Narayan Shroff (NS): Hello, and welcome everyone to our monthly podcast for Barclays Private Clients India. I am Narayan Shroff, part of the India Investments team and I will be your host for this podcast.
In the next few minutes I will share with you our broad economic and market outlook and our investment strategy, followed by a short interview with our guest Rahul Bajoria, Chief Economist, India and Antipodeans at Barclays. Rahul will address some of the key questions around challenges and opportunities facing India from a macroeconomic perspective in the post pandemic world.
Despite nothing being guaranteed when it comes to investing, almost all conditions needed to support a sustainable Indian economic recovery seems to be in place. The spread of COVID-19 seems well contained despite the busy festive season being underway. The inoculation rate in India continues to gain pace in line with our expectations demonstrating both the availability of and acceptance for vaccines.
The long series of pro growth reforms introduced by the government over the last few years should start bearing fruits. Both fiscal and monetary support continue to provide sufficient targeted support wherever needed as seen with the government’s performance linked incentive scheme for some of the manufacturing sectors this year.
The growing strength of Reserve Bank of India’s forex reserves provides the necessary shield to allow a more accommodative policy stance related to other emerging economies. With the economic growth gaining pace supply side bottlenecks seems to be easing barring some of the global supply issues such as semiconductor chips or the energy block of late.
The risk of rural growth emanating from erratic monsoon season also seems to have abated. Liquidity and capital, both local and global, available to businesses ranging from blue chips to start ups continues to be robust. Pent up savings have supported the robust recovery and demand for now.
Having said that, the pace of government’s capital expenditure remains constrained by tough execution targets and has room for a significant pickup in the second half of this fiscal year. Also a period of broader, better quality growth depends on the private sector participating more with capital expenditure plans getting executed, credit growth picking up (the inverse of the deleveraging cycle witnessed across many sectors), employment picking up, especially the big void created in manufacturing, construction, retail, travel and hospitality.
All this will take time and patience. While policymakers continue to keep close eye on these economic indicators, equity investors should watch the latest quarterly corporate earnings season underway. We do not see them being disappointed. In fact, the incoming data are likely to support their optimistic outlook.
Indian equity valuations as seen in earlier cyclical bull runs may start pricing in forward earnings for two or three years out. Valuations have also room to stretch considering the attractive earnings growth profiles of Indian companies, reducing debt levels and historically low cashflow discounting rates. With so much money lying on the side lines and with cash and debt yields so low, many may buy on dips. Therefore, any corrections may be short and shallow.
Investors might consider rebalancing opportunities to book some profits in Indian equities back to their neutral allocation levels and use any dips to stagger fresh allocations. For more discerning investors, buying a portfolio hedge to expand the portfolio carry of overweight Indian equities may be a more efficient way of reducing systemic risk while continuing to benefit from active management alpha.
We continue to have more conviction in high quality companies and investment teams. With the recent catchup by mid and small cap equities we have moved to an equal preference across market capitalisation. Among richer valuations and active sector rotations, pockets of satellite opportunities exist in technology, metals, select banks and non banks, real estate, late recovery themes including travel and tourism sectors.
In Indian debt markets, it still makes sense keeping core portfolios invested in high grade corporate bonds of up to five years, ideally through a mix of roll down strategies and actively managed portfolios. The steep rate curve appears to offer enough carry to compensate for any residual duration risk in this portfolio. Although with the journey towards policy normalisation getting shorter, volatility is expected to remain high.
Allocating to mid yield, high yield and structured credits at this stage of broad economic recoveries seem to have merits. Although the credit spreads trading at historically tight levels and demand far outweighing supply in this segment, there is little room for error, especially in the public debt markets.
With the latest set of RBI restrictions on banks and non banking financial companies and enhanced guidelines on credit mutual funds more opportunities are available in private debt markets in the mid market performing credit segment. With risk appetite in this segment still muted and traditional participants abstaining, this credit market offers opportunities to build portfolios with an attractive risk premium. Prudent selection, diversification and monitoring remains key when investing in private markets.
We now have Rahul Bajoria with us.
Hi, Rahul, thanks for joining us today.
Rahul, some of the key questions facing investors in India still seems to be more global in nature. Let us start with the two more talked about, the one around China – the debt issues, curbs, clampdowns and controls, supply side constraints as well as more geopolitical sprints we’ve seen. The other is around US debt ceiling and reducing pace of fiscal and monetary support. What are your views on each of these, especially in the context of any impact on India?
Rahul Bajoria (RB): Hi, Narayan. On the global front, India’s traditional weaknesses, that is it’s low market share in global supply chains and relatively weak linkages into the Chinese economy itself should provide us with some cushion in my view.
India’s decision to accumulate large amounts of foreign reserves, particularly in the last two years, I think will also act as a bit of a security blanket for the economy, especially as we look through a relatively volatile period of market performance across emerging markets, which have largely been triggered by concerns around changing global policy backdrop and higher inflation.
In my view, you know, to an extent the external stability that the economy is enjoying at the moment is probably the most attractive part of the investment thesis around India and this should continue to provide us with some cushion going forward.
NS: Yeah, thanks, Rahul. That is indeed an interesting perspective. Coming to the third area of concern, and that is inflation, we started with industrial metals but we have several key items being added to the global inflationary impulse. This now ranges from semiconductor chips to the entire energy block across oil, gas, coal and several other industrial components. Where do you see this heading in the more medium term, and what could be the implications for India?
RB: Yeah, so India’s lack of material market share in these major commodity markets basically means that we are a price taker on most counts. To me, when I look at the global backdrop, you know, what is pretty clear is that India’s disinflation in 2014 and 2019 in that period and the subsequent inflation that we have seen in the last two years has been a bit of a beta movement to what was happening globally in the commodity markets.
It is not to discount, you know, the actions that were taken on monetary policy front like inflation targeting or the decision to keep fuel taxes high but certainly when global prices are gyrating India really has no choice but to digest the price hikes.
This clearly has implications for domestic inflation but we reckon that India’s corporates have been really deft in their handling of these price pressures. This is also getting reflected in their corporate profits, which at the same time is also sort of pushing the government and not really budging from the decision to keep fuel taxes high. So the net impact perhaps is on consumption being weaker than what it could have been, but that probably is a conscious policy choice on part of the government.
NS: Rahul, what is our views on the monetary policy cycle in India? What is the sequence and timing of the policy steps we envisage? And although it may be a bit early to call, but what would be our peak rate estimations in this tightening cycle and why?
RB: Yeah, so fundamentally we believe that the tolerance for inflation within India’s broad policy settings has increased and as the economy finds a stable footing, we should see monetary policy turn less accommodative but not very restrictive per se.
In terms of timing we are currently expecting the RBI to continue to modulate liquidity in the system and we are looking for reverse repo rate hikes to begin from the December MPC itself. We also think the RBI can possibly look at repo rate hikes from the month of April next year, but we only are looking for rates to go up by about 50 basis points in 2022 and maybe another 50 basis points in 2023.
Overall, our sense is that as a post pandemic consequence, India’s terminal R-star, right, which is basically the real rate in a terminal setting, has probably gone down from the traditional 1% to 1.5% which was kind of being guided for during the Rajan era, it is now probably closer to 0% to 0.5%, which would imply that maybe the terminal policy rates on a nominal term is probably around 5% at the moment.
NS: Yeah, thanks, Rahul. Indeed, getting the pace of policy normalisation and the peak rates right as you described can help investors take good long term investment decisions beyond the near term volatility.
Rahul, India has seen credit pressures since 2018 with the IL&FS default, NBFC led credit stress in 2019 and then the pandemic led crisis since early last year. Do you see an inflection point in the credit cycle in India? Do you see the issue to be demand for credit or supply of credit? Which sectors or themes do you think would be the key offtakers of credit in this cycle?
RB: Yeah, so in any cycle credit is always going to be a bit of a lagging indicator and even what we have seen is that the pandemic probably did was to accelerate the deleveraging cycle which was already underway across various parts of the economy both within the corporate sector and within the households.
What has also happened is probably that with the combination of forced savings, accounting for the heterogeneity which is very high across Indian households and higher corporate profitability, we feel that there’s been a natural demand for credit, for new projects has been slowing down and amid that, as utilisation rates are improving, the overall pick up in credit demand is going to be slow. In general, India has been relying largely on the government for additional capex spending in the last few years and the private sector has instead chosen to be very selective in its capacity expansion.
Post pandemic, while there are areas like healthcare, pharma, maybe infra related sectors which are seeing greater demand for funds, the boom in equity valuations that has been in place for the last couple of years is probably also, you know, dampening the demand for credit to an extent and what we are normally seeing right now is the process of lags in the credit cycle and this is probably not a bad thing per se.
NS: Sure. We have already seen record global flows and interest in Indian risk assets, ranging from Dollar bonds to REITs and InvITs and big FDI equity flows into Indian listed corporates as well as start ups. With the relative positioning of India in the global emerging market pack and with the recent talks of inclusion of Indian government bonds in the global bond indices, do you see the dynamics changing in a major way on the cross border flows as well as any structural shift in the source of funding for both government and corporates in the country?
RB: So in the last five years India has not really had any real shortage of capital and it’s only in the last two years that foreign investors have probably participated meaningfully in the rally that’s been there, you know, for quite some time.
My sense is that in the next five years, right, both from a point of resiliency, from the point of diversification and also just looking at the innate growth story that India sort of offers, we are probably comfortably placed as far as capital inflows are concerned.
The government also, in my view, has become a lot more innovative in its fundraising capabilities and with the fiscal reticence which was kind of the defining feature in the first two-three years of this government, that has been forsaken for spending. So this should provide ample opportunities for new investors, both domestic and foreign, to participate in the India story.
So on the specific issue of index inclusion itself for Indian government bonds, we recently hosted a senior government official in an emerging markets conference for our clients and our sense is that there is some momentum behind India’s inclusion in the bond indices.
What I would still do is I would caution that the government does not move at the same pace as the private sector in its, you know, delivery. So it might still take some time for this to be realised given that several agencies have to be comfortable with the inclusion. But certainly it’s a priority area for the government and I do think that in the next 6-12 months we probably are going to see more progress in this particular matter.
NS: Yeah, thanks, Rahul. To summarise, what are the top two opportunities and top two risks for India?
RB: So let me begin with the risks. And I think even now India’s biggest risk probably remains the pandemic, right? I mean this virus is a very tricky thing and we remain fairly exposed to the possibility of more curveballs being thrown at us which we may or may not be able to anticipate.
The second key risk I guess in the near term is the rising energy costs especially considering the high rate of fuel taxation in India and its relative importance for fiscal spending given, you know, that it has been financing quite a bit of infra for the government, right? So that’s something definitely to watch out for.
On the opportunities, India appears perhaps best summarised in the language of statistics, you know, that we have, India has the ability to generate higher beta simply because unlike its other EM counterparts its macro stability is much better and balance sheets are clean, unlike the post taper tantrum period when we went through a period of adjustment.
On alpha, India really perhaps is the only major economy well poised to benefit from a myriad of relations that is being slowly engineered away from China to build capacity and resiliency into supply chains.
I mean these movements might take years and we may not see it happening right away and may not even see it in the data for the next year or so, but I remain confident that the whole experiment around India’s production linked incentive scheme is a fairly smart bet and it should also for most parts give us a stronger footing in the global manufacturing supply chain.
So, you know, there could be a possibility that India is also an export out performance story, which I don’t think a lot of people are focusing on right now. Overall, this should mean that India’s private sector, you know, which is the key source of India’s economic mojo, will remain fairly competitive, very focussed and profitable in the medium term and this should help in anchoring returns for our clients and for our investors over a long period of time.
NS: Yeah, thank you again, Rahul, for joining us today.
RB: Thank you, Narayan, for having me on the podcast.
NS: With this we come to an end of our podcast. Thank you for listening to us. We wish our listeners happy festivities. Stay safe and healthy, and happy investing.