In this interview, CNBC-TV18 spoke with Rohit Sah, who has been covering the Indian market as part of an emerging-market basket since 1996: first at Oppenheimer and now at TCW International, where he is portfolio manager for the asset manager's smallcap strategies.
Sah argued that out of all the BRICS countries, India alone looks set to join the select band of "Anglo-Saxon economies". Read on to know what Sah meant by an "Anglo-Saxon" economy and why he thinks India is poised to become one.
Edited excerpts from the interview with CNBC-TV18's Latha Venkatesh.
Q: Why are you so confident that of all countries, India will be an Anglo-Saxon economy?
A: Let us define what an Anglo-Saxon economy is. First of all, it is characterised by low-government spending, it generally has an open current account, secure property rights and stock market and capital markets which are geared towards growth. So, if you look at the successful economies in the last 100 years, they have been the US, United Kingdom, Australia, Canada and Hong Kong.
India today is not an Anglo-Saxon economy, in 1947 it was. However, today we have a long way to go before we get to being an Anglo-Saxon economy.
However, this election of 2014 has provided a political mandate to move away from the Fabian socialism that has been practiced unfortunately for the last 60 plus years in India.
So, I am hopeful; I think the political mandate is there. You have a prime minister who has demonstrated his ability to execute such an economy in the state of Gujarat. So, we can only hope for the best after that.
Q: What makes you so confident? Modi has accepted the Food Security Act, he is not talking of privatisation; he didn't even privatise PSUs in his own home state. So, why should you be confident that we should be in this Anglo-Saxon category?
A: I think the political reality in India is that it is a very poor country and a very unequal society. So, any Prime Minister of India has to take that into account. Modi comes in with a very large political capital base but that is a finite capital base. For him to be able to execute on the economic reforms where there will be losers as well as winners, you have to carry the country along with you.
So, these are initial steps, which have not done away with redistribution policies. I would say they have streamlined it but that is the reality of India. Over time you will see these things improve.
What I am expecting is that after the Maharashtra elections are over, you have to see some solid reforms come through for this optimism to be maintained about India.
Q: A lot of investors have already begun talking of a pulling back India's so called Modi premium especially after that decision was not taken on gas price increase. How long are you willing to wait for action from the new government?
A: Let us begin with the Modi premium and let us just define exactly what that is. First of all, the economy in the last few years has gone down so much that people across economic spectrum have expressed frustration.
I have had some of the richest people come to my office and tell me that they have never voted in their life but this time around they are going to go and register and vote.
When analysts come to my room and say that if this election is not a good election result, they are going to send their children out of the country, I have read about rickshaw drivers in the city of Benaras talking about the dollar-rupee rates. When you look at all these various voices coming across the spectrum, it is clear the reality has sunk in; you need economic reforms. This redistribution approach of the Fabian socialisms of the Congress party is dead.
To me the telling election was the Rajasthan election of December 2013 when the blatantly populist government of [Ashok] Gehlot was completely wiped out. I think all these are very good indicators that Modi comes with a very high political capital which he can afford to spend.
However, one question I am not sure about is whether is it a Modi premium or is it a BJP premium? Have people voted for Modi or have people voted for the BJP and that is an uncertainty right now.
If you move to the next step, you have to give him some time to get in, wait to see all the files that are there, get the bureaucracy in action. However, I do expect serious action after the Maharashtra elections. So, right now he is talking the talk; we have to walk the walk after the Maharashtra elections; a lot of political capital is still left so.
Q: You are the king of small and midcap stocks in your fund; year-to-date (YTD) the Nifty has delivered about 25 percent gains, midcap and smallcaps have been giving between 45 and 65 percent gains. So, are we in bubble terrain here?
A: Let me tell you what a very experienced fund manager colleague of mine told me. He said he was short Cisco back in the 1980's and he said he lost his shirt on it. The reason he lost his shirt was because the market correctly looked forward and said this is a fantastic story, this is going to be a 10-year story and Cisco peaked out at a USD 0.5 trillion market cap. So, I would say the same thing about the Indian smallcap market.
The Indian smallcap and midcap market unlike the largecap market is primarily geared towards the domestic economy. The domestic economy is coming off a very low base, you have tremendous tailwinds right now in favor of it and you have a government which has shown willingness to reform in the past. So, valuation is not an issue.
If you want to be buying the Indian smallcaps, what you have to focus is not on valuation but you have to focus on the quality of the management, the quality of the business and the financial returns that you are getting from these businesses and after that the market will take care of itself.
Q: Your biggest overweight sector is I noticed financials. You have 29.8 percent of your funds there. Now Rural Electrification Corporation (REC) is the top holding in that list. Do you like the PSU banks?
A: Let me just give you an overview of the financial sector. In the last 12 years, the growth of India's gross domestic product (GDP) in US dollar terms has been 12 percent. That is despite the fact that you had a Sonia Gandhi led government which didn't know what they were doing or maybe they knew what they were doing but it wasn't the right thing to do. Now, if you look forward I don't see any reason why India can't grow at 12 percent for the next 12 years with the right reforms. If you grow at 12 percent you double your economy in six years, in 12 years [growth is] quadrupled. So, you go from a USD 2 trillion economy today to an USD 8 trillion economy in 12 years time.
As we know that is one of the biggest accumulations of GDP in human history in that shorter time if that really does happen. The biggest beneficiary of this sort of GDP expansion have to be capital markets and financial deepening. So by default the financial sector has to be a big winner in the India that we hope to have in the next 12 years.
Now regarding public sector banks I am not optimistic. If I was the government what I would do is two things. First I would merge these banks as fast as I can. So, the PSU banks which are in the North with the South and sort of cut them down in size and importance that way. The second thing I would do is by default asset-stripping.
So for example, many of these PSU companies own a lot of property. What I would do is I would take these property holdings that the banks have and all their PSU companies have, put them in to a REIT, sell that REIT and you get some value out of these holdings that you have. However, in the long run these PSU banks are not the place to be.
Q: If not PSU banks what attracts you in the finance space in general is it private banks, is it non banks?
A: What I would do is I would think about the Indian economy growing from what it is today to becoming a global financial market and think about all the things that you need to get from here to there. So the first thing you need is very good rating agencies. So I would think about that sort spurt of the capital markets. I would definitely look at the private banks; both small, mid and large all of them. That is the easiest way to play the deepening of financial markets in India.
I would look at also the non-bank financial companies (NBFCs) but given governor Rajan's pronouncement so far it seems to me you are better off buying the private sector banks rather than the non bank financial companies. Also there is companies which will benefit from financial inclusion. In the financial sector these are smaller companies, they would be some of the ones I would look at.
Q: You have PSUs like Nalco , Engineers India Limited (EIL) , and Bharat Earth Movers Limited (BEML) . Now what's common, what kind of PSUs do you normally like?
A: Again let's go back to the crystal ball and look at India in the next ten years, you have to develop a global continental sized economy and that's the right way to think of India in the future. You have an economy which will look very similar to the China and the US in next 12 years.
So you have to think in terms of what sectors have to grow a lot before you can get there and which sectors are the ones where the Indian public sector is very well geared towards. So I would look at logistics as one, I would at property as another one; I would look at any sector where the public sector company has a natural monopoly.
I would shy away from PSU banks and I would shy away from any manufacturing company that the Indian government owns and that's the way I would go.
Q: The prime divestment candidates that are on the anvil are Steel Authority of India (SAIL) , Oil and Natural Gas Corporation Limited (ONGC) and Coal India . Do you fancy any of these stocks?
A: The Indian government has a demonstrated track record of selling these assets cheap simply because nobody believes them any more. So as a trade these are good trades. Coal India is a good trade, SAIL would be a good trade. I would hesitate to call them investments for the long-term. So I would stick to the companies in the public sector which are run every well.
Which are natural monopolies and I have already given you hints of which kind of sectors I would go into.
Q: Do you like the oil PSUs? They have been actually quite a rage on expectations of a fuel price decontrol and in fact lower subsidy burden?
A: Let me take ONGC as a very good example what problem might be for these companies. Most of ONGC's revenues and profits come from Bombay High. Bombay High is unfortunately a very old oil field and it is literally dying under their feet, they are running just fast to just standstill. So in my criteria of companies which I buy which are highly profitable, fast growing and able to maintain the first two characteristics for a long time ONGC does not fall in to that market.
The only oil company in India which really does fall in to that market that I like which is high recycle ratios in oil companies, long lived oil assets and very fast payback periods on oil wells is Cairn India but unfortunately Cairn India has serious corporate governance issues and so it is best to avoid Cairn India.
By default I would say the oil sector in India unfortunately is not the right place to be. India is the very geologically interesting country in terms of oil and gas discoveries. You have already had the KG-D6 as a potential world class asset but I am sure there will be others coming up in the future and what you want to do is you want to find those companies which are sitting on these kind of assets and may be it is ONGC in the future but the only time will tell.
Q: Actually most India investors seem to like autos ands auto ancillaries, why not they have done very well year to date, anything that you like in this space?
A: India has some very good auto ancillary companies I mean Motherson Sumi and Bharat Forge are the ones which immediately come to mind. I have not looked at others but those two are the ones I would recommend.
Q: This far this year liquidity has been very favourable for India. If the US Fed were to hike interest rates do you see a liquidity drought?
A: I don't think the Fed is going to hike rates. I think the US economy is not as strong as everybody thinks. What we have is a growth scare as some people call it, the scare that the US economy is growing faster than it is able to and leading to inflation. I don't see any such possibility happening. So, in that scenario what you have is the dollar strength. However, on flip side we also have China slowing down. So, commodity prices are coming down.
For India the most important things is not the Fed, it is the oil prices which are much more important, coal prices and so on. So, in that scenario India does very well because if the Fed is not raising rates, the liquidity will continue to move into emerging markets or at least to some emerging markets and India is by far the best story out there.
If the Fed were to raise rates that would probably mean that the US economy is doing a lot better than what I expected to do. If that is the case then the US will be importing a lot more goods from everywhere that should be good for global growth. However, only time will tell. Right now, I am assuming that the Fed cannot raise rates although the liquidity into emerging markets will slowdown.
The credit story in India is improving by the day and as long as Prime Minister Modi can deliver on his economic reforms I don't see any reason why the foreign money will go to a future continental sized economy like India.
Q: Chinese slowdown and the commodities down cycle has been very good for India but how long do you think both these trends will last?
A: The commodity market is right now being torned between two different factors. On the supply side we have a real crisis developing. After 2016 when you look at the future copper supply, oil supply, natural gas supply and all these various commodity sectors that are there, we have a real supply shortage coming up. What has helped us right now and probably for the next few months is China has slowed down a lot more than expected. So, I think this run of good luck continues maybe till the end of next year at best.
After that if Modi hasn't fixed the Indian commodity supply situation, we have a real problem in India. So, that is where I would leave it. I think the tailwind is behind India right now, probably dies out by the middle of next year and becomes a headwind by the end of next year.
Q: The evergreen big India stories are IT and pharma. You are under invested looks like in both these areas. Anything you like particularly?
A: I am not a big fan of the IT sector in India. I think it is actually a wrong classification. If you look at companies like Infosys and Tata Consultancy Services (TCS) , you do a simple calculation. You just calculate the ratio of their cash flow to employee and plot it backwards for the last several years. It doesn't matter which company you pick up; you get the same number – about USD 4000-6000 per employee, per year, cash flow, profits.
The problem is not the number; the problem is it is flat. It hasn't changed in the last several years. So, in other words if Infosys has to grow 20 percent, all you need to do is hire 20 percent more employees. That is not an IT company; that is a labour employment agency.
So, I am not very enthusiastic about the IT sector. Having said that, I have been wrong for the last five years; these have been some of the best performing stocks in India and globally I would say. However, there is a sell by date for some stocks and some sectors.
The pharma sector is one where there is a lot more hope. However, again you have to look at companies with new business models, not just the same old formulation of the existing medicines. You have to start with somebody who can generate sales in a different way.
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