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00:00 Thanks for tuning into Talking Point.
00:03 I am your host Neeraj Shah.
00:04 Our guest today is Neelkanth Mishra of Axis.
00:07 It's a really special thing to have him on the show.
00:10 Neelkanth, thank you so much for taking the time out.
00:13 Thank you for having me here.
00:14 The pleasure is entirely ours.
00:16 So Neelkanth, lots happening, geopolitically, risk assets, so on and so forth.
00:22 I would love to start off with that conversation or the question around risk assets.
00:28 Since 2020, at least as per my observation and correct me if I'm wrong, but it's largely
00:33 been the central banking action which has driven the fates of what risk assets have
00:38 done now, fourth year running.
00:41 Do you see that changing?
00:43 And if not, what could the impact be over the course of the next six to 12 months as
00:48 inflation looks to be sticky and the central banks grapple with the mandate of employment
00:53 versus inflation?
00:55 Yeah, so I would like to introduce a new variable in there, which is the fiscal stance
01:02 of the US government.
01:04 So the big change compared to the recovery after the global financial crisis has been
01:10 that instead of tight fiscal, loose monetary stance, the preference this time is loose
01:18 fiscal and tight monetary, which is one of the reasons why the expected US recession
01:27 is not happening.
01:28 Just for perspective, the current run rate of the US fiscal deficit is 8.5% of GDP.
01:37 It's just the federal deficit.
01:40 Now if you have a fiscal deficit at that pace, it is very hard to trigger a recession.
01:46 Now what this is starting to show up in is very sticky long-term rates.
01:52 And you would have seen the 10-year bond yield is at 4.37.
01:58 The expectation going forward, and we have an access bank, we have written a lot of research
02:03 on this, that why it is not just about inflation anymore, that the term premium that we build
02:10 in going forward needs to go up.
02:12 The R* needs to be much higher, which is the natural rate.
02:17 And therefore, the risk-free rate for the world, for global financial assets, which
02:23 is the yield on the 10-year US government bonds, which we have become used to 2 to 2.5%,
02:31 we now have to get used to 4 to 4.5%, which means that a number of financial assets, the
02:38 muscle memory of the market needs to move to much lower valuation multiples than it
02:43 has become used to over the past decade.
02:45 And this is not something that will show up in the next three months or six months.
02:51 But remember that incrementally, if you are allocating assets to various classes, if you
02:59 are getting risk-free rates of 4.5%, and as a corollary, interest rates on reasonable
03:06 quality corporate bonds are at 6, 7, 8%, it is very difficult to see a lot of allocations
03:14 happening to equities.
03:16 Yeah, I was about to ask that, that one, in effect, allocation to equities, two, allocation
03:23 to, let's say, emerging market equities within that subset, and three, the valuation multiples
03:27 that you mentioned because of the discounting rates.
03:30 So, do you reckon the market is still not adjusted to all of these and it will get happen
03:36 or it will happen over a period of the next two to three to five years?
03:39 Exactly.
03:40 So, you were there, right?
03:43 When 2010-11, when a stock, a very high quality stock trading at 40-45 times forward earnings
03:51 would be considered very expensive.
03:53 And then as the QE1, QE2, QE3 and sustained 0% interest rates kept happening, people became
04:02 used to 45-50, then 50-55, then 60, and now you hear these really silly arguments that
04:11 it used to be at 80 times, now it's at 70 times forward, so it's become cheap.
04:15 Now I think some of those benchmarks need to be revised downward.
04:20 This will not happen very suddenly because remember that it's a very large set of people,
04:25 large set of participants in the markets we're talking about.
04:29 But historically and in the last 300-350 years, there have been several periods where the
04:36 interest rates were kept very low for a sustained period and then because of other changes,
04:43 they had to be revised up again.
04:46 And then it takes several years for the markets to readjust back.
04:50 So, this is a sustained process.
04:52 I'm not saying because of this, the markets are going to fall in the next three months,
04:56 but I think the risk premium that equities naturally should have will be higher if you're
05:04 thinking 12-24 months out.
05:08 What does this do to, for example, a market like India?
05:11 I have a lot more macro questions, but since we're on this topic, I want to get this out
05:16 of the way.
05:17 There is a favorable position geopolitically, presumably from all that we are listening
05:22 to, and there is a large tap of money domestically which is following equities and very likely
05:30 will only become wider with time.
05:32 So, what does this do to a market like India, which is in the EM basket, which technically
05:36 as per what you've just said should attract lower flows, but in effect is also attracting
05:41 higher flows because of geopolitical favoritism, if you will, or not favoritism, but favorable
05:48 placing, if you will, and the domestic flows?
05:52 I think on the FII side, we have to remember that other than this three-four month period
06:00 in the middle of this year, FII flows have been somewhat muted in India since 2015-16
06:07 and I don't expect that to change.
06:10 So, incrementally allocations, if India's weight in MSCI is 15%, some people may be
06:16 at 17, some people may be at 13, only the extremes, I mean very few percent will be
06:21 at 25% weight for India, and those weights don't change very frequently.
06:26 So, if EM is an asset class, and exactly as you mentioned, if the attractiveness of EM
06:34 as an asset class fades or moderates because US rates are going up, then it's very unlikely
06:42 that we'll get a lot of FII inflows, but at the same time, the second observation you
06:47 had, which I think is very correct as well, which is that domestic flows, and I call them
06:53 unintended flows, the unintended flows into equities, and the reason I call them unintended
06:58 is that every month there is some deduction happening from my salary, every month 15%
07:04 of that is going into Nifty ETFs.
07:06 Now, even if I want to, I cannot stop that.
07:10 Similarly, on SIPs, I think there is, of course, some knowledge that this is going into equities,
07:19 but most of the investors are looking at it as fixed deposits.
07:21 So, if you just add that to the EPFO/NPS and add that to the allocations to insurance,
07:31 where insurance, again, penetration is improving, and some part of the assets need to go into
07:36 equities, you are talking about a $30-35 billion annual flow into Indian equities, and you
07:43 can see that behaviorally, that whenever you meet a fund manager, they're almost praying
07:48 for the market to fall because they know this is very expensive, that this is going to be
07:52 very bad for their performance, but they're getting flows and there's nothing you can
07:55 do.
07:56 So, in this environment, if you think about India PE and global PE, this is India PE,
08:04 this is global PE.
08:06 Now, global PE, as we are saying, will be maybe drifting lower or going lower in the
08:11 next two years.
08:12 And India PE, because of all this flow, can remain elevated.
08:16 But to think about this as an elastic string, beyond a point, it cannot stretch.
08:21 It'll start getting dragged down.
08:24 And that's the dynamic, I think, that will play out over the next couple of years.
08:29 Okay, well, we'll come to beyond the point at the Smith's end as well.
08:34 But just before that, Neelkanth, it's interesting that you speak about the FI flows and the
08:37 numbers, of course, I'm sure you know it better than most.
08:42 But when I look at the narrative or when I hear the narrative from fund managers or PMS
08:48 or AIF managers in India, who are now starting to get mandates from US-based moneybags about
08:56 wanting to increase exposure, when I hear some of the global bankers, which are operating
09:02 in India, they talk about how their clients want to increase exposure, it almost seems
09:06 that in the long term, India being considered as a favourite or a better place than China
09:12 and therefore more money to come in.
09:14 You don't believe that will happen.
09:16 You believe the weights will stay constant and the flows, therefore, will pretty much
09:19 mirror what has happened in the previous five, six, seven years.
09:24 I think we have to be a bit careful about the pace at which that transition happens.
09:29 So the fact that that transition is happening and will continue to happen is, my observations
09:35 are similar to yours.
09:36 I think where we perhaps disagree is that this will not happen very quickly.
09:44 And we can even try to quantify that.
09:46 So for example, of the $100 of FII holding India today in the top 500 stocks, about one
09:57 third is from sovereign wealth funds, from pension funds, from direct allocations.
10:07 And even those are mostly about percent of GDP.
10:12 So if India's share of GDP is 3.5%, then 3.5% will be allocated to India.
10:17 Mostly they try not to do too much or too little because they also face the fear that
10:23 they could be timing it wrong or whatever.
10:27 About the remaining two thirds, which are mutual funds or at least benchmark funds or
10:32 hedge funds, they have the same issue and that they are stuck to a benchmark.
10:40 And only about, I would say, one sixth of that, so maybe about 10% of the total FII
10:45 holding is from India-based funds, so India-focused funds.
10:49 Not India-based, but India-focused funds.
10:51 The rest of it is India allocation through EM funds, global funds, Asia funds or BRICS
10:57 funds.
10:58 Now, this transition will take a while to happen.
11:01 So you and I may keep hearing that, oh, there's another half a billion dollars of mandate
11:06 from some sovereign wealth fund and they are looking for some India manager, or there's
11:10 another billion dollars coming here.
11:12 But you think about it that even 10 years back, there was FII flows of $20 billion a
11:18 year that used to happen.
11:20 So a billion or $2 billion here and there, maybe $4 or $5 billion over six months is
11:25 not enough to move the needle.
11:26 Remember that we are now a $4 trillion market.
11:30 So you need a much larger sum of money to really move the needle.
11:36 Fair point.
11:37 Okay, fair point.
11:39 Now a question on whether, how do you foresee the equation between the kind of growth that
11:45 the country would do versus what the markets could do?
11:48 Because you did mention that up till a particular band of elasticity, India's PE and therefore
11:54 Indian market levels might still stay elevated, even if the global multiples go off a little
11:58 bit.
11:59 That growth is difficult to forecast, especially in a world which is slowing down around India.
12:05 How do you see that dynamic?
12:06 Yeah, it's a very important question.
12:09 I think, so when we think about growth, there are internal drivers and there are external
12:19 drivers.
12:20 So the question is how important are the external drivers?
12:25 So services growth or I say services exports are about 10% of India's GDP.
12:32 If the growth slows from say 15% year on year to 5% year on year, we are talking about a
12:38 1% erosion in headline GDP growth.
12:41 So that's quite substantial.
12:44 For goods exports, where we are at about, give or take, you know, 12-13% of GDP, the
12:52 decline has already started.
12:54 So incremental drag may not be that meaningful.
12:56 I would be a bit more worried about the imports going higher because India seems to be the
13:04 only place in the world where goods and demand is still elevated.
13:10 And the world has added a lot of supply.
13:12 So at Axis, we maintain a global goods demand tracker and that demand tracker is now showing
13:19 that the goods demand is well below the pre-pandemic trend.
13:25 So in such a weak scenario, it is likely that global manufacturers will start dumping goods
13:32 into India.
13:33 Well, dumping is a strong word that they will start.
13:36 So Indian manufacturers now will face a lot more competition than they have done in the
13:40 last two, three years.
13:41 So those are the reasons why maybe the growth might moderate a bit over the next 6-12 months.
13:49 But the internal drivers of growth are very strong.
13:53 And I think the strongest is construction.
13:56 And there, while there is some front-loading because of state and central government spending
14:01 on infrastructure, the recovery in the real estate market, I think, is a very powerful
14:08 one.
14:09 Remember that a very prime source of weakness in the U.S., in U.K., in China, in Canada,
14:16 in Australia, everywhere.
14:19 It's the housing market which is seen to be in a bubble territory and is correcting.
14:25 In India, we've had a 10-year correction in the real estate market.
14:28 And therefore, in the turn in the cycle that we have seen, and I'm sure you've been looking
14:34 at the demand for cement being strong, cables and wires, PVC pipes, tiles, some types of
14:42 MDF, plywood and all that, not plywood, MDF, whatever, boards.
14:48 This is all a sign that the independent home builder is also coming back into the market.
14:55 And this can be a very – think about it this way.
15:00 If you went from 16.5% to 11% or something, I think 10%, or no, yeah, 16% to 11% was the
15:09 decline in gross value of output of construction as a percentage of GDP.
15:16 I'm not talking about GVA, but I'm talking about output, the value of construction, because
15:20 that takes in all the input from cement, steel, wood, and everything else.
15:25 Now, if that goes up by 1% point, you're talking about a 3 trillion rupee increase in value
15:33 of construction.
15:35 And so while there could be a couple of billion dollars here and there, or various types of
15:41 things happening, but this by itself is a very large number.
15:46 And when you sort of think about what this does to job creation at 15,000 rupee per month
15:54 level, I think these are very substantial shifts.
15:57 So this is what keeps me a bit optimistic that I think we will remain at 6.5%, 7%, if
16:03 not higher GDP growth over the next 12 months.
16:07 So follow ups, does this typically follow as a cycle that after it's fallen and once
16:12 it starts to make a bit of a U-turn, then it swings back, if not to the earlier levels
16:17 of 16%, then some higher levels, would it almost be a given in an up cycle of sorts?
16:24 Yeah, so cycles, that's how they, so the reason why there are cycles is that there are self-reinforcing
16:32 signals there.
16:33 So, what starts to happen is, because some people have started to build, there is a certain
16:38 pace of activity, that pace of activity gives comfort to people.
16:41 I mean, some people have been very surprised at the crowds in the malls, the fact that
16:48 for some of the hit movies, tickets are not available.
16:52 I think these are all signs that the sentiment is getting boosted.
16:56 I'm not saying it's all happening because of housing construction, but cyclically, once
17:02 such a large segment starts to move, it creates a general feeling of goodwill, people feel
17:07 more comfortable, there are more incomes being generated.
17:10 You know, if there are, say, 1 lakh people extra who get a 12,000 rupee a month job,
17:19 then there would be 20,000 people who are supplying goods or services to them, who are
17:24 feeling better about it, and then some of them will build a house again, and that creates
17:28 another.
17:29 So, the cycle, when it turns, it turns for several years.
17:32 It does not get over in three to six months.
17:35 But you're constructive for 12 months because that's what you're forecasting right now,
17:38 but it could be a lot longer than the 12-month period.
17:40 It can be a lot.
17:41 I mean, I expect it to be a lot longer.
17:43 Okay, got it.
17:44 Okay, part one is that.
17:45 Part two, there are some quarters of people who think on the economy front who've written
17:50 off late that a lot of the capex that we're seeing is also a front-loading of the government
17:55 expenditure and looking at the tight fist plus oil rising, so on, so forth.
18:01 If private capex doesn't pick up the baton, then we might actually be running out of fuel
18:08 to fund the capex.
18:10 And then there is another side which says that they are seeing signs of private capex
18:13 pick up as well.
18:14 Now, I would love to understand how you are looking at this data.
18:18 So, there is a supply side to this capex and there is a demand side to this capex.
18:23 The supply side of this capex is that, you know, the balance sheets of the borrowers
18:31 and the lenders is the cleanest we have seen for the last 15 to 20 years.
18:38 And this is where I think that when we are thinking of future growth, an assessment of
18:44 balance sheets is very important.
18:46 And the striking example I gave in 2012, where growth was strong, you would have thought
18:52 that, oh, this is a fantastic time to be thinking about the next five years.
18:57 But if you had looked at the balance sheet, you would have seen that leverage for corporates
19:01 was going up.
19:02 That was the year where in my previous firm, we wrote the House of Debt.
19:05 The first of the notes for House of Debt was written.
19:09 And that is when bank indebtedness was a problem.
19:13 India's net international investment position was worsening because our current account
19:17 deficits were growing very rapidly.
19:19 And so the contra to that is what we see now, that firms have deleveraged, banks are very
19:27 well capitalized, the net international investment position has been, you know, minus 10% for
19:33 a while now, it's kind of flattened out.
19:36 And so from that perspective, the ability to do capex exists.
19:40 The question is the demand side, meaning where do you need the capex?
19:45 And there, I think we should be ready for some disappointment in the sense that if you're
19:51 worried about global oversupply, if you're worried about and see most company boards,
19:55 especially in large businesses, will think about that.
19:59 So they will be looking at, oh, for this type of chemical, we already seen dumping from
20:04 China.
20:06 And so it doesn't make sense to add capacity.
20:09 And so there are segments where India needs to add capacity.
20:13 Like for example, on renewable energy, on energy storage, I think battery capex, there's
20:21 some upstream electronics components, automation, renewable energy, you know, there's lots of
20:26 stuff that we need to sort of invest on.
20:29 And that capex, I think there is enough fuel or enough supply of capital to fund that.
20:36 But a meaningful expansion or acceleration from here, I think looks difficult to me.
20:42 And you're right that there is a lot of front loading of infrastructure spending by state
20:46 and central governments.
20:47 So what happens?
20:48 I mean, do you foresee that ability of the government side to fund the capex to run out
20:55 at some point of time because of the FIS situation, higher oil, etc., or you think it will continue?
21:00 No, no.
21:01 So I think the higher oil, that was, OK, so if the central government is doing 10 trillion
21:08 rupees of capex, and state government generally in aggregate do about twice that.
21:18 So we are talking about, you know, meaningful sums here.
21:23 So just a trillion or two trillion of potential increase in the subsidy bill is not something
21:31 that can derail the whole cycle.
21:34 So I would not extrapolate this beyond, because you have a certain allocated budget and you're
21:43 just choosing to spend a large part of that in the first nine months, because after December,
21:48 January anyway, you know, commissioning or inauguration of new projects is going to be
21:52 very difficult.
21:53 But that does not mean that when the next government budget is presented in July for
22:00 FY25 that there will not be fiscal space to do more capex.
22:05 So I won't go that far.
22:09 But you know, anyway, order flow, etc., is managed on a month-to-month basis, quarter-to-quarter
22:16 basis, and for the markets, definitely.
22:20 So will the order momentum start to slow from here or at least stop accelerating?
22:25 I think there is a reasonable risk of that.
22:29 Last two or three questions.
22:31 A lot of references being made to this current cycle having some similarities to 2003 to
22:38 2008, both on the capex and the equity front, but for the fact that the globe is no longer
22:43 as robust as it was back then.
22:45 How do you see this in relation to that, if it makes sense to see it that way?
22:51 And what are the implications of this cycle, not just for the next 12 months, but beyond
22:56 that?
22:57 I am not very comfortable using, you know, think about all the arguments that were made
23:05 about whether the global environment is like the '70s or not.
23:11 And you know, so the same I would hold true for, so there are similarities, there are
23:19 notable similarities.
23:20 There was a very big period of deleveraging because of Sarphezi in 2002, it's like IBC
23:28 forced a cleanup of corporate balance sheets.
23:31 That time Sarphezi was doing that.
23:34 There was a pandemic.
23:35 You know, there are notable similarities.
23:38 And then, of course, the economy just bounced.
23:40 But remember that China had just joined the WTO.
23:45 And the real estate cycle in the U.S. was likely to swing up, not down.
23:53 The Chinese growth story was just picking up.
23:56 Right now, we do not have any of that happening.
24:00 So this is a very different cycle.
24:04 And I would not extend the balance.
24:07 The fact that India has a reasonable runway of growth of 7 percent, 7 percent plus growth
24:13 for the next three to five years is perhaps similar to what we saw then.
24:17 But beyond that, I think it would be dangerous to extend that.
24:22 Got it.
24:23 I'm tempted to ask this question, and therefore I will.
24:26 You made a reference to elasticity lasting up to a particular point.
24:30 I'm extending that argument to what's happening at the broader end of the spectrum versus
24:34 what's happening to mainstream equities, which is the large cap hundreds.
24:37 Now a lot of notes out there, a lot of notes since the last three months talking about
24:42 how overextended the mid-cap, small-cap run is, and then it only goes further.
24:46 Order books are there, etc., etc.
24:49 Are you skeptical of levels in general in Indian equities and more so for the broader
24:54 end of the spectrum?
24:56 Or do you think this time around the cycle may actually surprise and skeptics may be
25:01 proven wrong when it comes to the skepticism around mid-caps and small-cap companies?
25:06 No, I think P/E multiples which are so stretched, and so while I have made the argument that
25:13 global risk-free rates are going to be higher in the next 10 years than they were in the
25:17 prior 10 years, and also that India's P/E multiples will remain stretched, I think we
25:23 need to be very, very careful about mid-caps and small-caps in India.
25:32 There is a reason why they have always traded at discount to the large caps.
25:36 There is one of the reasons why that same frothiness is not visible in the large caps
25:42 yet is that large caps also have that disciplining factor of very large FII ownership.
25:49 So whenever the valuations start becoming too stretched, then you have one seller coming
25:54 to the market.
25:55 In the mid-caps and small-caps which are primarily locally held, that disciplining force is not
26:02 there.
26:03 So, the fact that the valuations are stretched is a given.
26:08 The fact that it is happening because of an incessant flow of inflows into mutual funds
26:16 which are forced to buy that is also a given.
26:19 Will this end in three months?
26:20 Will this happen in six months?
26:21 But with these kinds of multiples, if you just do some back-testing that if you bought
26:28 these indices at these kinds of multiples, what were your returns over the next one year,
26:32 three years, five years, those would give enough caution that if you are voluntarily
26:37 trying to get into these segments, it could not be advisable.
26:42 Pertinent point.
26:43 Thank you for that.
26:44 My final question, a bit of macro here.
26:47 There is again divergent thoughts here.
26:51 And equally intelligent people, equally cerebral people have given both sides of the argument.
26:54 I would love to understand from you.
26:57 The talk of India moving towards current account or CAD neutrality, if you will, at some point
27:04 of time in the next two, three years, and what it does to interest rate sensitivity,
27:08 currency and thereby the appetite for Indian fixed income as well as equity assets.
27:16 What are your thoughts on this topic?
27:18 I think there is a very reasonable chance that we do become current account surplus.
27:24 There is a macro, there is a demographic reason for that.
27:28 So whenever your total fertility rate drops below 2.1, for the next 20-25 years, the number
27:39 of consumers per producer keeps dropping because your low age dependency ratio is falling.
27:44 After 20-25 years, the old age dependency ratio starts to go up.
27:47 So that's when the savings rate starts to come down.
27:51 But for these 20-25 years, every individual will be saving more.
27:56 They will be saving for their retirement, and there are fewer consumers to support and
27:59 all of that.
28:00 And plus, there is also more time to do work which is measured in GDP.
28:05 Like bringing up children is a lot of work as well, but no one gives you GDP credit for
28:09 that.
28:10 So there is a lot more of saving that will happen.
28:14 One manifestation of that is what we have written extensively on what India's business
28:19 services exports are doing, and we think that if business services exports, the way they
28:23 are growing, and I think we expect them to grow, that this will potentially take India
28:30 to a current account surplus in the next three years.
28:34 So that's the predictive aspect.
28:36 Now if you take a slightly prescriptive aspect to it, I hope that we don't get to a current
28:41 account surplus.
28:44 And the reason is that in an economy where we have to grow really fast, a current account
28:52 deficit shows that we are investing more than what we are saving, and therefore we are using
28:57 external capital to grow faster.
29:00 And I would rather that we grow faster than – but if we grow at 6.5, 7% for three years,
29:06 I think we will most likely be in a current account surplus situation, the oil price being
29:10 a major uncertainty.
29:11 But if you sort of flatten that out, then I think the chances of us having a current
29:16 account surplus in three years are quite high.
29:19 And once we achieve that, then the macroeconomic stability just improves dramatically, right?
29:26 So then we are no longer dependent on external capital, then the control that the RBI has
29:32 on interest rates will be all very domestic.
29:37 But there are lots of ifs and buts.
29:40 One of the things also is the fiscal deficit.
29:43 Remember that the current account deficit to some extent also represents the fiscal
29:46 deficit.
29:47 So if the government of the day is not focused on macroeconomic stability and the fiscal
29:55 deficit starts to go up instead of coming down, then you will again have a current account
30:00 deficit and again, you know, dependency on foreign capital keeps going up.
30:04 So but yeah, on current – if I was to draw a straight line based on the current expectations,
30:10 I think the likelihood of us becoming much more stable and a current account surplus
30:14 country in three years is very high.
30:17 But despite all of this, you rather for the sake of growth, because I remember from your
30:21 earlier conversation that if we don't grow at a particular level, job creation becomes
30:25 a problem.
30:26 So you would rather have a non-current account deficit India, which is growing faster.
30:30 Yeah, I would have a current account surplus.
30:35 So current account deficit country growing faster is a better place to be.
30:40 Got it.
30:41 Great.
30:42 Yeah.
30:43 Thanks so much, Neelkanth.
30:44 Much appreciate you taking the time out and speaking to us today and have a great festive
30:47 season.
30:48 Thank you.
30:49 You too, Neeraj.
30:50 Thank you so much and viewers, thanks for tuning in.
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