Markets India podcast September 2023

Narayan Shroff (NS):  Hello, and welcome, everyone, to our periodic podcast for Barclays Private Clients India. I’m Narayan Shroff, part of the India Investments team, and I will be your host for this podcast.

For this podcast, I have invited my colleague Rahul Bajoria, Head of EM Asia (ex China) Economics Research at Barclays, for a short interview covering his latest insights around “A breakout moment for India”. Following this, I will briefly cover our investment strategy in the current market setup.

Rahul, in your latest report on India, you speak of the potential for the Government to aim for a growth rate higher than what is being currently projected, even as high as 8% per annum. What has been the macroeconomic backdrop in India that is leading us to this reset point?

Rahul Bajoria (RB): So, Narayan, we are not exactly at a reset point right now, but we are approaching one perhaps in another 12 months, especially as the political dust settles post the general elections. Now, if one takes a step back and looks at India’s policy framework in the last 18 months, especially since the war broke out, there has been a very active desire on the part of policymakers to maintain macroeconomic stability, and this has been done with relative belt tightening, both in monetary and fiscal side, which has helped us achieve this macro stability without too much loss in economic growth.

However, my sense is that post the 2024 elections, there is room for a rethink on whether India should continue to prioritise macro stability over growth or, you know, shift gears and be more ambitious and go for higher rates of growth.

NS: So, Rahul, do we see a need to dramatically change the economic model given that it has worked well so far?

RB: So, you’re right. I think there is an element of, you know, don’t fix what ain’t broke kind of a philosophy when we look at India’s own economic growth story, which is fairly impressive in its own right. But, you know, despite being the fastest growing major economy, when we look at the numbers, you know, India will still not be the largest contributor to global growth even with a slowing China in the background.

So, this entire premise of a policy tilt towards growth is to ask whether India can potentially displace China in three to five years as not just the fastest growing, which it already is, but also as the biggest contributor to global growth where, you know, it kind of takes India to a different pedestal from a global relevance perspective.

NS: Rahul, what would be the economic preconditions to achieving this much higher growth rate?

RB: So, history tells us that whenever we have tried to grow very rapidly without necessarily strengthening a few preconditions or parameters, it typically tends to end, you know, with a lot of volatility and our macro stability indicators severely impaired. Now, these would be your fiscal deficit, current account deficit, inflation, value of the rupee or, you know, a combination of all of these factors.

Now, in the last few years I would say we have seen a consistent improvement in all of these factors to varying degrees, especially when we view it from a global context. So, any sustainable rise in growth rates needs these factors to be kept in check, hence you need higher domestic savings in order to finance more investments. I believe we will see a greater amount of participation of, especially of females (3.55) in the labour force. We need to continue to maintain clean and healthy balance sheets and we also need our productivity gains, which have been improving, to keep us on a path of macro stability even with higher rates of growth.

NS: So, will this reset require huge amounts of investments or will this magic momentum be led by higher productivity?

RB: My sense is that we need both, right? And our investment ratios while they are below, I would say considerably below what we were doing relative to the first decade of the current millennia when we almost went to 40% of GDP for investments, I don’t think we need to go back to those kind of levels. But we do need to have higher investment, but it can be incremental in nature. So, you know, what we have quantified is that you need from, (4.47) to go from around 30% of GDP closer to about 32%, 33% and this may happen actually very organically without really a nudge from the Government itself.

On productivity, you asked a very interesting question and, you know, what we see in the data is that, you know, thankfully in the last decade there has been a fair amount of investments both in hard infra and intangible stuff like digital connectivity and this, you know, combination of investing in connectivity, roads, ports, railways, airports is having an impact, you know, on our productivity gains and,, hopefully this will continue to play out over the next few years adding momentum to our growth cycle.

NS: So, how dependent is this growth on say foreign investments versus domestic savings in the country?

RB: So, at the onset I would say that foreign savings are still very important in our overall growth process, but perhaps relative to what it was say two decades ago, you know, their importance is declining at the margin. We really see two reasons behind it. I think, first of all, Indian domestic savings have really increased and they have also been financialised, right, and we see this trend very visible in the retail participation and the sophisticated investment vehicles that are, you know, ploughing money back into various asset markets and this is crowding in a lot of domestic funds for investments.

In other areas say such as manufacturing, you know, where the Government has introduced PLIs I think the bias is to not be selective in between domestic and foreign, so we are not necessarily leaning one way or the other, and the investment capacity and dependence on foreign capital, both for raising money and acquiring, you know, critical technology, will remain reasonably large on foreign investors in the foreseeable future so, you know, it still remains very relevant in the overall growth context.

NS: Rahul, as you know, everyone on the street is talking about this big capex cycle. How much of that would you expect being driven by the Government versus private capex? Also, what would be the key drivers for private capex growth?

RB: So, Narayan, my personal view is that a longer capex cycle with incremental gains is perhaps more preferred than a major overshoot and then stability at lower levels, right? So, we would rather extend the cycle rather than, you know, have a very volatile cycle with higher highs and lower lows.

The corporate sector especially I think is taking baby steps and they’re, you know, ramping up their capex cycle, and having done the hard yards to deleverage, you know, a profitability led capex cycle rather than a revenue led capex cycle is what we are more likely to experience. This I don’t think is a bad development itself, right, because even if it is more gradual and delays growth gratification, the sustainability of the cycle will be a lot higher.

Now, on this question of, you know, trade off between public capex and private capex, I think at some level one needs to accept the limitations of public spending, and while I think the Government has done a fairly tremendous job in improving both the quality and quantum of fiscal spending towards capex, the real big macro challenge we have as an economy in next five years is to reduce public debt, and build back fiscal space for the next growth shock.

So public capex will perhaps at some point in the future need to take a, you know, a seat back and hopefully private capex by then would have picked up more than enough to pick up some of this slack, right, but that trade off is inevitable in the future.

NS: Yeah, thanks, Rahul. How much do we think can be the contribution from exports?

RB: So this is one area where perhaps, you know, the geopolitical backdrop is providing quite a few tailwinds to India, along with the fact that there is a fairly challenging inflationary environment, especially in the Western economies after a long time. And so the first factor of the geopolitical backdrop is definitely leading to additions to our manufacturing capacity, while the second factor of higher inflation or stickier inflation is boosting our market share in export of services.

Now, when you put these two factors together, it really adds to our conviction that even in a weak global growth backdrop, right, where demand for goods and services globally remains low, India is still likely to incrementally gain market share globally in exports to the extent, you know, what we have been doing in the last few years we do think, and we have done quantification of this where we believe there is effectively an opportunity to double or even possibly increase it even more in the next five to seven years which will probably push up our global export share from less than 2% right now closer towards 5% and that will have a huge impact on our growth cycle.

NS: So, Rahul, India is also synonymous with its large working age population, the so called demographic dividend. How do we see this getting reaped to reset for a higher growth path? What policies would be critical here?

RB: So, Narayan, this is a very pertinent issue and, you know, you and I have discussed this in the past, that it really remains the key challenge and the, also the opportunity of a generation as to how do we raise our labour force utilisation and provide all the incoming young people productive jobs, right, which can be transformative in one way or the other for both the country and for individuals.

So, when we looked at this particular issue in our report, right, and we laid out what is the total number of people who’ll be entering the labour force, our key takeaway was that while there is really no real silver bullet, right, to solve this issue, incremental steps are needed and, you know, can be taken, especially looking at boosting our female labour force participation rate, which currently stands significantly below both global averages and our peer economy averages.

And, without really boosting female employment, you know, a lot of India’s demographic advantages, which perhaps has another window of maybe 15 to 20 years to properly reap the benefit from, will possibly leave our growth story somewhat stunted, right, in an economic sense. And this is a difficult but I don’t think an unsurmountable challenge to, you know, kind of try and solve for. It will be difficult, but it is doable.

NS: Finally, what are the key risks? Is it inflation, global slowdown, or is it the upcoming elections?

RB: So, I would say, you know, the window of risks perhaps changes as time passes and in the next three months I would say global risks, which is the Fed rate cycle, commodity prices, the weather cycle, they all are adding to India’s risk profile, right, from a fairly low base. And while for the next year, if we sort of take a slightly longer term view, the focus obviously shifts to the anticipated global slowdown and then elections in India itself.

Now, interestingly, we have looked into this issue, you know, about India’s own electoral cycles, and what we have found are that there are two very interesting trends which, you know, our clients should keep in mind, you know, which should keep them reasonably optimistic about the growth story being intact.

First of all, you know, Indian elections both at the central and at the state level have consecutively been getting more and more decisive, which naturally provides stability of tenure to whichever party and government is selected, which I think overall is a positive development in our view.

The second key factor here is that there is, by and large, I would say a bipartisan consensus on growing the economy, and while there are nuances around ways in which, you know, this may be achieved and how it gets distributed, we do not believe that India’s fundamental growth backdrop will change much due to elections, partly because of the first reason of political stability and this bias to have more decisive results, you know, which adds to the stability aspect.

So this effectively leaves us, you know, looking at India and its growth outlook from a glass half full perspective. Now, some impact of this would be that, you know, post elections if we do see a dip in sentiment and consumer confidence, we should see a revival in both consumer confidence and business sentiment and that should support asset prices generally speaking over the medium term.

NS: Thanks again, Rahul, for joining us on this podcast today.

As we heard from Rahul, while the developed world skirts a recession, the picture is different in India. Services and industrial production sectors have helped expand economic output. Though August services PMI has edged lower slightly month on month to around 60, it is still comfortably above the expansionary mark of 50. It is also due to a high base effect as July recorded the highest PMI in 13 years. Also, in services, the output price inflation is increasing at a faster pace than the input price inflation implying we could see improvements in margins and increase in profitability.

Manufacturing PMI on the other hand continues to be on the rise supported by international sales. This could help provide a strong contribution to the current quarter’s growth numbers. More broadly, manufacturing companies with a global orientation should benefit as external demand for manufacturing goods seems robust.

Increase in the pace of output prices is driven by strong domestic demand implying rates could stay higher for longer due to inflationary pressures. Also, with the domestic activity appearing well entrenched and slowing global growth far from collapsing this seems more likely. As such, the RBI has probably reached the peak in rates provided inflation continues to ease.

Bond investors considering locking in yields, might remember that after a rapid hiking cycle, history suggests that they can also fall quickly even after a longer pause.

Earnings in the April to June quarter illustrated the underlying health of the economy. Profits for the 50 largest companies shot up by over 35% compared with the same quarter last year. The financial, auto, infrastructure, cement, and energy sectors appear to be performing particularly well. However, earnings disappointment in technology, chemicals, metals, realty, and consumer goods industries is there.

However, there is a potential fly in the ointment. Surging prices, especially for food and, of late, oil that may dampen sentiment and consumption levels.

With positive net flows of money into the Indian equity market for the sixth straight month in August and robust investor sentiment indicator as reflected in the record low range for the Nifty VIX index, investor complacency is a distinct risk.

Despite the strong performance of the local equity markets in the recent months, we are cautiously optimistic on the market for long term investors.

Since the beginning of the current fiscal year until mid September, while the blue chip Nifty 50 index has rallied more than 15%, the Nifty MidSmallcap 400 index climbed by more than 35%. 

While valuations for mid and small cap stocks may appear rich, especially after the recent sharp rally, the experience of the fiscal year 2018 seems apt to compare. The Nifty 50 saw earnings per share surge 23% in FY18, so it was a high earnings growth year. By the end of the year, the price to earnings ratio for Nifty Midcap 100 index was a staggering 1.5 times the Nifty 50 trading P/E ratio of 21.4. This implies that in a high earnings growth environment, mid and small caps can command much higher valuation premiums than their large cap brethren.

While the 12 month forward earnings growth for Nifty 50 companies, as per Bloomberg estimates, stands at a good 18% mark, and this may compare well with the earnings growth witnessed in the trailing 12 months, we feel that the risks of earnings forecast revisions remains evenly balanced. Therefore, while we remain strategically overweight Indian equities in the medium to long term, we maintain a more cautious neutral stance in the near term.

Given the uncertainty over the path of interest rates and inflation, along with the global growth expectations, stock selection appears more important than usual given the speed at which the stock prices can move should company results disappoint. This is where the role of active management gains prominence. Staying invested usually pays off for long term investors within acceptable risk parameters.

Also, it seems prudent to diversify over the wider equity market, with allocations to mid and small caps calibrated to one’s risk appetite.

Finally, given the high level of uncertainty over the path of rates and inflation, gold, real estate investment trusts, infrastructure investment trusts as well as private markets are among the alternative assets that might offer diversification benefits, plus some of the best entry points seen for some time. 

With this, we come to an end of our podcast. Once again, thank you for listening to us. Stay healthy and invested and wish you a great second half of the fiscal year ahead.