16 NEWSFebruary 17 - February.23, 2017, SINGAPORE/KUALA LUMPUR° WWW.MINTASIA.COM

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B Y J O J I T H O M A S P H I L I P

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India will continue to be investors’ go-tochoice for the foreseeable future because itis still the fastest growing major economy

in the world and has “some great companieswith among the best balance sheets,” says JonThorn, co-founder and director of India Capi-tal Fund Management Ltd. Edited excerptsfrom an interview:

As an investor, when you look at corporate funda-mentals in India—are you excited? India now hasmany positives—an improving external environ-ment, stronger consumption, robust public capitalexpenditure… I am excited, and yes, I believe that earnings

will rise; some already have. The backgroundeconomic picture, going back now nine yearsis not a particularly pretty one, but that is inthe past. The stronger macro numbers that weare seeing now are simply the aggregate ofmicro data at companies—but we are in theearly stages of what we think is a long termand secular growth uptick.

The dispersion between companies is alsogreatest at the start of an up-cycle, and thenmore companies join the party.

As an investor you make the biggest returnswhen a company gets up off the floor. Fromskepticism or downright negativity, when thatconverts to optimism, then the biggest stockprice gains are made. But those gains can onlybe sustained by solid research.

We have built our own database of com-pany financials and we do in-depth researchon the ground in India. The low-index over-lap, research driven approach has producedresults for our investors: we have com-pounded by over 300 basis points (bps) morethan the Index over 22 years.

Unlike many foreign investors, the Fundalways buys stocks directly in the market andavoids using the so-called P-Notes—Participa-tory Notes—which are access products issuedby banks offshore. Now, tightened regulationis leading an increasing number of brokeragesto stop issuing P-Notes. We want the directcompany contact; and we don’t trade much.

To what extent do you see an earnings pick-up,and would that accelerate into a bigger recovery?EPS (earnings per share) growth for the

market this past quarter with over 90% ofcompanies having reported is near 12%—therelatively high figure is due to one index com-pany whose EPS went to +2.09 this quarterfrom-28.63 in the previous quarter—after hav-ing been negative for the past few quarters.Earnings weakness is a reflection of the gen-eral economic softness we have seen in Indiaand especially the failure of a new capitalinvestment cycle to start. However, for ourfund we saw 15% YoY (year-on-year) EPS gain,after having seen some strong quarters for ourcompanies.

What are the sectors that you are overweight onamong Indian equities?We are overweight banks, financials and

vehicles. We are underweight pharma, FMCG(fast moving consumer goods) and IT (infor-mation technology). We like the domesticeconomy, and we are also avoiding the impactof changes to US regulations, which will likelyimpact IT and pharma especially.

How much of a concern is the fact that oil pricesseem to be inching upwards?Yes, I think we would like to see oil as low as

possible! India is a major oil importer so thehigher the oil price is, the higher inflation andFX (foreign exchange) outgo is. India is also avery inefficient user of its oil imports,although that is improving, so that is a doublehit. But at these prices, the marginal impact ofa rise is small, but at above $70-80 a barrel,

then more pain starts to happen. As household balance sheets in India expand, areyou betting on discretionary stocks like autos andretail?We think there will be a strong rise in con-

sumer spending—three reasons for that.Firstly, personal debt levels are low, amongthe lowest in Asia, and secondly, and demo-graphically, the relative size of the demand pieis also growing—young people buy things,and India has around a quarter of the youngpeople in the world. It always surprises methat people talk excitedly, or rather used to,about the size of the China consumption mar-ket while having little idea about how toaccess it, especially profitably.

India is different in that it is both accessibleand similar to the developed world. But not allIndian discretionary stocks have done equallywell—for example, gains in the auto stock inthe ICF have far outpaced the sector’s per-formance. So stock selection still remains key,and that is based on direct research.

The third reason is that consumers in Indiawant the same things that consumers in Sing-apore and other places want—brandedclothes, cool experiences, and the latest tech-nology that they can afford.

The old days of accessing the Indian con-sumer market by buying, for example, sham-poo companies, is long over—shampoo is acommodity, but Gap, for one, is not.

Last week, Reserve Bank of India (RBI) not onlyleft policy rates unchanged, but also hinted thatinterest rates might actually go up. What doesthat indicate? We are confident that the capex cycle will

start, but both the base effect and the exis-tence of stronger demand would itself signalthat inflation is not guaranteed to keep falling,it’s not unidirectional. Rising demand meansinflation, as demand often grows faster than

supply. India has a supply problem, not ademand one.

But we don’t see it as an end to rate cuts: wewill have to see the inflation path. I think it’smore accurate to see it as a pause. Oh, and allthose commentators who wrote off the RBI asa tool of the BJP (Bharatiya Janata Party) after(Raghuram) Rajan left; how does a pauselook? That anti-RBI view was never a rationalmonetary analysis—how could one knowthat?—but more of a political one.

Are you happy that the budget has not done anything to rock the boat?The budget in our view was very strong.

There were tax cuts for SMEs (small andmedium enterprises) and the lower paid,there was a sharp 25% rise in infrastructureinvestment, now 20% of the budget, and therewere strong measures for the expansion ofaffordable housing. Also the things the marketwas scared of, an extension of capital gains taxand more uncertainty over the application ofgains taxation were, respectively, not presentand specifically struck down. What’s not tolike?

In addition, there was a confirmation thatthe fiscal deficit will be 3.2% (of gross domestic product) next fiscal year and 3% the following. Plus, there were no big pre-state electiongiveaways, as one has over many decadescome to expect. India obviously cannot affordsuch pork barrel politics but has neverthelessdone rather a lot of it over the years. That the(Narendra) Modi government was fiscally disciplined at this point and will likely be effective in its investment programme was rather pleasurable to see. I smiled a lot as I watched the budget on TV.

I can’t see why some commentators wereunimpressed.

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The problem specifically is how do youresolve the problem of bad loans in govern-ment majority owned banks. The private sec-tor banks are all fine, and some very fine.

The previous RBI governor had put in placesome new measures, but this is, simply put, achicken and egg problem.

Who has the balance sheet or the appetiteto take those bad loans over, if not the govern-ment, and without that takeover, how can thegovernment banks start to help the capexcycle by lending strongly again? There is nosuch thing as the balance sheet fairy. We arenot making enough progress in the rightdirection at the moment, and without a newdirection, or a new player, nothing much willchange.

To expect a bad loan resolution to originatelocally on the scale needed without the gov-ernment is absurd, as no one has the balancesheet to do it, as is the idea that US buyoutfunds are clamouring at the door. The buyoutguys will be less able to resolve these loansand so would obviously also pay less for them,even if they could buy them easily.

It could certainly go badly, but it can also gowell. Whether it goes badly or well, willdepend on how it is implemented, rather thanbecause this is a bad idea per se. It has workedin other countries. I suspect that if Mr. Modimakes it clear that he is interested in how thisis going—then it will have a better chance ofsuccess as I think we have all seen that hethankfully does not suffer fools gladly.

I would very much fear that in the old daysan Indian government bad bank would itselfbe a very bad bank indeed, but I have greaterhopes that today there is a clearer focus onresults rather than sounding good.

Regarding the mechanisms that could makethis happen, these could easily be enablingprovisions and a law which would attract abudget allocation. It’s hard to see much realopposition to this; the benefits are surely obvi-ous and universal. The RBI’s balance sheetwould have to do some of the heavy lifting,and that would make it viable and doable.

Will domestic investors make up for the foreigninvestors’ flight from equities?They already have. After demonetisation on

8 November the local buyers ploughedstraight in after the market fell. The foreignerssold. Some weeks it has been almost dollar fordollar, foreigners selling to locals. We will seewhen the foreigners decide to return, at higherprices.

Will India continue to be investors’ go-to choiceon the emerging market for the foreseeablefuture?If you look at the top investment strategists

and fund managers in Asia, most are stronglyoverweight India. Just to name two: ChrisWood at CLSA and Hugo Young at Aberdeen.They have done a lot of research and have thebest access to corporates, and they like Indiabetter than anywhere else. It’s a simple trade:the strongest and accelerating growth in theworld with some great companies with amongthe best balance sheets in the world. PlusIndia is going to stay that way for a long time.Currently the market is not especially cheap,but that will of course change if earnings startto come through.

With regard to demonetisation, is the worstbehind India? By when do you expect the econ-omy to be back to normal? ‘DeMo’, as it’s known, is already mostly over

in cash terms, as the new cash has taken overfrom the old cash. I would say that by April orso we will not be talking about it any more. Wewill instead be talking about how much of theprevious cash economy is now non-cash, howe-commerce has taken over a lot of transac-tions, and how e-payments are everywhere.

However, I think that biggest hit to earningsof some companies will be in this quarter, Jan-uary-March 2017, as both panic spending andgiveaways raised activity in November andDecember. We think there will be some dis-persion and surprises for earnings outcomes,in both directions.

We will therefore, post demonetisation, betalking about an economy that has more incommon with the developed world than withthe emerging markets in terms of transactions.To the extent that is the case, and we wouldsoon see, we would have been through one ofthe most remarkable financial and economicevents in history.

JON THORN/INDIA CAPITAL FUND MANAGEMENT

There will be a strong rise in consumer spending in India

STREET WISDOM

I would very much fear that in the old days an Indian government bad bank would itself be a very bad bank indeed, but I have greater hopes that today there is a clearer focus on results rather than sounding good.JON THORNCo-founder and director, India Capital Fund Management