Governments in a poor country like ours need to make a difficult choice. We seem to have swung too far to the left and consequently it is impeding investments and growth, says Rahul Bhasin, Managing Partner, Baring Private Equity India. Excerpts from an interview with ETNOW.
In less than a month, $200 billion have been wiped out and the pain appears far from over. What can the government do? I know the taxation of FPIs has escalated the sell-off in the market but what can they do now? Would it have to be a roll back? Will that make these outflows stop?
I can see there are two kinds of issues. One is the liquidity issue. In the last three-four years, the very important structural reforms which were needed in the economy actually have resulted in monetary velocity being destroyed. So the M1 to M3 transmission has impeded it. The fact that 70% of your banking system — the public sector banks — essentially had their capital wiped out and therefore could not transmit, meant that every time you give them money, they could not relend it.
The combination of the reforms plus the overhang of the public sector banking system woes, has led to a very sharp liquidity crisis. The other big issue which is harming and hurting the markets is the fact that in terms of policy balance, we have moved may be a little bit too much to the left. The social justice expenditure has gone up considerably. All governments have a choice of whether to invest in making sure that the people who generate income and wealth are allowed to keep doing that and to keep growing or to take part of that money and to start spending it on equity.
It is always a very sharp choice that governments need to make and in a poor country like ours, that is always a difficult choice. We have swung too far to the left and the consequence of that is it is now impeding investments, growth, reinvestments and capex is getting impeded.
One can talk about having intentions to lower corporate tax rates to make it akin to what is happening around the world. Look at Southeast Asia or other parts of the world, corporate tax rates are much lower than where we have them now but your lower corporate tax rates at one side add on. Instead of that, you have dividend distribution tax and then you have buyback tax introduced effectively you have done the same thing. You have actually raised taxes, not lowered them and it is very sad because foreign firms are not coming in and not integrating India into their global supply chains.
In an environment, where the world wants to diversify away from China, we are missing out on a massive opportunity here. Some of these kinds of taxation are retrograde. If a company cannot utilise its capital efficiently and wants to return the money to shareholders, want to redeploy it somewhere else, and if you start taxing that movement or mobility of capital, then you are damaging the economy.
These kinds of movements have actually hurt and damaged the economy, Incrementally you did it with dividends but there is always the opportunity to redeploy capital through buybacks. Now you have even put a tax on that. This the government will have to do something about correcting it. The government has gone a little bit too much to one side. It will have to do something serious about the liquidity. Our interest rates have been too high. It has knocked the bottom of a lot of real assets in the markets. A lot of lending in the markets to SMEs, to smaller companies have happened historically in India on the back of and the comfort of assets like real estate office space etc. which give comfort to banks. The fact that there is no market clearing in a lot of those assets is again impeding monetary velocity.
So a sharp interest rate cut, a whole host of measures are required to increase the M1 to M3 transmission plus correcting a little on the fiscal side. Strong initiatives have to be taken by the government to try and ensure that we get on to global supply chains. You need a combination of these things and you need them urgently. Just mere tinkering will not solve this problem.
If this were not to happen, do you think it is tough at this juncture for the animal spirits to return to equity markets?
You know you have introduced capital gains tax, you have buyback tax, you have dividend distribution tax. You also have tax on distribution in the hands of people receiving it. I am just saying the entire ecosystem is actually impeding investments and we just have to squarely face that fact. You know you have gone down a route where equity is good but there is plenty of evidence that if you increase the marginal rate of tax — direct and indirect — over 50% of what a person earns, it starts impeding investments and we are seeing that.
There is empirical evidence around the world on this but it is very sad that and we have learnt these lessons before in India and we have made these corrections but it is very sad that as the bureaucracy kind of retires and moves ahead, we get a new lot to repeat the same mistakes.
What would you advise investors to do? Would you be looking for value at lower levels, would you be risk averse given the current scenario and the uncertainty whether it is domestic or global?
I happen to be fortunate that I can take a long term view and the way I look at it is that a very small percentage of our economy or our population, less than 19% to 20% are in what I call normalised consumption pattern. That means that there is plenty of runway for the rest of the economy to catch up as far as that is concerned. I believe that these kinds of policy aberrations happened because there is always a conflict in a poor country to do social justice versus incentivising people to grow incomes, more so, because they can provide revenue and resources to the government and these balances will be corrected now. I do not sense an urgency in the government or the bureaucracy at this moment to do so. I would not make a bet that this is going to happen in the next six months or nine months but I am pretty sure that it will happen.
There is enough intelligence and enough economists around within the government ecosystem who will make these corrections. If I look beyond a lot of pain in the short term, I would stick to investing in equity. Now that the midcaps and small caps have gotten bashed so much, there is probably decent opportunity there.
Even if you are looking at the overall long-term picture, we have already slipped into negative returns. In 2019, we are not faring all that great even versus our peers in emerging markets. Would you be relooking at the kind of returns we could possibly expect?
We are focussed much more on what I call the disruptive part of the economy at this moment which is not that impacted by these policies. It is more impacted by technology changes and by business model innovation and the reality is that when you have an adverse environment for investments, cyclicality perspective narrows the scope of investments significantly. But it is a large country . For a fund, it is easy. It becomes much harder for the individual retail investor to be able to access this kind of opportunity set. But very serious structural changes are taking place in businesses around the world.
I think one needs to look at the fact that 50% of the market cap of the Dow now is accounted for by six companies including Amazon, Facebook, Google and Netflix. It is a technology driven part of the world which is dominating. The consensus view around the world is that the net present value of earnings is going to head there. So, a lot of these newer businesses will create value.
How long term are you really talking? There is a clear strategy here but we have also been in conversation with the Amazons of the world here in India and it seems to be a very long term trajectory riddled with regulatory hurdles, a lot of capital investment and if consumption is slowing down, how are they actually going to manage to show any kind of path to profitability?
I think that you are probably asking me about path to profitability of these businesses and the term that it will take to actually play out. Have I understood you correctly?
More or less…while a lot of investment is flowing into that pocket of the market…
Look I do believe that there is ample opportunity in the disruptive part of the economy for people like ourselves in our businesses. But in terms of the cyclicals return to the markets, sadly it will not be in months and more in years where that will play out. But it will play out quite sharply because whenever demand gets repressed in India, always bounces back very sharply. If you have seen slowdowns in the past when two-wheelers and four-wheelers stopped selling, it takes a while for it to come back but when it comes back, it comes back with 30-40% kind of growth.
In the auto sector one needs to worry about the EVs and the transformation to BS VI . That change over is probably impeding some amount of the sales currently. This is what I call technology structured impediments which are taking place in the short term. Those will be overcome faster according to me. If you look at talent, opportunity set etc, I am optimistic that we will find a way around it but there needs to be serious policy corrections whether on the monetary side and on the fiscal side. Both of these are imperative and they are required and they are urgent.