old Indian theory of the “Income J-Curve of India”, where 2 percent of India is car owners, 18 percent of India is two-wheeler owners and 80 percent of India is either walking barefoot or is on bicycles. The hope has always been that the 2 percent people will become addressable by the 18 percent people, and therefore it can be a ninefold expansion over there—that the two-wheeler owners becomes car owners. Similarly, the 80 percent people will become two-wheeler owners.
That’s why you keep seeing high multiples for consumption-oriented stocks in India.
I have used this example to make the point. Because when it comes to toothpaste, detergents or FMCG, penetration levels are there. It is only a case of up-trading—from say a Lifebuoy soap to a Dove—through price improvement rather than volume consumption.
In consumer durables, there is enormous scope to add number of consumers as well as get them to trade up. I don’t know if that helps you, but that surely the paradigm through which most investors will approach this market.
Tell us about something that you have seen in the recent past, which could’ve become reality and could present an investment opportunity. One sore spot that a lot of people have is that a large portion of consumer economy is not getting represented on the index and therefore it is not possible for people to buy. Any of the online sales and most car companies are not quite there.
What is it that is happening around the world which can get replicated in India? And can the listed Indian space offer an opportunity to investors?
That is the question which is foxing a lot of us—investing in public markets.
If you look at 75 companies, which control most of the market cap in India, a lot of it qualifies as what I call the old economy. In the rest of the world, no one is bothering to buy the equivalent of a GE, or a Siemens or a Bechtel.
While we will have this boom, and hopefully it lies ahead of us, while we spent on infrastructure and industrialisation, these are not sectors where you get high multiples because they won’t excite most global investors. They will be more excited about consumer, tech and financials but the multiples are elevated for most of the companies over there.
If I look at the Indian tech sector, the aggregate IT sector probably makes $10 billion of profit. If I compare it with other tech sectors in the world, an Apple alone will make north of $60 billion, and a Google will make $50 billion and so on. Even if you look at China, a big run in their market caps came where Tencent, Baidu and Alibaba created hundreds of billions of dollars in market capitalisation for them. It lifted the economy and the jobs which are occurring in the economy.
The only play that you have in India of that magnitude today, is Reliance and Jio. And how you would value them and what strategic deals they end up doing is the only large play available to Indian market in that space.
The other areas where unfortunately we have to look at is effectively Walmart has bought Flipkart. Alibaba and SoftBank between them have bought Paytm and they are probably trying to create an Alibaba over here. We are copying the model of Uber by building an Ola over here. We are copying the model of Airbnb by building Oyo Rooms.
There is nothing original coming out of India, which then remains addressable to the Indian investor and which then addresses the rest of the world.
So, people are willy-nilly falling back on consumer brands. The FMCG companies are trading at absurd multiples in a world which is becoming Amazon-ised.
As these online retailers figure out more about their consumers and they start putting out their own products, getting rid of 35 percent distributor and trade margins, their products become cheaper and more tailored towards consumer needs. This starts effecting the global brands as well. For example, Dollar Shave Club knocked out Gillette’s valuation globally. Warren Buffett, who is the holder of P&G, had to come out and admit that’s what happened over there.
Seeing where the world is going, with the way technology is moving and innovation coming in, I fear lot of India looks like a very old economy. For a country, which believes its destiny is to go from No.6 to No.3—maybe we’ll cross France, Germany and the U.K.—but when we eventually approach the U.S. and China, we have to get innovative in the next 10 years.
And sadly, you don’t see enough of that happening as yet. It is not because of lack of capital—because now it is available to India. It is also not because of lack of talent here... I think may be it is lack of will or lack of ecosystem. This is the space where I would expect the next big $50-100 billion company to come out of.
From a more immediate perspective, there are certain large trend lines that you can play in—the financial space, for example, which is everyone’s favourite.
The financialisation of India is starting only now and thanks to goods and services tax, demonetisation, etc., people have moved away from gold and real estate to putting more of their money in financial savings. Here, the trend line in the long term is going to be in favour of private sector banks as opposed to public sector banks. It is going to be a lot in favour of mutual funds—across the world mutual fund deposits are larger than bank deposits, but in India it is a fraction of what bank deposits are.
So, there is a big headroom for the mutual fund industry to grow in India—and similarly for a lot of other sectors in the financial space. But the financial sector is already 40 percent of our market cap. There can’t be just one engine driving us forward.
So, we will have to find new export engines, own Indian IT services, own Indian generic chemical and pharma-based businesses. This model is not that interesting, you are not going to make 50-60 multiples in those businesses. They have to take that cash flow and redeploy it into more and more innovation.
And newer sectors—whether it is automotive or engineering, textiles or tourism—will have to emerge to attract inflows, both from the forex perspective and utilisation of labour, and also the large profit opportunity available here.
So, there are a lot of things which can play out and you have to keep watching all of them. It’s eventually about getting the right opportunity at the right price—when it all really comes together.
From your answer it seems for somebody who is not equipped to go out in the private space and not astute of global trends and try and figure out what will happen here, a lot of other options are hop trades.
The only option which is not hop trade is financials, which is already a large portion of the market and therefore don’t know how much it will move ahead.
The (financial) sector’s valuation may be, in aggregate, 40 percent (of India’s market cap) but within the sector there are interesting companies. People, included me, have benefitted a lot from a HDFC Bank or a Bajaj Finance, but even these companies offer you stunning valuations at different points of time. Six months ago, Bajaj Finance was as low as Rs 1,900 (per share) in the middle of the NBFC crisis. Similarly, HDFC Bank—before its ADR and QIP—had actually come to a very reasonable price... The whole mutual fund space is interesting. There are companies which are equivalent to, say Bajaj Finserv, which could be really interesting to look at.
So, while the headline looks expensive, people do their homework and there are enough things to do over here. The media sector looks interesting. Automotive is flat on its back, but India cannot be a three-million car market or a shrivelled two-wheeler market, given that there are so many people yet to come to two-wheelers and two-wheeler people yet to come to the cars. The Chinese auto market by volume is more than 10 times and by price more than 4-5 times of India’s. So, it is 50 times a bigger market than India.
And it’s not like they are smarter than us or they are more organised than us... It’s the matter of putting a policy framework together and creating conditions for that kind of growth. Some time in the next 10 years if this happens, that time may be a 40 times larger company than what it is today, you will probably pay a higher price for something like that in bad times like these.
There is enough to do, is the short point I am trying to make.