The ingredients of a multi-year capex cycle — much needed for the Indian economy after years of consumption-driven growth—are in place, says Sanjeev Prasad, co-head of Kotak Institutional Equities.
The cycle is likely to be led by household capex as people look to upgrade homes, followed by private sector investment which could get a boost from recent policy changes.
“I’m hopeful about household capex, which is essentially money going into residential real estate,” Prasad told BloombergQuint in an interview. “If you look at household physical savings rate, that has come off sharply over the last ten years or so. It used to be 15-16% of GDP in 2012-13, it has come down to 11-12% of GDP currently.”
The conditions over the last 12 months, as a result of the Covid crisis, could precipitate a change in mood around investment in real estate. “What has changed in the last 12 months is that there is a big desire for everyone to upgrade because the quality of housing stock in India is very poor and, because of work-from-home, etc., people want to upgrade.”
The ingredients needed to convert that change in mood into actual transactions have been there for a few years, Prasad said.
Current volumes (across five major metro markets for real estate) are similar to what they used to be 8-9 years back even as the economy has grown. So clearly there is under-investment in housing stock in India. Second, prices haven’t gone anywhere in the last 5-6 years, which means affordability has gone up significantly over this period. Third, mortgage rates have come down from 10% to below 7%. If you add all that, there are a lot of things that have fallen into place for a housing cycle.Sanjeev Prasad, Co-Head, Kotak Institutional Equities
A real estate investment cycle, if it accelerates, will bring gains for the economy as it creates jobs and demand for a host of commodities from steel to cement.
“It can become a big positive for the economy because the multiplier effect of housing on the economy is massive,” Prasad said.
Beyond household investments in real estate, private sector capex may also pick-up as pandemic related disruptions start to fade. “There are a lot of good things the government has done over the last few years—corporate tax cut, labour reforms and PLI schemes,” Prasad said. “Hopefully all that results in more private sector capex.”
The Indian economy has seen weak investment growth for years now. The share of gross fixed capital formation in GDP fell to 28.8% in FY20, before the pandemic hit. This is well below the peak of over 34% in FY12.
Consumption, however, continued to grow as the ability of consumers to get leverage was high. While this story played out for sometime, consumption growth started to weaken as jobs creation remained weak.
Against that backdrop, an investment cycle is much needed.
India needs some capex for sure. Otherwise, you would have had consumption without any investment and job creation. Even before Covid, our economic growth had already come off. The problem was lack of investment. If you aren’t going to create jobs, consumption will suffer at some point in time. I’m hopeful, the ingredients are there.Sanjeev Prasad, Co-Head, Kotak Institutional Equities
In the near-term, the focus will remain on the growth recovery from the second wave of the pandemic and the recent increase in inflation.
Prasad is skeptical of a quick rebound in consumption after the second wave, as was seen after the first wave. He cites a few reasons for the caution.
First, the rural economy is more impacted this time compared to the first wave.
Second, in urban India, especially for the urban poor, this is the second year in a row that they have seen severe disruption in economic activity.
The bulk of the urban poor are employed in ‘physical’ sectors—construction, hospitality, retailing, travel, tourism. These are all either low salary jobs or self-employed workers. There is much lower economic activity in these categories for two years now. Plus you have medical bills which would have gone up this time.
Third, if you look at middle and high income households, a lot of purchases of items such as consumer durables, autos have already happened after the first wave. So the demand may be subdued from this category, Prasad said.
“Based on these three factors — there recovery could be slower compared to last time. I don’t think a V-shaped recovery is happening this time.”
Inflation, meantime, remains a key monitorable globally and domestically. U.S. inflation is running at its highest levels since 2008 and local inflation is now above the central bank's comfort band.
Is the current bout of inflation transitory, as central banks have maintained?
“We’ll get the answer over the next 6-9 months. So far, the market has assumed that inflation is transitory, as guided by central banks,” he said. “But if this (higher-than-expected inflation) continues for the next 6-9 months, markets, central banks and the markets will have to recalibrate their expectations.”
The higher-than-expected inflation prints may prompt central bankers to begin talking about an unwind of the extraordinary support provided over the past year. The pace of that withdrawal depends on how long inflation remains high.
There are two scenarios in front of us. One is you see strong economic recovery globally and in India and inflation continues to surprise on the upside. Second is you see strong economic growth and inflation stays high for some time but comes down eventually. As of the now, the second scenario is the consensus view. That’s what the Fed has been talking about, that’s what other central banks are guiding towards and that is what the market has assumed. However, either scenario will lead to tapering—in the first scenario, the tapering will be a lot faster than in the second one.Sanjeev Prasad, Co-Head, Kotak Institutional Equities
India, however, will find itself better-placed to withstand the impact of this tapering, Prasad expects.
Inflation is lower than where it used to be, the current account deficit is at less than 1% of GDP compared to 4.5% in FY2013. “So I don't see the same level of tumult (we saw in 2013) if the U.S. Fed starts signaling a reduction in bond purchases finally. And remember it will be a gradual process linked to new economic data.”
Sanjeev Prasad, Co-Head, Kotak Institutional Equities. (Source: Kotak Institutional Equities)
Markets & Market Opportunities
For now, markets have remained upbeat, with the benchmark Sensex and Nifty indices are trading at near record highs.
Prasad is looking at 30% growth in the net profits of the Nifty 50 companies for FY22 and 15% in FY23. “This is on the back of 22% growth in FY21, so it's not as if we have built in some conservatism.”
What multiples the market chooses to attach to these earnings and hence what levels it trades at depends on the mood of the market at that point in time, he said. “It will all depend on what is the growth inflation dynamics, which, in turn, will dictate the policies of the central bank, which in turn will determine bond yields and cost of equity.”
The market is reasonably valued in the context of bond yields even though it may look expensive at about 22X 1-year forward PE multiple. The yield gap is around (-)150 bps, which isn’t bad in the historical context. As long as bond yields sustain at current levels or even if they move up modestly from current levels, equity markets should be fine.Sanjeev Prasad, Co-Head, Kotak Institutional Equities
The buoyant mood in secondary markets is likely to spill over into the primary markets and this time a number of new technology firms are expected to consider listings.
Does Prasad see interest in this space?
Somewhat under the radar but many of these companies have built reasonably good business models and are quite scalable now, he said.
“If you look at the whole consumer retailing piece, you have several decent companies in various verticals, apart from the horizontal e-commerce platforms,” Prasad said. “Yes, many of them are still consuming cash but to some extent you have started to see consolidation also, which could lead to better economics faster.”
When asked whether these companies will manage to get the kind of valuations they have on overseas markets, Prasad pointed to high multiples that Indian investors are already paying for good quality business models in India. These multiples are based on the assumption that India's growth should be there for the next 30-40 years.
If you compound at 6% GDP per capita growth over 30 years, in per capita terms we can be six times from where we are. That will take us to $15,000 per capita, still well below the $50,000 per capita for developed countries. So that’s why people are willing to pay these kind of multiples. On the flip side, whether the same companies will be in a position to capture the large market opportunity, only time will tell.Sanjeev Prasad, Co-Head, Kotak Institutional Equities
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