Domestic Investors Bolster Markets Amid Foreign Outflows: Enam Holdings' Sridhar Sivaram

Sridhar Sivaram: I don't think even the most bullish (person) on the finance minister was expecting a 5.1% fiscal deficit and I think the trajectory for 4.5% for next year is very much on the cards now.

I think the path is looking much simpler. There was an expectation that some of the subsidy numbers would be much higher. On the contrary, the subsidy numbers were either flat or lower. So, we would have expected some extra spending before the elections and that's not happening.

And capital expenditure—which is the other number that one look at—is anywhere between 12% and 15%. If you take the revised budget expectations for the current year, then it's around 15%, which I think is very good given that it was up 30% last year, and they almost spent almost 90% of that. Almost close to Rs 9,50,000 crore is what the revised budget estimate is talking about (in terms of) capital expenditure from the government. I think that is very commendable, because many experts believe that they will not be able to spend so much and they have actually done it. So, I think, I would say 10 on 10 from all standpoints.

The absolute fiscal deficit number is also down, which was one of my concerns in the previous budget, because that determines how much you borrow, not just the percentage, because your denominator is going up. But your absolute fiscal deficit is coming down. So your absolute borrowing number is coming down. So it's really good on all fronts and not expected that this would come in an interim budget and I don't see this change if the government continues, where probability of that is very high, that they will change this too much. So, I would say it's very good that in the past three or four years, transparency from this government on budget has significantly gone up. I would like to thank the finance secretary also for that. I mean, they have actually gone on record to say that they will clean up and they have done so.

Sridhar Sivaram: So, I actually made a presentation to a bunch of investors in the U.S. and one of my slides was about a country under construction. So if you just go around, not just Mumbai, you just go around and I travel a lot. There's so much construction work that's going on.

On top of what has already happened—roads, airports, bridges—a lot has been done and a lot is being still done.

So, I would say that this is what has happened, which is the capex number that we speak of. And, we have to keep in mind that when the government says that capex is Rs 10 lakh crore or whatever that number is, on top of that, there's a leverage. So actually, if you see what is happening in Mumbai, I think the government puts only 10% or 15%. The rest is all multilateral agencies giving you loans. So, in our case, it's Japanese and German, you know, counterparts giving us loans in very favourable terms. So there is a multiplier that the government puts in. So if the amount is say Rs 10 lakh, the actual capital expenditure is possibly eight to nine times that, and that is what is making a difference, because India is a very favourable destination right now for a lot of global multilateral agencies to fund capital expenditure.

Given that, I think what has happened is that private capex, for whatever reason, hasn't really picked up to the extent it should have. And I think, even the government will feel disappointed that they did give a lot of sops—and, in certain pockets it has—but in the previous term, a lot of the capex came in bulky, like the power sector. And this time, it is more in granular, smaller pockets like say the PLI (production-linked incentive) given in the EMS (electronics manufacturing services) sector, where we're seeing a lot of activity.

In solar and wind, we are seeing activity but they don't guzzle up as much capital as the thermal. So I would say that a lot of this may change post May and the finance secretary also made a comment that they expect private capex to pick up in the second half. So, I think in the second half, and may be next year, we would see a significant increase in private capex also.

Sridhar Sivaram: For a while I've been saying that I think EM as an asset class is dying. For almost 17-18 years, EM as an asset class hasn't given any returns. I am talking about dollar returns. And I have, you know, in my previous avatar spoken to many pension funds and have presented my case for India and the EM.

You know, one of the things that always comes out is that when EM as an asset class doesn't do well, for about five years, most people absorb it. But after 10 years, it's a serious red flag. And now, we are almost 15-16 years. And even within EM, only two countries have actually given any serious returns—one is India, the other one is Taiwan.

So, my point is that the EM as an asset class is not homogeneous. It has, you know, countries which have per capita of $35,000 and $2,000. You have current account surplus countries and current account deficit countries and you have commodity exporting and importing countries. So the benefit of one negates the deficiency of the other. So, the sum of the part is zero and that's what shows up in the index—that it hasn't given any returns. That is one of the reasons why I see a lot of FII outflows. Despite India doing very well, the asset class is not doing very well. I think that's my concern. So, a lot of people are now talking about EM X China or Asia X China. May be once those pick up...because China has their own issues. I am not an expert on that. But that country hasn't done anything for almost 17-18 years. So it's quite a shocking number.

Sridhar Sivaram: I think that the domestic investor has really picked up. Some of the research analysts have spoken about the 401 K for India, which is the pension funds investing in the markets and then the entire mutual fund industry, which is now say Rs 50 lakh crore, or Rs 50 trillion. And almost 30-40% is equity out of that and that is continuously growing. So, almost $30-40 billion of domestic flows come into the Indian market, which is able to absorb any selling that comes from the FIIs. If, for whatever reason, emerging markets stabilise and then flows start to come, India will definitely get a disproportionate share. Keep in mind India's weight has almost doubled in the last three years. We are almost touching 18% index weight. We used to be in single digits—8-9%—if you go back three or four years. So, index weight has also gone up. India is getting flows based on the index weight in MSCI.

But the overall asset class is shrinking. So that is the larger concern, I would say. But I think the domestic flow is a big story and that has possibly held us very well despite FIIs selling. If you go say two years back, the FIIs had a massive sellout in India.

Sridhar Sivaram: For Active also. If 18 is the benchmark and I have to be plus minus 18. So, earlier I was nine, even if I was very positive, I'll be 15. Now, if my benchmark is 18, at 15, I am underweight the country. So I need to be at least 20-25 if I am positive. So it works both ways.

Sridhar Sivaram: I think, large pension funds don't want to make country-specific calls. So when I speak to my friends, who run India-dedicated funds, they're not seeing disproportionate allocation vis-a-vis how the country has performed from an index standpoint. If you compare India versus China over the last five years, there's been a massive difference, almost like 20% CAGR (compound annual growth rate) difference, which is very massive.

But I think, the reason is that countries are in favour or flavour of the year for a period like China was. We know what happened to Russia. Literally, people had to write off to zero. Similar issue has happened with Turkey.

So, within emerging markets, I don't think pension funds are large investors who want to take a specific-country bet. They're happy taking a regional bet, or an asset class bet because that seems safer for the person who makes the asset class. I think it may change, over a period of time, if India continues to outperform the way it is doing.

Also, global asset allocators haven't really allocated as much capital to India, as they would have to China. But now that the index weight has gone up and the buzz on India is also far higher, I think that may change.

On the valuation argument, I think, to a large extent India's pockets have both valuations. I mean, you have very high PE stocks and low P/E stocks also. And you're somewhere in between. Our financials are no longer where they were. I mean, you can't call a two times price-to-book, which is one standard deviation, or one-and-a-half standard deviation lower than the 10-year average, as expensive as some of these banks. So, I don't think it's the valuation argument anymore.

Sridhar Sivaram: I think we were quite lucky. I mean, they've mentioned this in the past that sometime in November 2020, we had a call with the chairman of one of the public sector banks because they were doing a QIP and we actually jumped into the call, only to understand you know, how Covid is impacting and the government had announced some credit guarantee programmes, and to know how that is playing out.

As the conversation went, we realised that their market cap was lower than the pre-provision profit by a big margin. I mean, normally, market cap to pre-provisions are 2-3-4 times and they were like at 0.6 or something. I mean, that was so absurd. That, you know, we just kept the call. It was one-on-one call, but we just figured out that evaluations were really absurd and then we checked all the others and we said that you know, this is really out of sync.

Honestly, I never thought that I will be jumping into buying a PSU bank, but very early in my career, some of my earlier bosses always told me that whenever you get into a meeting, keep an open mind, don't be biassed. We all have our biases. I mean, PSU banks have not delivered returns for decades. But you know, at every meeting, you go with a clean slate, not with biases. And sometimes you learn it the hard way and those learnings did play out here. We did jump into it and then we looked at others and we saw the same absurdity everywhere.

Hand on heart, did we expect that we'll still hold on to many of those for almost three-and-a-half, four years? No, we didn't. But we're still holding, because the earnings have outpaced the market returns. So, if you take the earnings from, say FY21 and what they're delivering now, and see the stock price returns, the earnings have outpaced. So, they actually got de-rated.

So it's a shocking number. I knew on the back of my hand that this is the case. I recently did the numbers to see and it's shocking by a big margin. So they have actually outpaced earnings by a big margin and I think one of the big reasons for the outperformance in earnings has been credit costs. So the credit costs on an average is about 2% for most of these public sector banks. The last number for SBI would be 0.2. Now, I think it can't go any lower than this. So I'm just giving you an example of how the credit cost has behaved and as Mr. Kotak said it's like the Cinderella moment for the Indian banking industry that you know, everything is falling into place. You know, people are paying on time, and many of the PSU banks have provided so much that they have a lot of cushion.

So one of the reasons for the outperformance is that the environment was benign. They were shifting from a focus more on corporate to retail. As a result, the NIMs (net interest margins) were improving, and the credit costs were falling. So I would say, this was the broad framework. Private sector banks didn't have the cushion of the credit costs falling because they were already very efficient. Whereas these companies were, are or are now becoming more efficient.

When I meet some of these PSU bank chairmen, I do feel that they are really good. I mean, the discussions that you have with them, it almost reminds me of how HDFC Bank used to be before. I mean, they want to provide more. In most of the cases, I can tell you that if they want they can show far higher profitability, and they keep telling me ‘Sir, aap saara profit ek quarter mein le kar kya karoge. There is uncertainty ahead. There's a change in regulation. We want to have some cushion.’

I mean, discussions are at a different level. So that's how I would put it—that there is a method to the madness and we think that selectively, it may continue for some more time.

Sridhar Sivaram: I think one of the reasons for private sector banks to have not performed comes from the fact that emerging market as an asset class is not doing well and FIIs are selling and this is a heavily over-owned sector among the FIIs. So, if you see, the FII holding in some of these banks are structurally coming down. So it comes from the original discussion.

Plus, I think some have had structural issues because of merger or whatever, which is behind us now.

Plus, the RBI's liquidity position isn't also really helping the case for banks in general because there's a scramble for deposit. I mean, you speak to any bank chairman or CEO and he'll tell you that deposit is the big issue right now. The asset side is not the problem. The liability side is the problem. I think that may change. I would say, may be it is a one or two-quarter issue. I would still be quite bullish on the private sector banks also, because they've reached valuations which are looking very good. May be (there will be) one or two quarters of pain, because of the liability side. But structurally, I think, if the economy were to take off and we see private capex coming back, these banks will do well.

Sridhar Sivaram: I think, the power sector looks very exciting. I mean, this has been a sector which has been ignored for a long period of time. I would say everything in the power sector is looking good. Even the thermal side is looking good, because India is underinvested in thermal. We are literally hitting peak capacity everyday during the peak hours. So, we are seeing companies scramble to put in more thermal power.

We will double our wind capacity in the next three to four years. We'll triple our solar capacity in the next three to four years. So, in the ecosystem, there is lots to play in this. So I'm saying, in the entire power space, be it thermal, wind, solar, there's lots to play because the government is also playing favourably. They also want the commitments that they have kept globally on moving green to happen.

So I think, this is a space to be watched out for and the entire ecosystem. I mean, individually, people have to figure out what needs to be played. But I think that's a space which we remain quite bullish on.