• Home
• |
• Careers
• |
• Site map
• |
• Contact us
• |
• Kotak group site

Home > Media > India and the march of emerging Asia

Media

India and the march of emerging Asia
Financial Times – Ask the Expert
20th July 2009

India’s main equities index was unsettled by the country’s recent budget, falling 918 points on the day. Until last week’s rally, the Sensex had lost more than 10 per cent since Pranab Mukherjee, the finance minister, outlined his plans.

The fall represented unfulfilled expectations of the reforms sought by Indian business groups and news of an expanding fiscal deficit.

Nitin Jain heads the Long-Only Equities Asset Management Team at Kotak Mahindra and has over 13 years of experience in the Indian equities markets.

Ask Nitin what’s next for India’s stock market, the long-term economic prospects for the country and how it will compare to other emerging markets? His responses are published below:

What sectors of Indian equities will provide the best returns in the long term? One might think that a bet on the growing Indian middle class would indicate the retail sector is a safe bet?

On a macro basis, the Indian economy provides growth opportunities in three broad themes: infrastructure development, consumption and outsourcing.

Within this, the infrastructure and financial services sectors are my favoured bets. India has a clear and wide gap in its infrastructure which is hampering growth. Infrastructure growth remains a top priority for the government and with broad policies in place to increase spending from the current 4-5 per cent of GDP to 9 per cent of GDP by 2012, the sector has growth prospects of around 20-25 per cent over the next 4-5 years.

The penetration of financial services remains in single digits in most segments such as credit cards, mortgages and mutual funds, and we expect rapid growth in these segments. The Indian banking system remained unscathed from the global financial crisis and with single digit leverage, net non performing assets of less than 2 per cent, and capitalisation of around 10-12 per cent, the balance sheet of the system is strong.

Over a much longer time frame I am bullish on emerging sectors like media and retailing. These will be led by increasing discretionary spend.

Domestic private consumption accounts for nearly 60 per cent of India’s GDP. With more than 90 per cent of the retail sector still dominated by traditional stand alone stores and with a burgeoning consuming middle class, the more organized sector does look very attractive. However, India does not allow foreign direct investment in the retailing sector and the local players lack both expertise and deep pockets in this long gestation and capital intensive business. Also, apart from the political and social challenges, the sector has numerous near term challenges such as lack of logistics and supply chain management issues and high lease rentals. So while we believe that organized retailing looks attractive, it will be a long haul and until then the mom and pop stores will continue to dominate the retailing landscape.

In the light of record jobless claims in the developed world, how do you assess the short term prospects for the outsourcing business model?

In a democratically elected world, it is natural that governments of countries with rising jobless claims yield to calls for protectionism. Economies today are highly integrated both functionally and financially and have benefited from global trade through rises in productivity and low inflation.

From an Indian perspective, specific measures like visa restrictions will have a near-term impact on IT related outsourcing. However, the outsourcing proposition in recent years has been moving away from just a cost arbitrage to skill arbitrage and we see very limited longer term impact because of the shortage of skilled IT workforce in developed economies. At the other end of the spectrum, faced with slowdown and recession, companies in the developed world will be looking at outsourcing to reduce cost and improve efficiencies which represents a big opportunity over the medium term.

Outsourcing in manufacturing segments like textiles, engineering, auto components, remain largely unaffected. In the near term, I do see some impact, but companies are cutting costs and looking at different geographies to mitigate this. As economies in the developed markets stabilise, noise levels against outsourcing will reduce. The world is too interdependent for any large scale attempts at protectionism to endure.

Could you please compare India with China and other emerging markets in Asia in terms of economic and financial present performances and future prospects?

India and China represent two bright spots (more like footballs rather than spots given their rapidly increasing size) in a gloomy world. India is a democracy, and democracy has a price which we pay in gradualism. China is a centralised, investment-driven and planned economy which has its advantages but comes with its own sets of challenges. The jury is still out on the success of an investment led export-oriented model which fails to ignite domestic consumption.

The Asian tigers have had strong growth in the past but were all built around the export model while the Indian economy is more a domestic consumption driven economy and thus represents a secular long term growth story. I believe that the Indian economy can grow at 7-8 per cent over the next decade. Having grown in a capital starved economy, Indian companies are more measured and efficient in their capital allocations.

The biggest positive for India is the strong demographic profile and entrepreneurial talent. India will be the largest contributor to the global workforce and will be one of the few nations to have a falling dependency ratio for a few decades to come. India however suffers from disadvantages of a weak infrastructure, capital deficiency, fiscal constraints and poor education. These are factors which if not properly addressed can crimp growth ambitions.

There has been much talk about improving the rural economy and the need for ’inclusive’ growth. How important a factor do you think this is and what is the Indian government doing to achieve it?

The parliamentary election campaign of 2004, with its ’India Shining’ vs. ’Common Man’ confrontation, highlighted an apparently widespread perception that the benefits of economic growth were simply passing too many people by, and the recent elections in May 2009, which surprised most pundits, has put the common man, the rural economy, equitable development and the mantra of inclusive growth on a high pedestal. Winning on a platform of inclusive growth, we expect significant focus from the incumbent government on rural spending which to the surprise of many has brought in unexpected gains. A large part of the 10 million plus new mobile telephone subscribers every month come from the rural and semi-urban population.

The highly successful, National Rural Employment Guarantee (NREG) scheme (in force for over 2 years now) has given rise to a buoyant rural economy and greater penetration of manufacturing and services to semi-urban and rural areas. Apart from efforts to improve farm productivity, the other areas that the government would focus on as a part of the drive for ”inclusive growth” would be dispersion of skills across the population thus revamping the educational system, mass housing, focus on rural connectivity (both road and IT), investment in irrigation, rural electrification, among other areas.

As one of the architects of the economic reform process in India, Montek Singh Ahluwalia puts it, ”if we can take care of agriculture (read rural and inclusive growth) and infrastructure – both of which are critical focus areas – then an average growth rate of 9 per cent a year won’t be a problem”. The theme of the 11th Five-Year Plan, which runs from 2007 to 2012, is ”towards faster and more inclusive growth”, which clearly reflects the need to find a sustainable balance between growth and inclusion. In my view, the success and sustainability of the economic reform process lies in inclusive growth.

After this budget do you believe the reform process will accelerate sufficiently to achieve double digit growth in the near future as the government hopes? What hope is there for labour reforms?

With a lack of market-friendly buzzwords such as divestment, FDI and deregulation, the recent budget seems to have disappointed many who had expected big bold policy announcements. In my view, the budget was just a possible let-down against a back-drop of high expectations and a five-year government agenda versus a one-year market expectation. To be fair to the government, it had very little time to present the budget and technically the budget is just a presentation of the revenues and expenses and not necessarily a policy announcement platform.

The presence of a stable government armed with more teeth is very heartening in the current global economic environment. We expect policy announcements, especially related to disinvestment, opening up of the insurance sector and banking reforms and measures for fiscal consolidation to be announced shortly with some developments on disinvestment already taking place. The new government will be very keenly judged with respect to implementation and delivery.

Given the constraints on capital availability globally, double digit growth in near future remains challenging. However we are hopeful that India will deliver 6.5-7 per cent GDP in fiscal 2010 (April 2009 to March 2010), and around 7.5-8 per cent GDP growth in 2011 (April 2010 to March 2011). A double digit growth rate will also be dependent on the global economy and I expect we will possibly see double digit growth on the back of accelerated reforms, infrastructure spending and resumption of global capital flows in 2011-12.

It is fair to assume that in the current environment of rising joblessness and of calls for greater public sector participation (ironically coming mostly from free markets), big steps in labour reforms will have to wait.

How do you see India sustaining growth, given the lack of infrastructure, less spending on research and development and agriculture, increasing population and poverty?

Often the Indian growth story has been written off on fears of issues that you have raised. Cognisant of this, infrastructure development and ”inclusive” growth have become the cornerstones of government policies. Success of schemes like the NREG also holds the key for poverty alleviation. I believe that while we are very much in the sweet spot of our demographic transition with a low dependency ratio (ratio of non-working (children and senior citizens) population to working age population) and enjoying the benefits of demographic dividend, we cannot ignore the fact that we have a big challenge in revamping the education system for proper skilling of our vast population and finding jobs for them.

As we have seen in the past few years, a consistent high rate of economic growth is the best measure against poverty and the recent budget has favoured growth over fiscal deficit. In the wake of the recent global slowdown, which has had an impact on India’s urban-centric growth, the buoyancy of the rural and semi-urban economy has come to the rescue of many industrial segments like consumer goods, automobiles, mobile telephony and cement. Ensuring that growth opportunities percolate down to all sections of the social pyramid is likely to be the most important challenge for India - wherein the investment opportunity arises from the new vast and growing consuming class.

Do you see a link between India’s infrastructure issues and its ability to generate real economic growth?

Under-investment in (physical and social) infrastructure is most definitely the single largest impediment to economic growth in our view, with the Planning Commission commenting that the infrastructure gap in the country was holding back economic growth by 1.5-2 per cent every year. India has been one of the very few countries which have transformed from an agrarian to services dominated economy, bypassing manufacturing and industrial growth. With a large working population, it is our belief that significant employment opportunities need to be created outside of services, and impetus on infrastructure spending will be one of the major avenues to address this issue.

Infrastructure spending and development remains one of the key controllable actions in the hands of governments worldwide to spur economic activity and growth and the Indian government is targeting to increase the spend to up to 9 per cent of GDP by 2012, implying a spending increase from currently around $50bn a year to more than $150bn a year. Since capital availability remains a big constraint to stepping up investment in infrastructure, the government has made good progress in attracting private capital through the public-private partnership model in many areas such as roads, airports, power, ports etc. The government has gone through a fair bit of a learning curve in refining these investment models and would be able to accelerate the process substantially in the new political environment. For India, it is inherently necessary to spend on infrastructure not only to combat slowdown but also as an investment for long term sustenance of GDP growth at between 7-8 per cent a year.

Everyone seems to be talking about India as a place for long-term growth. Does that mean I should be concentrating on investing in fast growing small caps or big companies with well established brands?

In my opinion, a focus on the larger names with well-established brands or fast growing smaller companies is a function of risk appetite of an individual investor. The risk aversion towards mid and small cap companies that we saw during this financial crisis, and large volatility swings, can at times unnerve most investors. In that context, an ideal blend would be a portfolio of around 60-70 per cent large cap to play both growth and stability and 30-40 per cent mid and small cap to capture rapid growth in some sectors.

There are many sectors which are big in developed markets like media, real estate, pharmaceuticals, retailing, insurance and brokerages, even construction, that are still in their early part of evolution in India and are dominated by mid and small cap companies. As discretionary spending rises, these will see rapid growth. However, the challenges of managing growth and the need for regular intakes of fresh capital, means the growth while rapid will also be volatile.

Moreover, in this rapid growth stage, leadership often changes hands frequently. At the same time, some of the larger sectors like infrastructure and financial services represent in my view, amongst the best long term plays.

To what extent would you consider the functioning of the regulatory bodies who monitor the key trading activities within the subcontinent have a consistent approach, especially in a market where 80 per cent of the trading is made by good few players?

One of the better elements of investing in India has been a fairly transparent and consistent approach by the regulatory bodies, be it the SEBI (SEC equivalent) or Reserve Bank of India, the Indian central bank. An independent judiciary plays an important role and creates a proper system of redress.

The complexion of the market has been changing rapidly and the regulator has kept pace with the changes. The trading system in India is fully computerised, paperless and has a T+2 settlement system (final settlement of transactions done on trade day takes place on the second business day after the trade day) which functions very smoothly. Mindful of issues relating to corporate fraud, the regulator is taking the level of disclosures, transparency and accountability to global levels.

In recent years with the increasing size of the domestic mutual fund industry and the insurance industry, the market has become more institutionalized, transparent and broad based. With more than 5000 listed companies , (more than 100 companies of these with a market cap of more than $1bn) and a market capitalisation of more than a trillion dollars, foreign institutional ownership of around 20 per cent and trading volumes in excess of $15bn a day, Indian markets are now fairly wide and liquid.

Contact Us

Copyright © 2008 Kotak Mahindra Group. All rights reserved.

 

General Privacy Policy | Terms of Use |