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Negotiating turbulent markets

The chief investment offices of India's largest mutual fund talk about the best investment avenues for these times

High inflation, rising interest rates and a scam-hit government are grabbing headlines and have led to Indian stock markets underperforming in the current year. Sunil Singhania and Amitabh Mohanty, the two chief investment officers at India's largest mutual fund, speak on the investing climate, how they are positioning their funds, and advise investors on the best investment avenues for these times.

Compared to other emerging economies, is the Indian market not more expensive in terms of PE?

Singhania:The market is trading at 15x 1-year forward PE, if we take financial year 2012 into account. However, there are two issues I would like to point out.

In India when you speak of market PE, it does not make for a straight one-on-one comparison with other emerging markets. For instance, the PE of Brazil or Russia will always appear cheaper than that of India simply because they are more commodity driven as far as the index weightage is concerned. On the other hand, we have Pharma which trades at 20PE, we have FMCG at 25PE and IT at 20PE. This skews the overall PE of the Indian market.

Secondly, you must always keep in mind that India is a growth market. So whenever an investor invests in this economy, he is always looking at the growth potential of the country from a long-term perspective. So that is a reason why high growth countries like India trade at a premium to lower growth countries.

So you do not see a slowdown of capital flows because valuations are steeper?

Singhania: As long as outlook on growth continues to be strong, it will not happen. What you are seeing in the near term right now is because investors are concerned about inflation. Which naturally leads to issues on the interest rate front which will translate into growth slowing down. So if you are playing for growth and growth itself slows down, then that would put off some investors. As long as growth and GDP continue at the 8 per cent trajectory, there is ample attraction to investors. We do believe that over the next 5-7 years India has the potential to grow at 8 per cent plus and thus long-term investors will continue to view Indian equities as a good investment.

Is double digit growth in India achievable?

Singhania:It is achievable but will come at the cost of something else. If the government only focuses on growth, inflation will be 20 per cent. While balanced growth is needed, an 8-8.5 per cent consistent growth is a reasonable target.

What are the hindrances you see to the India growth story?

Singhania:What is plaguing the Indian economy is inflation and non-execution. Inflation will continue to be a problem till the supply side issues are addressed. On the one hand, a wide spectrum of the population is being empowered by increasing the income level. Naturally demand for food, vegetables and a more nutritious high protein diet will increase. A good back end is needed - in terms of storage, supply, transportation and other retail issues. Today we have a situation where 30-35 per cent of the produce rots and is wasted away. However, we do believe that the government is also realising that and there will be steps taken in the near-term to address these challenges.

Mohanty: The current account deficit will improve if exports rise and imports dip. But we are very worried about the fiscal deficit and inflation, specially that portion of inflation which cannot be controlled by monetary policy but actually requires strong fiscal measures. And all this has to be dealt with in a manner where growth does not fall off the cliff.

You say inflation will continue to be a problem till the supply side issues are addressed. In that case, if it's a supply side issue, do you think the RBI will be able to tame it with a rate hike?

Singhania: You cannot bring down the price of vegetables and food with a rate hike. If interest rates rise you can bring down the consumption of real estate and automobiles. Interest rate hikes have a place, but it is not the only tool to tackle general inflation. A lot of money is getting diverted to real estate, which is not a good phenomena. In that way, short-term rates being hiked will help channelise the money into financial assets and find its way into banks. This is necessary to help build capital and the multiplier effect comes into play. But if it gets stuck in land or gold, it does not contribute to the momentum. Financial savings must get invested in the multiplier effect kind of instruments.

Mohanty: If we look at the liquidity tightness and RBI hikes in the past, there has been ample monetary tightening. RBI cannot control food inflation; it is definitely a supply-side issue. But what the central bank is attempting to do is ensure that this sentiment does not spill over to other areas of the economy. It is something nebulous that they are trying to target - “inflationary expectations".

The problem is that till late 2010, growth was not part of the equation. This year going forward, there will be a trade-off between growth and inflation. So RBI's dilemma is how much of monetary tightening it must resort to, given the fact that inflation is being fuelled through factors which are essentially non-monetary in nature. Core inflation, which is manufacturing inflation, is around 5-5.5 per cent. If this gets hit, it will have negative implications for growth as well.

What are the reasons for food inflation? In 2009 it was the drought. In 2010, it was unseasonal rains. Then the Minimum Support Price too was a factor which could be held responsible.

Mohanty: If you break it down, cereals and pulses have moderated. That part of the good monsoon story has played out. In few items which normally people expect to see a significant fall in price in winter, because of the seasonal impact, did not happen. Prices of onions, tomatoes and garlic are the prime examples but across the board prices of vegetables etc. have not fallen as much as expected. The prices of meat, fish and milk have gone up and not come down.

On the one hand, we have the government increasing social sector spending. The natural corollary is that people will increase their nutritional intake, which will lead to an increase in demand. Don't misunderstand. I am not saying the government should not spend on the social sector. But it should generate funds to do so. It cannot be done by borrowing. Or it should look at parts of the expenditure like subsidies -fuel, fertiliser and food. Are they reaching the targeted audience or is there a huge leakage in the system? A simple example: a 2-wheeler owner does not have a diesel option but an SUV owner has. Who is enjoying the subsidy? These are not simple issues but they need to be addressed. Only then can we address the social aims and goals at a much lower cost with less inflationary implications.

To go back to our earlier point, the answer to the issue of food inflation is not in the monetary domain. Almost a third of our produce gets wasted due to lack of storage or transportation. If we can at least halve this, it would result in an effective 15 per cent increase in production.

Do you feel scams and inflation have polluted the investment climate?

Singhania: The news flow in recent months has not been positive, specially when the numbers involved are that large. The frustration, however, is that there seems to be no end to corruption and no execution either. Asking for a good road is not asking for the moon, it's a necessity - it's just basic infrastructure. Even international investors ask this when they visit India. 'If a country cannot even produce decent roads on what basis does it deserve a 16PE?' is the question that we face from the international investing community.

The government has spoken a lot about spending $1 trillion on infrastructure, it's time for action and implementation. And we do need capital flows - without it the 8 per cent growth will never be achieved.

How closely are you watching the price of crude oil and its impact?

Singhania: Crude oil prices are very important from India's perspective. It is difficult for the government to pass on the entire hike to consumers. It has a political impact, an affordability impact and an inflationary impact. So higher crude prices put pressure on the fiscal deficit because the subsidy burden increases. Higher crude prices also put pressure on the rupee since it is a key component of our imports, so that impacts the current account deficit and the trade deficit. The best thing to happen for Indian economy and equity markets will be a softer oil price scenario.

Mohanty: Almost 80 per cent of our crude requirement is imported. The last time when it touched $150/barrel, India was viewed negatively and a few of the global strategies were “long on crude, short on India". We don't know how these gas discoveries will pan out and they will not at least for a few years.

On the flip side, the global dynamics do not support a huge spike. Europe is pretty shaky. The U.S economy is not out of the woods; a huge stimulus is still in place. Inflation is also starting to creep into certain economies in Europe. So it is in no one's interest to see the price of crude go higher. And if there is a fundamental increase in demand, OPEC has a lot of spare capacity to boost output. Therefore we do not see a huge spike in crude oil prices.

In India partial deregulation has taken place. In petrol, the price hikes are being passed on. It will be painful, but in the long run will benefit India as demand gets rationalised.

What about other commodity prices?

Singhania: In 2010, India was growing fast while the rest of the world was not. That resulted in low commodity prices and crude prices. Now the developed world has shown signs of revival and growth, hence prices are rising and the extreme winter in Europe has resulted in higher crude prices too. Higher commodity prices will impact companies, some positively, others negatively. The producers of commodities will be positively impacted, like steel companies, metal companies and oil companies. The consumers like a capital goods company or a vehicle manufacturer will be negatively impacted. So the overall impact on the index earnings won't be too much.

How worrying was the IIP data?

Singhania: The reported numbers are a cause for concern but there is a need for these numbers to be rationalised to some extent. When the data is deciphered, one will see that the sectors which have been beaten down significantly are salt, sunflower oil and coconut oil. These are all the negative contributors to IIP. While we do believe the IIP will slow down, we do not believe the variation will be so large. So while it is worrying and we are closely watching it, it is not as alarming as the upfront numbers indicate.