Inflation will probably surprise us on the upside… could lead to higher interest rates:


Prashant Jain, ED and CIO of HDFC AMC — the longest-serving fund manager in the country — on the impact of global events on Indian economy and markets, surge in the number of new retail investors, new-age companies and the way ahead for investors. The session was moderated by Sandeep Singh, Resident Editor, Mumbai. Excerpts:

Sandeep Singh: Over the last few months, markets have been impacted by several events — Fed tapering followed by rate hike, inflation, FPI outflows, Russia-Ukraine war, and now the RBI moving to tackle inflation. How should one see the markets and what should investors expect? 

Probably no one has a good answer to this. The nature of markets is that in the short to medium term, they’re extremely hard to forecast. You may spend as much time in markets, but the short term is very uncertain. Markets in India are reasonably valued, but I think they will deliver reasonable returns in line with nominal GDP growth over three to five years. The economic outlook has improved post-COVID compared to what it was pre-COVID. The profit growth cycle has clearly reversed and there has been a fairly broad-based recovery in profitability across all manufacturing sectors.

What are the worries? I think retail is a very big participant in these markets. Whenever retail participation is very high, it is not a good sign. In stock markets, the majority is seldom right over long periods. If you look at the retail flow of savings into equities, roughly $40 billion a year is coming to mutual funds. Maybe, $15 billion net flows into the insurance industry and another $10-15 billion is coming through the EPFO and the NPS. If you assume direct participation in stocks to be another $10-15 billion, it adds up to $80-100 billion per year. India’s pool of household financial savings is about $300-350 billion; 10 per cent of the GDP. This suggests that almost 30 per cent of household financial savings is now getting into equities. Easy money conditions in the world and spike in household savings rates during COVID has also contributed to this. I think all that is set to reverse, more outside India than in India.

Sandeep Singh: A lot of new investors come with the hope of making quick money. Is that a challenge for the mutual fund industry?

For mutual funds, I don’t think it should be too much of a challenge. These are markets that are reasonably valued. While there are pockets of excesses, there are also pockets where value is reasonable. The profit growth outlook is quite robust. Unlike  2018-19 and 2020, which was a very narrow market, where just five-odd stocks delivered more than 100 per cent of NIFTY returns, these are very broad-based markets. As a mutual fund manager, I feel okay to generate reasonable returns for unitholders over long periods. What worries me is the shift in trading volumes in India — all of these are coming from options. This suggests that the entire retail participation is speculative. Futures and options is a zero-sum game. In derivatives, you make money only if someone loses money. When I travel to very small towns, I’m surprised to see that earlier it used to be men, now it is youngsters and women. Everyone feels very comfortable trading in futures and options. And that is a bit worrisome. I don’t think it will end nicely.

George Mathew: Despite the huge volatility in the markets, SIP investment is at an all-time high. What is driving retail investors into stock markets?

In 1992, we were in a similar situation. Everyone was investing in equities. Even in 2000 and 2007, it was  similar. What is happening is not new. Of course, technology has made this possible along with few other factors. One, post-COVID, the markets fell sharply. Combine that with good savings in households, because COVID did not impact the upper-income mid-income households in India. Their savings simply went up. Also, digital adoption was accelerated and interest rates collapsed. They also probably had a lot of time at home. Combine all of this with the fact that whatever little investments anyone made then, turned out to be extremely profitable because markets were so low. The good experience has been reinforced, and it has spread by word of mouth. Demat accounts that were about four crore pre-Covid, have risen to about nine crore. But many people are likely to be disappointed because they are looking at making money on equity as a monthly income.

Anil Sasi: Typically, rising interest rates mean a good time for equity investors while the bond investors will perhaps worry. Does that hold in the slightly abnormal situation that we are in now? With a number of global events — the US rate hike, the geopolitical situation, and the inversion of the yield curve that probably is a pointer to inflation, or at least it’s been a pointer to a recession in the past – how do you see everything put together?

The impact of global developments on India’s economy is quite limited despite the fact that India has opened up quite a bit. Given the demographics, the consumption-led economy, other than oil, we are reasonably self-sufficient, and our pool of savings roughly matches our investments. Our exports to GDP and imports to GDP are quite small. So the variability of India’s economy to developments outside India is quite limited. The best example of that is that even in the Lehman year (2008), India’s economy grew by more than five per cent. The underlying drivers of the economy, whether it is demographics, increasing working age, population, low penetration or consumer durables, all of that hold us in very good stead. When it comes to capital markets, however, there is an impact that global capital markets have on Indian markets. Not over the long term, but over the short term. I think inflation will probably surprise us on the upside. We should be prepared for meaningfully higher rates in the US. I don’t think that should have a material impact on India’s economy or even capital markets. Equities are a hedge against inflation. Inflation means companies increase selling price of goods and services and it shows up in higher earnings. To that extent, equity investors need to be less worried about inflation.

Harish Damodaran: In terms of stock markets, India has been a consumption-driven economy, more than an investment-driven economy. Is that story over?

India was and continues to be a consumption-driven economy. Of course, the patterns of consumption are changing. For certain categories, as income levels have improved, the penetration has increased and growth rates have come down. But, consumption baskets are changing. The mobile handset market is as large as the car market and mobiles take priority over cars. If Ola and Uber have come in as an alternative to owning a car, the fact that white-collar wage inflation in India has seen negative real growth, could also be impacting the car industry.

I think consumption in India should continue to grow. But we should not link this to stock markets. Today, commodity prices are going up sharply, which will put pressure on the margins of these companies. There are no tailwinds or further tax rate cuts. So whether it is paper, sugar, textiles, chemicals, metals, capital goods, banks, everything is growing now. The premium of the scarcity of profit growth is missing. Finally, the cost of capital is also going up. So it is quite natural for these companies to derate. And I don’t find that surprising.

Post Lehman, investments in the world have gone down, especially driven by ESG concerns. CapEx and capital formation have been low in traditional industries for a variety of reasons and that is beginning to show up. We have under invested and the renewable space has not been able to take up the entire space at the speed that was desired. There have also been some supply bottlenecks due to the situation in China and Ukraine. I think the balance will shift slightly, because if basic commodities experience inflation, clearly, it will mean more profits to those groups of companies and better market caps. It will mean higher interest rates and could also impact consumption a bit. This could end up adversely impacting other businesses.

P Vaidyanathan Iyer: The pricing power has shifted more towards the larger corporations who are generating higher profits. While it positively impacts stock markets, what about the MSMEs — the backbone of the industry, many of whom are facing stress, and some getting wiped out? How do you look at its impact on the economy in the midterm?

SMEs are absolutely critical because they provide employment to very large numbers. A number of factors have come together to create this. One, of course, was the lockdown. One is the formalisation of the economy; GST, which clearly has hurt them. The flow of credit to the new entrepreneurs in traditional businesses and even to the existing SMEs has clearly been challenged. Even the DFIs funding is missing in India. Lack of proper credit has created a challenging situation. E-commerce also has an adverse impact on some of these businesses as India is a land of shopkeepers. However, there are a few things that could improve. Make in India is a very big theme. We have genuinely gained competitiveness over China. Chinese manufacturing wages are now two to three times of Indian wages and their per capita income is five times ours, which was not the case 20 years back. Their subsidies are being reduced and they are themselves discouraging export of energy-intensive products. So, it’s a conducive environment for India to improve its share of manufacturing. PLI is a great initiative, so is defence indigenisation. A Rs 2 lakh crore subsidy, at the rate of five per cent means Rs 40 lakh crore over five years…

Read More: Inflation will probably surprise us on the upside… could lead to higher interest rates:

Notify of
Inline Feedbacks
View all comments