‘Foreigners’ interest in India continues to remain high’

The outcome of recent Assembly elections has led to concerns that the government might resort to populist measures in the upcoming Budget in February, upsetting the fiscal balance. KENNETH ANDRADE, founder, Old Bridge Capital, tells PuneetWadhwa that soci

Given the rally thus far in calendar year 2017 (CY17) and the outcome of recent assembly elections, can we now see a time-wise and price-wise correction over the next six months? Corrections have always been difficult to predict. The biggest risk to market valuations remains interest rates. And while they trend higher, the risk on high valuations will continue to increase. The increasing geopolitical risk could also lead to turmoil in asset markets globally. The situation for India remains the same. Valuations are expensive. But, unlike 2007-08, corporate balance sheets are much healthier than they ever used to be. Over the past two years, a lot of cash flows from the private sector has gone to pare down debt and deleverage balance sheets. If the trend continues for the next two years, the debt-to-equity ratio would be at its all-time low.

While in this cycle, markets remain steeply valued, the mortality risk for corporates, at least in India, is much lower than the last cycle. While we argue on valuations being high, the counter-argument remains that we are investing in the corporate sector where the underlying balance sheets have never been as robust. So, even in the event of a significant disturbance in global macros, it is unlikely we will see any solvency risk like in the past, which also means that we could bounce back much faster. How do you see flows into Indian equities playing out over the next one year? Given the lack of alternative investment opportunities, domestic flows into the capital markets should remain robust. The overall interest in the Indian economy by foreigners continues to remain high, except for the valuation of this market. Should this correct, we should see the return of foreign capital into the cycle. Do you think the markets will react sharply negatively in case the government does not adhere to fiscal prudence in the next Budget? Closer to an election year, historically, social sector spending picks up. I don’t think it would be any different this time around. This is largely expected by the market and I don’t think this singular event would have any material impact on the sentiment. How do you see corporate earnings shape up in FY18 and FY19? For the remainder of the next 12 months, earning growth would be historically higher than the past three years, the main reason being the low base. The economy went through an almost negligible growth phase from December of 2016, a lot of this would be corrected over the next 12 months. I don’t think we should be surprised with an above average growth in the near term. Social sector spending by governments would be a key driver for profitability of companies in the near term, addressing the population at the bottom-end of the economic pyramid.

From a longer term horizon, the collapse of the investment cycle (private sector capex) could lead to higher capacity utilisation for existing companies on the ground. The asset turnover ratio (capacity utilisation) for the manufacturing sector is at 70 per cent, which is lower than what the 10-year numbers have been at. GDP (Gross domestic product) growth of 5 per cent would take utilisation rates somewhere close to 80 per cent plus in the next four years. The material difference this time is no incremental capacity is being set up.