Desai dismissed concerns of a slowdown in retail and domestic fund flows into the Indian market.
With India’s relative valuations dropping to levels last seen during COVID, and global earnings estimates declining at a faster pace, India, he believes, is set to be a more attractive market comparatively.Also Read | Raamdeo Agrawal’s advice: ‘Don’t hesitate to start buying if…’
These are the edited excerpts of the interview.
Q: This market has seen only a 3% correction after the COVID rally. So, where do we stand? We were upset over the last several months because of US exceptionalism. Money was going to the home market. Now, over the last two to three days, it’s become very apparent that exceptionalism is being questioned. Does that feed into your already positive narrative on India?
A: So, India peaked at the end of September last year, and the idiosyncratic reason for that peak—aside from global factors, which are complex—was that India’s growth was slowing down. In my view, this slowdown was triggered by policy tightening. The fiscal deficit was reduced in the last 12 months by about 120 basis points, from 6% to 4.8%. We’re still finishing this financial year, and a lot of that compression happened in the first six months due to specific factors like elections, heavy rains in August. It was further compounded because the RBI was quite stringent with its policies. Beyond interest rates, liquidity was tight, and regulatory pressure on the banking sector had increased.
By the last quarter of the calendar year, credit growth had slowed from 16% to under 11%, and government spending had significantly slowed down. This led to disappointing earnings, which caused stock prices to decline. Meanwhile, something I initially underestimated was China’s shift in policy. On September 27, China announced a fiscal policy change. Many commentators argued that China needed more consumption-focused stimulus rather than investment-focused stimulus, but it still marked a turning point for the Chinese markets. At the same time, India was tightening its fiscal and monetary policy, leading to steep underperformance relative to China.
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Now, in February, we saw a policy pivot, one of the biggest in my 35-year career. The RBI implemented a three-pronged strategy: cutting interest rates, committing to liquidity, and easing the regulatory burden on the banking sector. The government’s fiscal contraction continues, which is necessary to prepare the economy for future crises. However, the pace of fiscal consolidation will slow in the next 12 months, dropping from 1.2% of gross domestic product (GDP) to just 0.4%.
This is why I call this budget a “magic budget.” The government’s capital expenditure as a percentage of GDP is increasing from 4% to 4.2%, funded by reducing subsidies, which are now at near all-time lows. The RBI policy shift has been largely ignored by the market. However, India’s policy environment is now more stable than that of the US, Europe, or China. Investors will recognize and invest in this stability.
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I suspect that February may have been record inflows. And a lot of people have been quizzing me about when will retail give up? And I have got tired of saying this, they won’t. You will get the data tomorrow. I won’t be surprised if it’s a record high or near about there. Retail is not going to give up, because this is a shift in the balance sheet allocation that got underway in 2015 again, because of a major policy shift.
I am digressing a bit when the Prime Minister allowed retirement funds to buy stocks – there is provident fund and NPS, which was very similar to what Ronald Reagan had done in 1980 when he allowed 401(k) plans to buy US stocks, we got a 20 year bull market in America, which ended with the NASDAQ bubble. And it ended because a lot of baby boomers started retiring, and they had to take money out of the markets. Nobody’s retiring in 20 years. This has got many more legs to go. So the retail bid is persistent.
You mentioned, oil prices are down. That helps. It’s not a major game changer for India as it used to be in the past, because the oil intensity of our GDP has halved in the last five, seven years, again, due to major structural reforms that the government has taken – electrification of the railways, faster highways, fasttag, goods and services tax (GST).
For those who been long enough in this market will remember that 20 or 25 years ago, one of the quintessential trades in the market was to buy diesel genset companies. Nobody is using diesel to fire up electricity now. Electricity is on the grid, and almost every household in India has electricity. So our consumption of oil versus GDP has more than halved in the last few years.
Sensitivity to oil has broken down, but I will take 65 on oil and we have the DXY, which was a source of pain. So what you should see is the real effective exchange rate. And the rupee was doing very well in December, even though the headlines would be, it’s going down. But on a relative basis, it was doing very well. The RBI was defending it. But since then, the rupee has gone down by 6% in real effective terms, and it’s now at levels that we have not seen in a while. It will go back all the way to 2017.
So there is a big correction that has happened in the currency markets. The most important thing and don’t look at what equity investors are doing, look at what bond investors are doing – $900 million of inflows two weeks ago, last week it was $2 billion, foreign portfolio investor (FPI) debt flows have turned like this. They are suggesting that the rupee has now reached a level where they don’t expect much more in terms of downdraft, in fact, if anything, probably an appreciation. And that is a very important change that has happened.Q: The last time we spoke, you called this a “magic budget,” but unfortunately, for equity markets, the reaction has been disappointing. One of the biggest reasons for this is the aggressive selling by FPIs. They are at multi-year lows. What’s your sense? Are earnings going to return? Capex spending is expected to pick up, and crude prices have eased.
A: Let me try to explain this for the 500th time. There are only two cohorts in the market—domestic investors and foreign investors. Domestic investors can be further broken down into institutional and retail investors. Every morning, at 9:15 AM, domestic investors place their bids relentlessly. For foreign investors to buy, two things must happen: either domestic investors must sell (which they won’t at these levels) or corporate issuers must increase issuances, allowing FPIs to participate.
Otherwise, expecting that foreigners will buy without domestic selling ain’t happening. It is just not practically possible.
In 2024 last quarter if you look at the issuances on an annualised basis, it was about two thirds of the previous peak, and that was when foreign investors could buy. Once the issuance is faded, their ability to outbid domestic is constrained. You must understand that those who are 8,000 miles away from India understand India a lot less than those who are sitting one mile away from the stock market.
Q: But isn’t it true that the last five months were also about realising that India is not the only game in town? The US exceptionalism trade was in full force—the US economy and markets could do no wrong. Tech stocks surged, and China started gaining attention with its stimulus measures. So, from that standpoint, are we now better placed?
A: The key metric to look at is India’s relative valuation compared to global markets. Foreign investors were concerned about high valuations. However, India’s valuations have declined significantly and are now approaching levels last seen during COVID. Meanwhile, global earnings estimates are falling faster than India’s, making India relatively more attractive.
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Foreign investors are at their most underweight position in Indian equities in 25 years. This creates a strong setup for India to outperform, especially as a low-beta market. Unlike in the past, India will likely outperform in global downturns, similar to consumer staple stocks.
Q: So, 12 months from now, where do you see the Nifty? You’re clearly optimistic. Given the 15% correction, what kind of return should investors expect?
A: Timing the bottom is difficult. But in time, this correction will be seen as a good buying opportunity. Historically, the point of maximum uncertainty coincides with the point of maximum return. The uncertainty may persist for another month, but as it increases, investment opportunities will also improve.
India will likely outperform global markets, and small- and mid-cap stocks could perform well in the coming months. While they might dip slightly further, they are close to a turning point.
Q: India outperforms many emerging markets from hereon.
A: India outperforms the world at large including the US markets from here, and from a sectoral perspective, financials are doing well right now. They will lead this market out of its problems, and then it will transfer to consumer and industrials and other sectors.
Q: Industrials and capex is a theme that you’re still very optimistic on. So in the pecking order, where does cement fit in in terms of how to play that theme? And how do you look at industrials?
A: I would put cement much higher than the rest. Very simple reason, it is a non-tradable. So it is really not exposed to any threats from global trade disruption. Very hard to import cement. So whatever we make domestically is what is available to us. In capital goods, you can get large scale imports now, if tariffs realign because of all the free trade agreements that we are doing, because of the trade deal in the US, there could be threat to certain capital good companies.
So you have to be more careful about those, because we do not know how that will unfold. Cement is, in a way, simple, and also cement straddles many sectors – not just private capex, but government capex, residential demand, office space, so a lot of things in that. So the multiple drivers there, the consolidation that we’ve seen in the industry over the last 10 years, sets us up very nicely there.
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