HDFC AMC’s Prashant Jain Says Tax Cuts Won’t Stem Slowdown Yet. But There’s A Silver Lining

I think that’s right. This is what was happening in India in the last few years. We were going entirely led by consumption and that consumption growth was also supported by falling household savings and rising household leverage. Actually, white-collar wages have been under pressure. So, you could not have continued to grow despite low income through borrowings. What we needed to do was to revive the capital expenditure cycles so that new companies are formed and new plants are put up to create jobs. This will help consumption grow on a sustained basis. I think the good thing about this is that it reverses the negativity in the economy - which is very important. Two, this entire money will go to companies and what will companies do with this money? It is at a gross level, 20-odd billion dollars. Companies will either cut prices which is good for lower inflation and good for consumers, or they will put up new plants, or they will pay more dividends where again, money comes back in the system. So, I think this is a very apt move despite its small fiscal impact. I still believe it is good because the demand for credit is so weak, that I don’t think it will lead to any crowding out on the fixed income space.

See, I think banks should benefit overtime because the three-year window that has been given where you must attain commercial production by 2023. March 2023 will lead to a huge urgency in terms of setting up new capacities. Mainly I would expect the new capacities to come from outside India companies, which are global multinationals. I think Indian companies could also chip in. So, it should lead to enhanced credit growth overtime on the capex side.

I think you are right and in due course of time, that’s how it should play out. I think we must keep in mind that now is an opportune time to do this and why do I say this? It’s because the largest economy and importer in the world- the U.S., and the largest exporter (China) are trying to re-negotiate the trade terms and if you look at the region, Indian tax rates were becoming less competitive; whether as Vietnam, Bangladesh, Thailand, or Singapore, all had much lower levels of taxation.

Indian wages are now much lower than Chinese wages because of the very high growth in China over the last 10 to 20 years. So, the economic support manufacturing in India, China and when some of the factories relocate in China, if you don’t have a competitive enough tax rate, these factories; some of them at least would’ve gone to the neighbouring countries. So, I think this was good both from the local reviving capital expenditure cycle point of view and also for bringing in the advantage of this once in a lifetime opportunity because once the factories relocate out of China to some other geography, they are not going to go back. So, I think it’s a very timely and very apt decision. The fiscal slippage is a very small cost to pay. Look at it this way—in two days, the markets are up broadly by 10 percent. That means the wealth has increased by $200 billion. For 75 percent of the wealth, the shareholders are in India. So, a $150-billion increase and yes, we’ve paid a small price, $20 billion; if you, of course, spread it out over four to five, it will be a bigger amount. But then, if the economy starts growing faster and then I think, the taxes can come back again.

See, the consumption slowdown will not stop, and I think this is the right way to go because you cannot go on consuming without income. And even though people say India’s household debt is below benchmarks at global levels, I think the point that is missed, if you adjust the 20 percent household debt to GDP for the much higher interest rates in India, the interest expense is actually where the rest of the world is. So, I think, you can’t sustain consumption through borrowings. You must earn and then spend. I think, this puts resources where they should go; that is to companies. Only when companies invest in locals and multinationals, that is the only way you can create jobs and bring back consumption on a sustained basis. So, I think, overnight, we should not expect a revival in consumption.

So, people like me are always asked, what’s the outlook for markets and I always respond by saying, I don’t know in the short-run and I think this is a great illustration that the ‘I don’t know’ is the right answer in the short term. But I’ve been optimistic about the markets. Corporate profit growth is recovering in any case because the progress in the IBC has been slow, but it is there. So, I think the corporate banks should revert to normal levels of profitability by next year or by the second half of the current year. I think profit growth cycles were any case reversing and of course, this increases more meaningfully in the short term. I think the interesting point to look at Indian markets is, India’s market cap-to-GDP is near all-time lows and if you look at these markets; both consumer discretionary and consumer staples, it is very cheap. Whatever parameters you look at; whether it is price to growth, whether it is forward or PE multiples, whether it is market cap to GDP; Indian markets are actually quite cheap both in terms of consumers or discretionary staples. I have rarely seen this kind of value in a long time.

I think so. In the non-consumer and IT- pharma space, valuations are reasonable but I think the big change should happen in capital expenditure, in corporate banks, especially.

This whole debate of small, mid or large caps have been a very misplaced one. See, businesses are small or large, is depending on the nature of business. So, if you buy an auto parts company, even if it’s a leader, it’s going to be a small or mid-cap company. If you buy a car company, it will be a large company. So, this whole debate is very misplaced to my mind. I think it makes more sense to discuss along sector lines whether you are in exports or consumption or discretionary or staples, or capex. I think it makes more sense to discuss along those lines. Size is the function of the nature of the business. It has got less to do with growth. So, there are many cases where bigger companies are growing much faster than small-caps but what indeed happened is that in the last two-three years because of the extremely bad NPA cycle, many large corporate banks did not grow profits, in fact profits de-grew. That led to a situation where Nifty EPS did not grow and that’s why small and mid-caps outperformed. And when something outperforms, a lot of money chases that and that stock in a way ran much ahead of the fundamentals.

At least I’ve been of the opinion for some time that the whole argument of small and mid caps growing faster was misplaced and you can go back and see that in maybe 7 or 8 out of 10 small, mid-cap companies; the bulk of the returns come from multiples going up and not from earnings. I think that course correction had to surface. So, I would say, we are in a situation where the returns of small, mid and large caps have converged once again. In the future, the deviation in returns between these two should be less. I think the returns will vary more across sectors and less across capitalisations.

I think it’s a flawed notion that only consumption is quality. I think nothing could be further from the truth. They are good businesses, they have a lot of franchise value so, they are very good businesses. But, this definition of quality, I’ve seen it since so many times in my career. I mean, the same consumer companies were trading at 10 to 20 times 10 years back, 15 years back. So, were they weaker quality then? They were the same quality. We have seen pharma correct 70 percent. Has it become lesser quality? It has not. So, I think, this whole debate of quality at any price and when the definition of quality keeps on changing, I think to my mind, it does not make sense. If tomorrow capital expenditure starts growing faster and consumption does not grow, markets may again shift; what will happen to auto companies? How have they suddenly become a weak world? The business is same.

See, I am not so convinced that volumes in auto will come back in a hurry. One, I am sure the discounts are much bigger already than last year. The retail slowdown in auto actually started last year. See, the numbers what we get in India are wholesale numbers and industry does not share retail numbers. But If you look at the retail sales also, they have been extremely weak for over one year. Pipeline inventories were rising and now, and now you’ve reached a limit of those inventories and therefore wholesale dispatches are coming down very sharply. I think retail sales are not as negative. But I don’t see a situation that overnight, things will change. See, why have auto sales slowed? It is because to my mind that, the wages in India have been weak and the IBC resolution process while it is very good from a longer-term perspective, in the near term has led to several job losses. India’s savings rate has fallen very sharply in the last ten years. Household debt has gone up very sharply. People buy most of the things on EMIs. Why? Because they are not able to afford the cash down.

It has moved down on the priority list. Because the mobile market in India, the handset market, is as large as the car market. Anyone would prefer; if you choose between the two, and buy only one, you’d buy the handset first. I think cars will grow overtime and just one final point on this; you’d be surprised that even in the last ten years, the car industry in India has grown at only 6-7 percent. Why? I mean, Maruti grew much faster because they gained share. So, the car industry was growing at a low volume growth for quite some time and I think, the reason for that is very low wages in the private sector.

Did you read this last interview, which he gave two days back and he said the challenge is wages. So, the starting salary of an IT engineer in India was Rs 2.5 lakh in 2003 and today it is Rs 3.7 lakh. So, what does that tell you? It tells you that the wages have grown 40 percent in 16 years and in this period, you have this huge industry of mobiles which has LED televisions. So, the buying preferences have changed but income has not kept pace. That’s why I think this is a structural and deeper problem and I would not be so optimistic about the auto sales recovering. In any case, this tax cut does not go to the individuals and I think that’s the right way because you must do everything to increase the income of the consumer. That will happen only when companies will start spending on new products.

As we discussed last few years, we’ve seen that consumption was a favoured theme and earnings have done better; certainly, much better than the other parts of the economy and multiples have gone up very sharply. So, I would say, except for consumer discretionary and non-discretionary, which are trading at very high multiples and I think the growth expectations implied by those multiples in my judgement are unlikely to be met. I think the whole markets broadly look either deeply undervalued or reasonably valued. See, the price to look in India is near all-time lows. When your market cap-to-GDP is near all-time lows and two sectors are at all-time highs, it tells you clearly that the rest of the market must be much lower than what the aggregates are also investing. So, that is how I look at this.

Financials I think, most commentators like to discuss private versus public, but I feel it makes more sense to not focus on the ownership but instead focus on the nature of the business. If you look at banks, there are banks which have suffered due to high NPAs and there are banks which have not suffered. Banks which have not suffered are high-quality businesses and are reasonably valued, they should continue to grow but the other banks which have suffered high corporate NPA stress, I think their stress should come down and we are already seeing significant improvement this year. As we go into the second half of this year and next year, I think we should see near-normal levels of profitability in these large corporate banks.

See, I think the PSU banks; the large ones are fairly sustainable, I don’t think there is a challenge and we own them. As I said, I don’t think ownership makes that big a difference. The asset quality has made all the difference and asset quality for private corporate banks and public corporate banks should move in tandem broadly. So, they should improve. I think mergers are a great thing and even the last time around, I fail to understand why the merger between two-three similar banks can hurt anyone. So, you have taken care to merge banks between similar or same IT reforms, the pay scales are the same, you will just bring more scale, you will be able to rationalise costs, overhead costs like the treasury function or HR or IT costs could drop and the bigger the bank, the more you can spend on IT which is clearly becoming key. I don’t see any downside to this merger and with time, there should be meaningful efficiency.