Expect Gradual Surge In FPI Inflows To India, Says UBS Securities Global Head

Gautam: The best way to describe the world is, people have been forecasting different versions of the Fed cycle—rate up, rate cut, rate hike, inflation.

But largely, the economy has held up globally. We have seen China digest the entire property correction and is still growing at 4% plus, not 1% or 2%. So, still a good enough growth rate and even the global economy is holding up.

So, unless something really big, negative happens, no cause to worry.

We've seen some kind of banking shock early last year in America. And unlike the 2008, the lessons were learnt and it was managed very very well. We also saw something happening in the European side, etc.

So, all have been digested and the global economy is holding up quite reasonably well. We get various views out there about what happens in one year, but the broader global picture is still supportive of India.

Gautam: So, yes and no. Let me put this in perspective. If you talk to global investors, who invest in India, they have remained largely bullish for the last 5-10-15-20 years.

They all believe in the India growth story. It goes up and down a bit. But if you look at long history, India has remained a key overweight market for all EM-benchmarked investors. The level of overweights goes up and down.

Today, it's one of the lowest relative overweights. So India’s weight in the benchmark has also gone up dramatically and the investors have kept pace. But the active investor's overweight is one of the lowest we have seen in many, many years, partly reflecting the valuations in India. They want to buy more, but in their mind they struggle with the valuations and secondly, attractive opportunities on a relative basis in markets like China. The valuations are very, very cheap. So it reflects that dichotomy in their mind as to what to do.

How that will change? One is, the point you raised in the beginning—will India deliver a growth surprise? And that's a very, very moot point, which we should discuss because Street estimates are priced at 7% of GDP growth, while markets are priced for higher GDP growth and higher earnings growth.

We saw a big GDP surprise in FY24. Will we see that as the beginning of a cycle where GDP surprises? That’s a big debate. That’s the moot point. That's what will drive, whether the foreign investors are forced to overcome their valuation resistance and jump in, in a big way.

The second factor that is also relevant is, what has happened in the last few years. Emerging markets, as an asset class, have struggled. So it's also not just about India, specifically. If emerging markets as an asset class are not getting inflows or are getting outflows, it doesn't matter. They can't really pump in more money in India, because the investor class which are running global benchmark funds, for them to keep from a global landscape to put in money in India that is very difficult for us to predict. That will be episodical, depending on the investor but not broadly.

If you look at the global investor base, the key market for them and the key source of funding is still America. It is doing very well. For most benchmarks, it is doing well. So there's no desperation for them to chase something. So, part of it is the emerging markets, part of it is relative valuation. Whether they come in a big way or not will depend on the growth supply.

So my answer to that would be, in the near term, if you're expecting a big surge in foreign portfolio investment flows, it may not have happened in a hurry. But as growth actually surprises positively, then possibly.

Gautam: So they remain overweight. I don't see them changing their overweight stance on India.

Fresh money will be in line with either flows into EM, or India's weightage in EM itself, because if India keeps delivering 13–14% growth, there is more free float available.

Gautam: Not really. They are still overweight. Again, few investors might have done that tactically but on an aggregate level, they're still overweight. But the relative overweight is one of the lowest we have seen in many, many years.

Gautam: Or comfort with the earnings delivery. So right now, the broader Street and even investors you speak are like, okay, India can grow at 7% but can it grow at 7.5–8% for a longer period of time, and therefore, much higher earnings growth. India's earnings picture compared to many other markets is not necessarily that attractive, from a 1–2 year perspective.

Longer term, yes, because a lot of the other economies in emerging markets are coming off. So the earnings headline earnings growth as a market is not necessarily weak versus India. So they see pockets of opportunity. Most investors also have to outperform from the next one-year perspective. So, if the earnings cycle supports 15% growth in other markets like Taiwan, it looks attractive.

Gautam: We advise them, from a longer term perspective, it's a great market and they agree. There is no debate on that. So they agree and they're convinced of that and that's why they remain overweight. So I don't think they will go to an underweight position as such, unless there is a negative surprise.

But for them to dramatically increase their overweight stance from where it is today, either EM asset class sees a lot more flows, or we see the earnings delivery.

Gautam: The big picture, in my view, in our view, we have seen in many cycles globally and here also in India, the big earnings delta will come from sustained capex cycle. We saw that in the pre-GFC cycle the 2003–08 cycle.

Gautam: The big picture, in my view, in our view, we have seen in many cycles globally and here also in India, the big earnings delta will come from sustained capex cycle. We saw that in the pre-GFC cycle the 2003–08 cycle.

Ultimately, the capex cycle was so strong that despite the government trying to increase spending towards consumption, the fiscal deficit kept coming down. That's what the power of the cycle is and hopefully the government sustains it, that even if they want to do more spending towards consumption, it's within those boundaries.

Now let's look at the so-called spending on consumption or trying to do more socialist spending. The easiest way to do that is tax cuts, because that's the most efficient, effective, immediate transfer of money from the government to the consumer. Immediate. Any other social scheme takes time to deliver, execute.

Even when the UPA government had brought in MGNREGA, it took a year to two years for it to devise the scheme, put it on the ground, etc. If you do something similar, it will take time. But this nuance is important because when you hear in the Budget, what they're doing, how much will it affect consumption near term versus longer term, how much of it is political, social. This will help all of us in the markets devise that. So barring any big tax breaks immediately, a lot of it will be more for political, social and longer term action, rather than immediate.

The second part is the scale of spending. Even MGNREGA, in the scale of spending today for argument's sake, is a far far smaller percentage of GDP, and therefore more fiscal than it was in the 2000s. So that's the second thing to remember, while capex has gone up, and is a far bigger component in terms of compared to any incremental consumption scheme.

So the scale is also important, barring major tax cuts. So we should nuance that when the Budget comes out—how much is for headline, how much they actually constrain the space for the fiscal and therefore for capex.

The last point I wouldn't add there is that, ultimately, the government has been doing public capex and I would highlight the two aspects here. Public capex ultimately is done to pull in private capex. So that's far more important, in my view that at what stage, the private capex cycle actually starts happening. Public capex cannot go on till perpetuity... They will always spend at a particular level. But they cannot keep growing double digits for many, many years, because at some stage it becomes difficult.

The second aspect is public capex has also been helped by stronger revenue collection in a way and that is a virtual cycle. We saw that in the 2000 cycle also. So as long as the GST collections, you mentioned, the income tax collections you mentioned, they are keeping pace, even public capex can keep pace.

So there is a case for that virtual cycle to happen but things have to align and that missing picture in all this—if I look at it from various angles—is private capex cycle. And that is the key thing to watch out for if I am taking a three-year or five-year view. All these points which we discussed do matter for the next 3–6 months but from a three-year perspective, as you said, markets are priced to perfection, the key picture is private capex.

Gautam: Let us look at the big picture first. You mentioned capex and consumption separately, but we have seen in consumption, the top end doing well and bottom end struggling. It also reflects the capex cycle in a way because ultimately in the longer term you need a capex cycle to drive a much stronger headline GDP and that's what flows into the bottom end of the consumption curve beyond the goodies from the government.

Ultimately, the goodies from the government cannot be sustainable in gthe longer term. So that's what the missing piece is and linkage to the capex cycle.

The second part is pockets right? So one of the pockets, which our analysts have identified as something worthwhile is around air travel and that has implications for airlines, for travel agencies, even hotels. So, a broader ecosystem of travel sector. And their view is that the airline travel will surprise materially, positively over the next 5–7 years, based on the modelling they have done.

I think the numbers they have is double digit CAGR, versus the high single digits, which the markets are forecasting. And that's based on the pace of infrastructure building happening, the connectivity and precedents we have seen on other markets when we see this kind of pace of growth.

So just the propensity to use air travel and therefore all this supply coming in will be absorbed. I think that's one good signal of the power of this cycle beyond household incomes or income level for the lower income households. So pockets like airlines, hotels and leisure will keep on doing very, very well. Pockets like retail and staples will depend on how the cycle actually evolves at a broader level.

So, if you ask for our house view for the next 6–12 months, discretionary specifically, we'd prefer to be underweight from a six-month perspective. Longer term, obviously all of these portions of the economy should do well. But in the near term 6–12 months we are underweight, unless something changes—either the capex cycle surprises positively or there's a material government spending towards consumers.

Gautam: Some of them did well, post the elections already. Some of them were doing well even through the early part of the year, as there were some early green shoots of rural recovery.

Again, it boils down to the nuances frankly. speculatively, possibly, but boils down to the nuances of the government support—whether it's rural, it is tax cuts, where they focus their spending on.

So I would wait for those nuances rather than jump in because as I said, our strategy is really still underweight that space, unless something material changes. Little bit tweaks here and there will not change things materially. If something major happens on the support schemes or new schemes, then yes.

Gautam: Broader capex becomes actually broader segments for investors to play in a way. Broad-based capex cycle means it is no longer limited to say automation slash where the MNCs did well or just the power sector where there was cyclical demand-supply shortage. But it becomes a broader set of things.

And again, if it coincides well with a meaningful supply chain relocation, then even industrial equipment supply chain players, they all could be beneficiaries of that.

Traditionally, if you look at the last big capex cycle in the 2000s, that was more infra, power, telecom, energy. A lot of that and matters. It's a nuance because they are typically more capital intensive.

So when we will define the capex cycle in dollar terms or rupee terms, how much money you spend, those sectors are more capital intensive versus setting up an automobile plant.

So this cycle versus that cycle, that's a nuance to keep in mind. But this cycle, unlike the last cycle also should have potentially more supply chain driven capex happening. So more scattered, more number of players trying to step up capacity, adding up possibly. But these are the two things to keep in mind.

If we start seeing capex spending picking up infra, energy also. Then it could become very, very strong similar to what happened in that decade. But otherwise, for it to become a proper private capex cycle, this needs to be more broader based than what we saw that time, because it's difficult for us to argue today that you'll see a big private capex cycle happening in power. We all remember the big surge towards setting up private power plants last time. It's difficult to replicate that because the context was very different. Similarly on energy.

Gautam: So again, that's where these supply chain, etc., come in, because if it coincides with a proper supply chain setup in India, then that cycle is meaningful.

If you look at thermal power generation, India has local supply—BHEL, etc. So the capex is much more local economy supportive, while for solar, even wind it's much more import intensive. So, for it to really drive the economy, the supply chain has also to keep pace.

Gautam: There is clear talk of that. Again, this is more global and not just Indian. We have seen even the western world trying to create barriers around the renewable energy side because China is very, very competitive.

So what happens globally will also, to some extent, influence India indirectly. Is India's ability to set up local at scale just for local markets going to be enough or will the policymakers have enough tariff barriers to support that scale up?

So there are two moving parts—tarrif barriers to support the local ecosystem to scale up. The second part is, if the western world is also trying to protect itself, will that opportunity open up for Indian suppliers.

Gautam: So, as of now, we are overweight industrials and utilities from a 6–12 month perspective, because there's no reason to believe that the course will change negatively at all.

If the cycle continues and if the private capex cycle, GDP plays up, this sector will keep throwing earnings surprises. Like, our analyst’s estimates typically, generally speaking are definitely higher versus the street. And this is without building up a proper private capex cycle. If that cycle happens, this will be even broader.

So I would still go for being positioned for that. For specifically when thinking about a three-year cycle, that's where you could still be making Alpha compared to markets.

Gautam: They all come into the picture. Everything, everything benefits from that.