India is doing well among emerging markets mainly because China has suffered in the last several months owing to the trade war and a pickup in the investment cycle depends on the new government’s policies, says Shankar Sharma, vice-chairman and joint managing director of First Global.
“We are facing a lot of headwinds locally. Globally, things are looking quite okay. It is just that India seems to be in a slowdown mode on the headline numbers as well as corporate earnings,” Sharma said in an exclusive interview with CNBC-TV18.
Excerpts from the interview. Your thoughts on the rally that we have had, which is driven by domestic factors and the fact that we have outperformed the emerging market index by 7 percent this month. How would you read the current situation?
India, for the last two or three years, has been more or less a market performer compared to global markets. Often it looks as if it is going to slip into a long term underperformance and then it manages to stage a pullback. Within emerging markets, India has been relatively okay mainly because China has suffered in the last several months because of the trade war. However, if you compare India to Brazil and Russia, it has been a little bit of a disappointment. I do not want to speculate as to what happens in terms of relative outperformance that we have seen in the last few days, whether it is sustainable or not, because my view has been that in an election of this kind, the moves usually will be fairly short-lived. Of course, there was an exception in 2004 and 2009, but in general, market moves linked to elections will be violent either on the up or the downside.
In this particular election outcome, it was already a majority government and it has added on top of that. So, the market's reaction has been not violent on either side as some might have anticipated. Adding 20 or 25 more seats is not going to materially alter the strength of the government.
The second thing the market obviously would want to look at is what kind of fresh thinking will be presented by the new government. The markets will have their initial euphoria or whatever we have seen but I do not think that itself is a determinant of where markets go 3-6 months from now. It will come back to what policies the market sees, whether it likes those policies and whether those policies actually translate into genuine growth numbers for the economy.
We are facing a lot of headwinds locally. Globally things are looking quite okay. It is just that India seems to be in a slowdown mode on the headline numbers as well as corporate earnings. So, the market will look past this event. It will want to focus on clear policies to revive slowing economy.
I have heard arguments made in favour of a pickup in the investment cycle. Also about more money in rural India because of last-mile rural programmes getting a push. How well placed is this hope trade that began on May 24?
You hit the nail on the head, it is a hope trade. I will go back to what I just said. It is the same management or the same managers of the economy back with slightly stronger numbers which doesn't mean much. So, it is the same set of policy thinkers and if you liked what they did in the first term then you should continue to like what they do in this term. If you did not like what they did then the real question is will the thinking be radically different in the second innings compared to what they played like in the first innings, I do not have an answer to that. People change, managements change, thinking changes, we need to have an open mind and see whether this government has an open mind to accept a completely different approach.
The second thing, and very significant in my thinking, is that this mandate, the back-to-back majority mandate, have told us that India is now almost 50 percent China in terms of the continuity of the management of the economy. It is not there yet because there are going to be elections every five years, but like China you have a very strong or at least a semi-permanent kind of government at the Centre and if that is really what it is then I think the government has to take a lot of risks with this mandate. If you do not take risks then I do not know when you can take those risks because in my view if you want to emulate China's growth path, you need to take very hard decisions which might be perceived in a democracy as being anti-people. Let us say strong labour reforms or strong land acquisition policies which hurt people, people do not like it but today is the time when the government can do that.So, if you want to transform India into a China, this is the window to do very brutal reforms which are anti-people. But China has been anti-people and in hindsight who is to say whether that policy was right or India's relatively more
people-centred policies were right. So, this is the mandate. I am not saying that you should be anti-people, I am just saying that this is the mandate that allows you to be that, whether the government becomes that or not, that is another big open question.
Last year we went through a brutal phase for midcaps. All of a sudden it has started to see some bit of buying resuming. That space is now back, will it get its mojo back?
Hundred percent. There is no question about it. In midcaps, inevitably the moves will be very violent on either side. I think, now you will see a little bit of a disconnect between the largecaps and the midcaps and I think you are seeing a bit of that today already. It is probably the beginnings of some degree of spring in midcaps or smallcaps in particular because you are seeing smallcaps being flat to moderately up while the largercap indices are down.
I think smallcaps have become amazingly cheap. Across the board, I see so many stocks in single-digit P/E multiples and in largecaps you had a mixed bag or more or less terrible set of results barring a few names here or there. But in midcaps and smallcaps, any number of companies we watch, the numbers have been very good but stock prices are down 50 percent. So when that happens, that is not a cause for despair. That is the cause for being even more bullish.
You become bearish when you see the numbers were terrible and the stocks have been down 50 percent but none of the stocks that we track or watch have the numbers disappointed. They have all been good year-on-year, quarter-on-quarter, sequential YoY and yet the stocks have been down. That has to reverse. It cannot continue like that and I think you are seeing the beginning of that move.
With the liquidity issue of housing finance companies (HFCs) and non-banking financial companies (NBFCs), we have seen what the Reserve Bank of India has done. They want to tighten regulations without necessarily providing a flood of liquidity to everybody. So what are we looking at in the NBFC space, is that a very dire situation, are we going to look at some sort of a Black Swan event here?
My view on this sector is clear. It has a great first three years of any new cycle because you are booking very high spread loans and obviously loans don't go bad. If I give you a Rs 1 crore loan, you would not start defaulting from the very first quarter. You will take some time, you will at least keep paying me interest - that is usually the deal that I know you are going to go burst because nobody can borrow at 24 percent and not go burst. The business model is flawed. You have a very narrow liability source and based on that narrow and obviously volatile and short-term liability source, you are building a tottering pile of assets which are in all kinds of shades of grey and black because none of the good guys are going to come and borrow from you at your kind of spreads.
So you are going out there doing promoter funding or real estate. A friend of mine was telling me -- in housing finance there are some 80-odd companies now doing housing finance. And he was saying that he started a housing finance company and is going to tier-III, tier-IV, tier-V, I don't know whether they can be called towns or villages, and lending to self-employed people like carpenters. I was saying how on earth are you going to track them and it all comes back to that, no CIBIL score will look at it. I was talking to somebody, a carpenter. I asked him whether he knew what a CIBIL score was and he had no idea. He gets Rs 50,000 loan and enjoy with that. I don't understand this business model. This is meant to breakdown, it takes a while to breakdown, it has broken down. I don't know how RBI is going to get anything done for this sector.It is unlike the US spread which is an aggressive central bank, it bailed out a lot of co-operations in 2008. Indian central bank is a little bit different, it doesn't go out and start to pump liquidity directly through some liquidity window to NBFCs because if that is there, that is for banks. That is not there for the
second-tier financial institutions, which NBFCs are.
So I think this sector will just trade water, the good ones and the bad ones will have a big problem because you have to repay the liabilities and obviously you cannot create fresh assets.
There is another big problem. When you don't have growth of assets then your non-performing assets (NPAs) in terms of percentages start to balloon because growth can optically take care of a lot of the problems of NPAs. So if you keep growing assets, your percentage of NPA keeps looking optically low even if in absolute terms they are rising. But if your asset growth tapers off, then suddenly this number starts to look terrible.
If you have a 15 percent NPA, which in reality is probably more than that, you are basically burst given your leverage.