'An asset must generate income. Equities yield dividends, bonds pay coupons, deposits give interest, and real estate earns rent.'
'Gold, silver, and even Bitcoin produce no income, they merely store value. So, they should not be compared to productive assets.'
India's macro story has turned on its head, and that keeps Ridham Desai, managing director and chief India equity strategist, Morgan Stanley, "structurally bullish".
In a fireside chat with A K Bhattacharya/Business Standard, Desai says markets may not generate positive returns every year while advising that investors should invest in equities with a long-term horizon.
You are called an 'India bull'. Let me flip the question, have you ever been bearish on India? When and under what circumstances?
In January 2007, I wrote a report titled 'Skating on Thin Ice', where I predicted that the Sensex would drop to around 11,000 from about 15,000.
Of course, I was premature because the market surged to 22,000 in the following year before crashing back to 11,000 by the end of 2008. So, my call was a bit early.
In 2007, I was genuinely concerned about the relentless appetite for IPOs, inflated market valuations, and stretched earnings.
The profit share of GDP had peaked, signalling that margins were topping out.
I believed earnings growth would slow, IPO excesses would create technical challenges, and valuations would correct.
However, the global bull market delayed this until January 2008, when the decline finally materialised. I was bearish then.
So when did you turn bullish?
I had some concerns in 2013, but it was a brief cycle. Since 2014, I have been bullish. This year marks the 11th year of my bullishness.
That does not mean the market will generate positive returns every year.
I often remind people that equities are the longest-duration asset class and require a long-term perspective.
Unlike fixed deposits or bonds, a minimum five-year view is essential.
If you can't commit to that, three years is the bare minimum. Holding equities less than 12 months? Good luck.
From being bearish to maintaining a long-term bullish view, what has changed? What macro variables underpin this constructive outlook today?
A fundamental shift has occurred in India, often misunderstood. It relates to our savings deficit or current account deficit -- the gap between savings and investment rates.
Historically, India had a higher investment rate than saving rate, leading to a current account deficit of 2.5 per cent to 5 per cent.
This was largely because India had little to export and relied heavily on importing energy, especially oil.
The current account deficit was mainly funded by capital market flows, primarily equity, since foreign direct investment was limited.
Setting up manufacturing units in India was complicated, so multinationals preferred acquisitions.
The equity market flows were cyclical and often reversed during global recessions, leaving India vulnerable.
In 2008, India was not directly affected by the global financial crisis. Our banks were stable and the RBI had pre-emptively tightened policies.
Yet, we were the second worst-performing market that year because global capital market flows dried up when India needed them most.
Meanwhile, oil prices peaked at $148 per barrel in July 2008, adding pressure with a $140 billion import bill -- 14 per cent of GDP -- unsustainable for any country.
Since then, India has transformed dramatically, a fact even the government seldom highlights. Our oil dependency has reduced by nearly 60 per cent.
Trailing 12 months, India imported 1.7 billion barrels of oil on a $4 trillion economy. Even if oil prices spiked back to $140, the import bill would be about 6 per cent of GDP, much more manageable.
On the other side, a silver lining from COVID-19 is the rise of GCCs (Global Capability Centres).
With remote work accepted globally, MNC CEOs realised it's cost-effective to operate from Mumbai instead of Florida, enabling a boom in services exports.
GCC exports reached $70 billion last year and are expected to double within 4 to 5 years. Unlike traditional IT services, which are cyclical and tied to US growth, this trend is secular.
These changes bring India's current account deficit down to about 0.5% of GDP -- roughly $20 billion -- which is minimal in global terms.
We have become less dependent on volatile global equity flows and more attractive for stable FDI.
Another crucial development since 2015 is India's migration to flexible inflation targeting.
This has resulted in the lowest inflation volatility globally, which reduces interest rate volatility and increases growth volatility, good for stock markets.
The discount rate for equities can fall due to lower real rates, making India's equity valuations attractive.
Domestic investors, who understand these fundamentals better, have increased their equity share in portfolios from 3 per cent in 2015 to around 7.5 to 8 per cent today, likely to rise further towards 20 per cent, compared to 15 per cent in Europe and 40 per cent in the US.
This reflects a genuine structural shift in India's economy and markets.
This reduced dependence on global capital markets has lowered India's market beta to 0.4 from 1.3 in 2013, making it a defensive market.
In a global bear market, however, India's low beta should make it a strong performer and highly sought after.
What could go wrong for India?
Many risks are external and beyond India's control, which complicates matters.
On domestic fronts, corporate and household balance sheets are robust, and significant reforms remain to be implemented, representing low-hanging growth fruit waiting to be plucked.
However, external challenges loom. The global economy is burdened with record debt and its population is aging, which could trigger crises within the next few years.
The geopolitical environment is volatile, with India's neighbours economically or politically unstable.
Internally, farm sector reforms remain critical. India has around 200 million farmers, and while reforms were proposed earlier, progress is needed to lift farmers out of poverty.
If 400 million non-farmers surge ahead while farmers lag behind, societal challenges could escalate.
Indian agriculture spans nearly half the country's land but productivity is low; matching countries like China could transform this sector into a $2 trillion economy capable of feeding much of the world.
What's the outlook for corporate earnings growth?
Corporate earnings are cyclical. Profits as a share of GDP grew from 2 per cent post-global financial crisis to 5 per cent, followed by a mid-cycle slowdown last year due to government spending contraction around elections.
However, recent RBI policy pivots and GST rate cuts set the stage for a strong growth revival.
I expect corporate earnings to rise from 5 per cent to possibly 7 to 9 per cent of GDP over the next 4 to 5 years, implying 15 to 20 per cent earnings growth aligned with 10 to 11 per cent nominal GDP growth.
Capacity utilisation, currently in the high 70s percentile, should improve, driving capital expenditure.
Private sector capex-to-GDP is now above 31 per cent, approaching, but unlikely to reach, the 39 per cent peak of the previous cycle, partly because productivity improvements reduce the capex intensity needed to sustain growth.
What's the outlook for gold and silver?
I don't consider gold and silver as asset classes. To me, an asset must generate income.
Equities yield dividends, bonds pay coupons, deposits give interest, and real estate earns rent.
Gold, silver, and even Bitcoin produce no income, they merely store value. So, they should not be compared to productive assets.
You spoke about AI and disruption over the next five to seven years. Which sectors, in your view, face the least disruption risk from an investor's perspective?
The jury is still out on how exactly AI will shape the world. I don't believe large language models (LLMs) are the main source of disruption.
The real disruptive force, in my view, will be embodied AI-robots capable of performing physical tasks.
This is still early days, and the picture will evolve over the next 12 to 24 months.
I don't see disruption hitting manufacturing or IT services soon. In fact, India could benefit from the next wave of AI adoption.
When AI gets monetised globally, India will likely develop much of the customer-facing and operational software.
Many global multinationals are already doing significant AI work from India.
Yes, we don't manufacture chips, and we aren't creating our own LLMs, but those are early stages of AI.
As the real applications emerge, India will be well positioned to lead.
Feature Presentation: Rajesh Alva/Rediff
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