Monthly markets podcast India June 2022
Rahul Bajoria, Barclays’ Chief Economist for India and the Antipodes, addresses the key challenges and opportunities facing local investors as we enter the critical monsoon season.
18 July 2022
In this month’s podcast, Harsh Shethia, Managing Partner and Head of Investcorp India, shares his insights on the key themes and opportunities across private markets in India, which have seen record growth in recent years. And as investors grapple with concerns about both inflation and recession, Narayan Shroff, Investment Director for Barclays Private Clients India, discusses the latest outlook for financial markets and India’s fast-growing economy.
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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 for the period ahead, followed by a short interview with our guest Harsh Shethia, Managing Partner and Head of Investcorp India. Harsh will share with us some of the key themes and opportunities across private markets in India.
The global investment community remains split between inflationary and recessionary impulses. Risk assets, including the commodity markets, continue to witness high volatility in this wake. The key change over the last few weeks has been the resilient tightening stance of the central banks in fighting inflation, despite the risks of significant slowdown in growth or a mild recession in the medium term.
We believe that we are at, or near, peak inflation and price increases. While inflation is likely to remain above pre-pandemic levels, it should gradually moderate in the coming months. A mild recession is possible in the US and probably in parts of Europe. Yet, a temporary period of contraction isn’t necessarily the precursor to a crisis. Any downturn is expected to be mild and short-lived. We think slow but steady growth tends to be much more supportive than when it is high but decelerating.
Central banks are trying to restore their credibility and the era of free, abundant liquidity is probably over. That being said, with inflationary pressure gradually abating, we believe that the hawkishness seen from central banks in the first half of the year won’t be repeated.
Market gyrations, however, will likely persist, as there are no quick fixes to the current worries. It may probably take a few more months for investors to become comfortable around these issues. It is critical to tone down the noise and let long-term plans and goals dictate portfolio allocation.
Coming to Indian economy, forecast of normal monsoon bodes well for rural income and agriculture output. Economic activity is at all-time high with robust GST collections; toll, mobility and electricity consumption continue to grow; capex seems to be improving and Purchasing Managers’ Index indicators remain healthy. However, global uncertainties and lower demand could weigh on growth outlook.
We expect India to still post a reasonably healthy number of 7% GDP growth for the fiscal year 2023, which is slightly lower than the RBI’s estimate of 7.2%. However, risks to growth are tilted to the downside. This still positions India as the fastest-growing major economy.
While we continue to stick to budgeted fiscal deficit and borrowing numbers, there are upside risks, given the government’s increased fiscal measures to contain inflation.
We expect inflation to remain elevated and likely to breach its official targeting framework and average around 6.7%. Good monsoon augurs well for containing food inflation. Also, a persistent correction in global commodity prices, as witnessed in recent weeks, could soften the hawkish stance of central banks.
Co-ordinated approach between fiscal and monetary policies could also lead to inflation being contained somewhat. The RBI’s latest announcements mark a material relaxation of regulation to enhance debt capital inflows and followed the government’s recent action to reduce the current account deficit by raising import duties on gold and oil exports. These measures represent a coordinated effort to manage currency weakness that should over time lead to greater inflows.
Though we may see terminal policy rate in India closer to 5.75%, the advantage is that rates are being revised up from a record low level. This could ensure credit growth remains on an uptick, at least in Fiscal Year 2023.
Consensus corporate earnings estimates for Nifty50 companies remain strong at 16% in FY23, with some downgrades likely. Normal monsoon and sustainability in underlying demand should support earnings well. Banks, industrials, power and capex intensive sectors are favourably placed and will likely drive earnings.
Indian equity market may remain volatile till clarity on inflation and growth emerges. At current valuations, they are trading closer to their long-term averages, which offers potential upside on the back of expected earnings growth. Next couple of quarters will remain key to observe the earnings trajectory.
We continue to prefer quality growth companies. Current stock price correction in high quality, sustainable businesses having the potential for strong long-term earnings growth present good investment opportunities. Active management remains key in these markets through bottom-up ideas, hence we have no bias towards large or mid-cap companies.
We like Banking and Financial Services sector as credit pickup through strong retail loan growth, improving asset quality, consolidation in stock prices and attractive valuations offer good opportunity to invest.
We also continue to like Information Technology sector with attractive valuations, focus on digitisation and margin improvements due to reduced wage cost pressures, which augurs well for this sector.
In Indian fixed income space, we expect rate hikes to continue with terminal policy repo rate at 5.75%. The current term spreads (i.e. five-year g-sec over repo rate) of more than 200 bps offers a good opportunity to lock in yields. Three to seven-year bonds maturity segment remains the sweet spot as more than the future rate hikes seem to be priced in.
In foreign equities, current equity risk premium remains adequate to compensate investors for owning stocks relative to bonds. Global equity valuations have corrected sharply and remain closer to their long-term averages. Europe remains more attractive than US on the basis of available equity risk premium, while Chinese equities may offer opportunities in second half of the year.
We now have Harsh Shethia with us. Harsh joined Investcorp 20 years ago in 2002 and has held different roles and responsibilities across the globe. He moved back to India in 2019 to head the Investcorp India business. Harsh joined Investcorp from Goldman Sachs in London where he was an Executive Director. Prior to that, Harsh worked with Deloitte Consulting in New York.
Hi, Harsh, thanks for joining us today. Harsh, let me get straight to the point. After a record growth in the start-ups to late stage VC investments in India, we see some semblance returning to this market. Where do you see this going from here?
Harsh Shethia (HS): Thanks, Narayan. Normalcy in terms of fundamental assessments, appropriate diligence, and appropriately pricing risk is healthy for the industry and investors. We see further global headwinds impacting India too in the near term, in terms of inflation, demand contraction and currency volatility. Our focus remains on backing four megatrends, which have long-term tailwinds, and in the current environment we find it easier to price assets at an attractive valuation than a year back.
Our mid-market positioning, that is backing businesses at a more mature Series C / Series D stage, means by and large our portfolio is EBITDA positive, core businesses cash flow positive, and an attractive longer-term growth story.
I can’t share details of the private business performance, but want to give two recent examples of value accretion, that is public information. We have just signed a full secondary sale of our 15% stake in ASG Eye Hospitals, at a 3.4x gross MOIC. Another listed luggage company in our portfolio, has seen its YTD as on July 11 share price increase by nearly 5% versus Nifty50 index which is down more than 8%.
NS: While we get that, do you see any fundamental shift in business models, survivorship or profitability for some of these new age businesses, especially with the change in liquidity, interest rates and input costs (including labour costs)?
HS: We see a meaningful shift in the approach taken by unprofitable businesses. Capital has become more scarce, it has become pricier, and it takes longer to raise. Naturally, companies that have it / get it are changing their propensity to spend.
As businesses adopt, private markets with their hands-on, medium-term approach are supportive. Investcorp has been active in India the last 3.5 years out of our 40-year history, and already we have faced the NBFC liquidity crisis in 2019, our deep recession during COVID-19 first wave in 2020, the skyrocketing VC-led asset values in 2021 and now the unprecedented global inflation levels in 2022.
So, challenges and cycles are part of our investment thesis. We need to back robust businesses providing solutions that India needs (not solutions looking for problems), back top quality entrepreneurs, and be both agile and patient as investors and partners.
NS: Harsh, we have seen the challenges around availability, costs and mobility of talent recently and more so in the technology space. Add to that the diminishing value of ESOPs. Do you see this as a structural issue, both globally and in India particularly?
HS: Scarcity of tech and digitally native talent is a global phenomenon and India, given its well-regarded status as Global Capability Center for the developed world, is facing shortages and wage inflation across the board. I see this situation normalise within the next 6-9 months. Private businesses are becoming more frugal in terms of cash burn and the developed world, with its recessionary concerns, is already slowing down new additions.
I recently spoke to the first year MBA class of Indian Institute of Foreign Trade in Delhi and Kolkata. Younger talent is still very keen to take on the risks of a more entrepreneurial business environment in return for a more rewarding career, from a personal development and growth perspective. Talent wants to solve complex problems, back a greater purpose, and not be processors in less nimble organisations.
NS: How is the India story being received by global investors and which sectors or themes look attractive from a five-year perspective?
HS: We see a lot more interest in India versus say three years back. We are benefiting from a stable government, lot of infrastructural changes already made (which gives credibility that the ones in the works will also be done), and the digital adoption that has been accelerated by COVID-19 first wave.
Based on past experiences, the overwhelming majority of global investors want to navigate Indian waters with trusted partners like Barclays, versus DIY.
Asset-backed investments, healthcare, financial product distribution, enabling digital transformation and e-commerce logistics are very attractive areas in our view.
NS: Harsh, my last one to you is perhaps a paradoxical theme that I have been pursuing for some time now. In all these years of the great pursuit of asset-light businesses in driving efficiencies and maddening growth rates, asset ownership and leasing seems to be gaining premium on the other end. Where do you see this going, especially in the current inflationary and higher interest rates environment?
HS: At a fundamental level, a balanced portfolio comprises of both equity and fixed income allocations. Comparing fixed income performance to equity and vice versa can be done on a risk-adjusted basis, which most investors unfortunately do not do. We are a firm believer in alternatives to both asset classes. Private equity market investing as an alternative to public equities and real asset plus private credit investing as an alternative to fixed income.
While in 2020, 100% of Investcorp India’s investments were in e-commerce businesses, in 2021 our largest allocation has been to warehousing and businesses with real assets.
Real assets are net beneficiaries of inflation and rising interest rates. They generate current returns and a capital appreciation which is a great inflation hedge. We are actively looking at our next set of industrial / warehousing investments as well as evaluating data centres.
NS: Yeah, thank you again, Harsh, for joining us today and sharing some great insights into the private markets landscape.
HS: 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. Stay safe and healthy, and happy investing.
Rahul Bajoria, Barclays’ Chief Economist for India and the Antipodes, addresses the key challenges and opportunities facing local investors as we enter the critical monsoon season.
Narayan Shroff and Jean-Damien Marie discuss how investors can buckle up for the potentially bumpy ride ahead, as well as casting their eyes over longer-term trends.
With escalating Russia-Ukraine tensions and inflation worries testing investors’ nerves, our India podcast host Narayan Shroff, Investment Director at Barclays Private Clients India, looks at whether the country’s outlook has changed, and what we can expect in 2022.
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