‘Indian markets no more slavish outpost of developed markets’

Bharat Shah is a market veteran, who started his investing journey at Birla Sun Life Mutual Fund in 90s, after private sector was allowed to run mutual funds in India. As executive director of ASK Group, Shah spoke to Mint on why he thinks Indian markets have an edge over most other global markets. Edited excerpts:

What is the difference between markets now, and when you started your investing journey in the 90s?

Today, Indian markets are far more resilient. Earlier, Indian markets were slavish kind of extended outpost or inferior cousin of the developed markets. Despite record sale by foreign investors, Indian markets have been pretty resilient so far, unlike Western markets (including US), which have been materially dented.

So, the character of the participation, quality of the understanding of the participants when it comes to investing, has evolved and matured a great deal.

₹35,895 crore of investor assets across PMS and AIF.” title=”ASK IM manages ₹35,895 crore of investor assets across PMS and AIF.”>

View Full Image

You might also like

How much will a US recession hurt India?

Why the scene needs to change for PVR in Q3

EM flows uncertain, but India has an edge

Ignore India at own loss, Nifty numbers say loud and clear

There have been so many reasons for markets to have surrendered: global supply-chain disruption, commodity price inflation, Russia-Ukraine war since February. So, you couldn’t have found fault if the markets were to reflect the pain, especially when there has been an intense one-way selling from foreigners, but it’s a great tribute to the maturity of the participants, both retail and institutional investors.

And from my discussions with thousands of clients and investors over the years, I can say there is far greater degree of understanding as to what good investing is supposed to be. I recall the interactions I have had after the dotcom burst in 2001, post-2008 crisis, and there is a radical difference this time. There is greater understanding of equity as an asset class. There is a greater degree of self-confidence, self-belief, about the businesses, about the future outcomes. And also, there is a far greater confidence about strength of the economy, on the back of several important reforms, which have occurred over last seven-eight years.

Many of these reforms are now not only getting reflected in economic outcomes, but also in terms of acceptance of the investors that the change is structural and not tactical. Therefore, there is a greater belief about future, and greater belief about future means longevity.

When there is a belief about long-term and the belief stems from structural changes, then it is directly correlated to longevity, which is just a mathematical correlation that valuation should automatically improve.

View Full Image

Why makes you think that investor behaviour has changed for good?

It is beginning to show in the participation of domestic institutions, participation of retail money for which the proxy is the monthly SIPs (systematic investment plans) coming into mutual funds, which has gone up to almost ₹13,000 crore last month. So that shows, behaviourally participants in the country are realizing that equity is a superior asset class, with a great long-term potential to create value, net of inflation, net of any cost applicable to that asset class, and net of taxation.

What has led to the resilience of markets?

When the developed world started raising interest rates, there were legitimate fears that it will impact not only the funds flow but also the valuations because any rising interest rate scenario has a direct negative correlation with equity valuations and it definitely affects fund flows. We are probably asking this question now for the first time that is it the Western world, which abused its financial behavior, bringing interest rates close to 0% or thereabouts.

Those perversely low interest rates obviously had to be reversed. And therefore, that reversion was inevitable, in the very act of bringing those interest rates down. So, they had no choice but to do it.

As far as India is concerned, instead of throwing cheap money or free money in the hands of the people, we focused on the supply-side economics, which is the harder one as you need to carry out reforms. But that is where you deal with things better.

We wisely refrained from that adventurism, as it would have created a chaos for us with the fiscal deficit going out of hand and the consequent implications on the interest rate and on the currency. It would have damaged our capability to come out from the pandemic itself. Credit to the government for acting very wisely under pressure.

The phenomenon of reducing interest rates and abusing the financial system in the West is not merely a pandemic-period occurrence.

India initiated a series of reforms. The Production Linked Incentive (PLI) scheme is one example, which is aimed at giving boost to India’s manufacturing and take advantage of China-Plus-One strategy of global businesses. The farm bill, which was introduced, was a very important supply-side intervention.

Today, war can be played through different ways, whether through vaccines, semiconductor chips, or even using interest rates and currencies to inflict pain on others, what we have seen in the West.

The government has realised that it is important to build self-sufficiency and capability in critical areas. Lot of economists have reacted with the standard stock responses that this is inward looking, but in my opinion, it is one of the most important, strong economic and business decision this country has made.

In India, over last eight-nine years, compared to where interest rates were, they have come down materially. In response to recent tightening by US Fed, there has been some amount of increase in interest rates, but if you look at it over a longer period, it is very evident that the cost of capital has declined.

And hopefully, we are unlikely to see those unaffordable cost of capital issues that have plagued the businesses in the past.

Which sector are you bullish on and why?

Banking sector has endured several changes over the last six-seven years. Demonetization in 2016, goods and services tax (GST) in 2017 had a deep impact on the businesses, 2018 was the year when IL&FS happened and subsequent fiasco, 2019 was the year of huge non-performing asset write-offs on banks’ balance sheet, the pandemic struck in 2020. Lenders were forced to recognize and anticipate pain and reflect it in their balance sheet again.

There was next round of pandemic in 2021 and a new set of worries and again write-offs. In 2022, there were supply-chain disruptions, commodity price inflation, energy cost inflation, war. So, many things have happened and the developed world has raised the interest rate.

So, bank and non-bank financial companies (NBFCs) have faced a staggering number of challenges over the last seven years, but it is to their credit that bank and NBFCs’ balance sheets have never been better than what they are today.

Capital adequacy has improved on the lenders’ balance sheets. The write-offs are significant, therefore balance-sheets are clean and reflect the real value of the assets rather than make-believe ones and cost of capital has come down.

Why lower cost of capital is important? It has deep implications on consumption demand, business profits, asset values, lending volumes and quality of the assets on lenders’ books because low interest rates favour better quality of assets. And therefore, that is a good condition for lending volumes in general, for funding to be done on a more profitable and structural sound basis.

On the other hand, the balance sheets of the borrowers have improved. As I mentioned to you, during the pandemic period, the debt-equity ratio in this country has come down, which is a remarkable achievement and in the pandemic period we have reported some of the highest quarterly profits ever in the history that shows the character, resilience and capability of the businesses to quickly adapt to situation and alter the character of the business. In this period, the return on capital employed (ROCE) and return on equity (ROE) of the borrowers’ business have improved.

On the supply-side, things have deepened with more innovation and new instruments. Green bonds have also emerged. At some stage, G-Secs will get listed in the international market. InvITs (Infrastructure Investment Trust) and REITs (Real Estate Investment Trusts) have now become very popular and large drawers of capital. Supply of capital is visible in public markets as well, as despite selling by foreigners, they have remained resilient.

On the demand side, exports have been doing well. Except for the last few months, they have been affected due to what is going on around the world and the rate of growth has come down. But exports are growing well. We had record exports last year and therefore the need for export funding has improved. There are very clear signs that capital formation has begun to happen.

And it is also helped by reduction in cost of capital and therefore that capital formation whether the businesses are replacing assets or building new assets, either making a brownfield plant or a greenfield plant, this capex cycle needs to be funded.

We can very clearly see the consumption demand. We are seeing sharp growth in real estate market.

We are also seeing huge amount of effort in infrastructure, which earlier was helped and pushed by the government, and now we are also seeing participation from private sector. So, I think the stage is perfect for a long-term sustained growth of the finance sector, whether banks or NBFCs.

View Full Image

How does India compare vis-a-vis other global markets?

From my perspective, there are some inescapable points.

When I look at Europe, I see deep structural fault lines. Europe is less and less innovative, or more leaning into its past and legacy. Therefore, lack of innovation and lack of entrepreneurship, both are afflicting the European economy, as well as European businesses and therefore their valuations. Due to its status-quoist mindset, legacy-oriented mindset and lack of willingness to change and adapt to the changing realities of the world, I think Europe is in a state of difficult long-term period.

Look at their crippling behavior on their energy issues. The kind of hapless efforts they are making is incredible. There is no strategic thought behind any of this.

Unfortunately, Japan has been in difficulty for a long period of time with adverse demographics. And structurally they are stuck there, and therefore I think the best outcome of Japan will be little over 0% kind of growth, if at all. But it’s hard to expect anything much.

In Latin America, socially, politically, economically, currency-wise, everything is chaotic and violent. Africa is resource-rich but system deficit. I don’t know whether there is capability-deficiency or not, but system deficiencies are so much, that even if there is capability, it will take long time before its effects materialise, maybe decades.

That leaves us with the US and Asia.

The US itself has deep faults. And many of the inadequacies of American capitalism are coming to the fore the way they’ve dealt with the cost of capital issue. Also, in many areas, barring technology, America has very little entrepreneurship. Most of the entrepreneurial efforts in America are centered around technology. US seems to be stuck in its own image of the past, that of a leader, a leader which has weakened, which still wants to kind of cling on to its past glory rather than adjust to reality in a fair way to create a sensible economic order.

But the US has abused the financial system for so long. Just because you have a universal currency in the form of dollar, you simply keep printing it without paying the cost of it. And despite such glaring abuse, when American debt recently for the first time exceeded $31 trillion, you have the irony of dollar appreciating.

But America is an adaptive and innovative society and therefore I still believe America will remain at the forefront of value-creation despite a lot of inadequacies, a lot of abuse of the financial system, a lot of poor political behavior in America.

China has entrepreneurship and strength. But in last two-three years, many Chinese businesses have melted down. Over the long-term, if you look at 30-year record of China’s economic growth, which is outstanding, only a tiny fraction of that has got converted in terms of market returns.

Economists are concerned with the size of GDP and rate of growth, but markets are concerned with the quality of growth, capital efficiency, value creation. And therefore, markets in China have given a clear verdict. And in the last two years, the way economic steps have been taken in China, it looks like the Chinese businesses are going to have a long winter ahead. And it reflects in the decimation of the market cap of so many businesses, some of the leading businesses of China.

South Korea, while a good economy, a strong economy, which has grown fast and created prosperity for people, but I think it just about remains where it is and has reached its limit. If you look at some last 30-odd years, South Korean market returns in dollar terms have been negative.

Taiwan is a good economy but small, and there is only so much that can happen there.

And then you are left with India. So, I believe for next 15-20 years, it will still in my opinion be only India and America. I cannot really see any meaningful third place to put money in. I can see only these two places with any value creation potential there.

If you take a look at last 30 years, 20 years and last 10 years, India has been among the two places in the global markets across these periods. So that says something. And I believe coming 10 and 20 years are likely to be economically and structurally more rewarding for India.

Elsewhere in Mint

In Opinion, Vivek Kaul probes the puzzling popularity of insurance over mutual funds. Niranjan Rajadhyaksha says two of the four determinants of rupee’s dollar value are favourable. Parmy Olson writes on a trophy asset of choice of wealthy ideologues. Long Story delves into the Jaypee jinx.