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"There is nothing in this budget I would call bold" - Views on News from Equitymaster
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  • Mar 1, 2005

    "There is nothing in this budget I would call bold"

    Ajit Dayal is the co-founder and Chairman of Quantum Information Services Limited that owns Equitymaster.com and Personalfn.com. Ajit is one of India's best-known investment advisors; he set the stage for entry of FIIs in India. He founded India's first equity research company in 1990 (this company has evolved from that pedigree). Currently, he is the Chairman of Quantum Advisors, which manages funds for institutional investors and HNIs.

    In this interview, Ajit gives us a low down of what he thinks of the Budget 2005-06. While we were at it, he was gracious enough to give us his views on the Indian stocks markets and their relevance to global investors. He also gave his views on other investment avenues like Real Estate and Gold.

    Eqtm: How would you rate the budget on a scale of 1 to 10 (10 being the highest) and why?

    Mr. Dayal: Yesterday, I was thinking of giving it a 6 or 6.5. Now, I will give 5 to 6 on a scale of 1 to 10. And the reason why my initial reaction was higher than what it is now is because I think atleast what I was expecting from the budget was a continuation of the past economic reforms. No sudden shocks and no change in the path. I got that and that’s an A+ and is 9 on your scale.

    And the next thing was that is the budget doing enough to balance economic growth? I.e., trying to distribute wealth away from urban India to rural India. I believe it is a liability and is the responsibility of the government to do that. I think to that extent, the estimated amount of money they want to spend in rural India is higher, including giving loans and lands to farmers, it is great, if it is monitored well, as the Finance Minister has indicated. That’s great and therefore, would get 8 out of 10.

    And the next part I was expecting from the budget is something to take India’s GDP growth level from what I think is a sustainable long-term growth of 6% per annum to a more sustainable 8% or 10% per annum range. I did not find anything in the budget to give me atleast the comfort that you have taken steps to move a notch higher. And when I kind of read (I have not honestly read the entire budget or the Finance Bill), I heard from the people this morning who have been analyzing it that some old sections, particularly with respect to taxation, which were removed by Dr. Manmohan Singh when he was the Finance Minister in 1991, have crept their way back into the Finance Bill.

    There is something specific called Section 115-W, which you should spend more time on. Section 115-W basically says that if a company sends me on work for the US for a marketing trip or wherever, a part of my trip is considered to be a perquisite to me because I have the benefit or the advantage of going wherever the destination is and the company is expensing it. So let’s say, they spend Rs 100,000 on me on a trip, I don’t show that as my income because it is not an income for me. But of that Rs 100,000, may be half of it or some such number, is seen as a perquisite paid to me by the company. So, the company has to pay a tax on that so-called perquisite or fringe. I think that is ridiculous. I think that is a backward looking, archaic old-age thinking sort of number.

    If you want to raise more money from taxation from corporate India, which I think they should have done, my view would have been to either increase the tax rate or create an extra slab for what I would call the ‘super-rich’ or the even wealthier. But by this fringe tax, you have created more administrative headaches for companies. It’s a silly notion that you tax an expense, I mean you tax profits and not expenses. So, it is a very backward step in my view. But again, that’s just the one section that I have heard of and I am not a tax expert.

    What I was looking for was something on infrastructure to show me that the government and the people in the opposition and everyone, is keen on pushing the GDP growth from 6% to beyond 8% on a long-term sustainable basis. Not a one off snap because of some bumper agricultural output. And I have seen nothing of that.

    Eqtm: What are the measures that you would term ‘bold’, if at all, in the Budget?

    Mr. Dayal: No, there is nothing that I would call bold. I mean, the fact that he has cut peak import duty is nothing great. He is supposed to do that because we have signed a global agreement. The fact that we are bringing more rationality in the tax system, barring the Section 115 (w), is again a part of what the Kelkar committee had outlined.

    To me, the bold step would have been, you know, here is the budget for infrastructure. We are going to be spending 10% of our GDP on infrastructure and instead of that we have got Rs 100 bn in this SPV (special purpose vehicle) to build something on infrastructure, details yet to be worked out! Well, what is this SPV supposed to do? We don’t know. To put Rs 100 bn in perspective, it is about US$ 2 bn or roughly about 0.3% of India’s GDP. This is the country, which needs to spend US$ 50 bn or something like 9% of GDP just on building these roadways. We will spend US$ 150 bn, which is another 25% of our GDP on building power plants, forget about the airports bills, ports bills and everything else. Just these two items are more than 1/3rd of our GDP and yet, instead of 30% of GDP, fine, you can’t spend this in one year, but if you want to be bold, then you got to put 10% of GDP on the table.

    Eqtm: Any three budget measures that you think are important?

    Mr. Dayal: I think the overall objective, as indicated from the initial statements of the budget, that growth has to benefit the maximum number of people, that has be adhered to. We are living in a country of 1 bn people. For every one person who watches CNBC or invests in the stock market, there are 300 people who do not have food to eat. That is the reality of the country. So, you have to have a transfer of wealth. In theory, there is no better mechanism than to enact the transfer of wealth. The fact that the budget recognises that continuously is encouraging, because I wish things do not get lost in India’s urge to ‘so-called’ privatize.

    I am glad that they are maintaining that stance and the government is taking upon itself the task of transferring wealth from people like us to those who don’t have it. So, that was nice.

    Eqtm: Talking at a much broader level, while the US interest rates have risen in the last one and a half years, it has not made much of difference, in terms of money flow into the emerging markets like India. Why is it so? Given the prospects of interest rates going up further in the US markets, what is your view on the global markets?

    Mr. Dayal: Actually, if you think on a percentage basis, and I think this is where I got my calculations wrong. I guess sometime last year in my thought process, we believed that US interest rates would rise in the calendar year 2004 a lot more aggressively than what people expected. If you remember the interview with you a year ago, I think we expected interest rates to increase from 1% to 3%. The general consensus then was 1% to 1.5%. It ended up at 2.25% and so, we were much closer. Yet, the global markets did not tank.

    I kind of went back to my friends in the US and said you know what, interest rates have more than doubled in US from 1% to 2.25% and yet the stock markets went up. And one investor gave this wonderful view. He said listen, you got to think about it and you are right that interest rates have more than doubled. But they doubled on a lower base. At 2.25%, I as a long-term pension fund investor, I am still saying international markets look good and equities look great. But if you start giving me 3.5% or 4% cash, when rates go to that level, then I will start thinking. Then, there is a real alternative. So even though interest rates doubled, in absolute numbers, they are not that attractive to result in an asset shift. The first thing is from equities to fixed income and then globally, from international stocks back to the US. So, I think you have got to wait for that threshold limit and the limit from what I have explained to you, is somewhere between 3.5% to 4%. And in this year, we are going to hit that threshold limit, probably the upper end. At 4%, dead cash is a real alternative. Because if this is near-term money, long-term money is probably closer to 6%. Then, suddenly, you have these pension funds scratching their head and saying do I need to go through all the risk of anywhere in the world or should I just be in the US?

    And please keep in mind that we love to tap ourselves and pat on ourselves on the back that India and China are rapidly growing, which we are. But at the same time, in absolute dollar terms, US is the largest economy and if the US is still showing decent rates of growth, the US itself will attract decent capital flows.

    I strongly believe, country’s like India and China (and I think China is a little more ahead of India) should have the stated objective to become independent growth engines, independent of what happens, to a large extent, to the global environment. Infact, as of now and in the last 30 years, the US is the only economy that can claim to be the engine of global growth. You know what happens in the US, influences the world. Whereas what happens in India, does not really influence the world. You can talk a lot about BPOs. Frankly, if you close down all the BPOs in India, they will move to Philippines or Eastern Europe. It is not going to impact the world in a big way. If the budget had taken those bold steps to put India into the 8% to 10% path as China has been doing for more than a decade, then what happens in this economy becomes independent of the global economy. Infact, it influences the global economy like China does on the commodity prices front. They influence textile prices in America and they influence a lot of things in the world. We need to get there and this budget has not given us any incline, barring this Rs 100 bn SPV, which at 0.3% of GDP is nothing.

    Eqtm: Do you see a change in the mindset of corporates in India, since you have been meeting number of companies these days, compared to ten years back? Do you think corporates have learnt from their earlier mistakes?

    Mr. Dayal: I think that the Indian managements are one of the best I’ve met or seen anywhere in the world. I mean they are fabulous. They understand the insides and outsides of the business. They have worked in a business environment under a socialistic garb for a long time. And I think over the last decade and a half, their interaction with global companies and their increasing travel (that is now being taxed as a perquisite under section 115 (w)) has made them understand what’s happening globally. And they have changed a lot. So, I think yes, Indian companies have learnt, Indian companies have changed the way they understand business, the way they approach business and the way they implement things. At the same time, Indian companies, like anyone else are fallible. They make errors, they make mistakes.

    So we are going through this business cycle when everyone is getting excited. And my gut feeling is that, maybe in another six months, or nine months to the very maximum, you will see huge expansions being announced. A classic case is cement. Everyone will be running around doing cement. But that does not mean Indian managements are bad. Rather, it means that everyone has this wonderful vision of India and everyone’s gearing up to build this huge step-ups of capacity. And as economic cycles teach us, the first lesson is that economic cycles are not dead, they are alive, so there are cycles. The second is that demand grows on the margin and supply grows in huge steps. So, like cement, like steel, like iron ore, you name it and there will be huge step-ups in supply side and demand will not catch up and there will be a turn of the commodity cycle worldwide, including India. So, some capex that some companies may end up doing, that end up starting in the year 2005, will actually be bad decisions. They will become bad decisions in a year or a year-and-a-half from now.

    Eqtm: Just before the May 17th crash, you opined that ‘the buying opportunity has begun…” What is your outlook for the Indian stock market with a one-year and a three-year perspective?

    Mr. Dayal: I think we were right last year. We gave three predictions last year, broadly. The first prediction was in January 2004 – ‘don’t buy.’ We also indicated that the index would be lower at the end of the year. That prediction was sort of wrong because the index shot up in December. We do not mind losing on that because the general pattern was right. And in the third statement that we made in May was that ‘the buying opportunity has begun.’

    Currently, our view is that it is a good time to be in equities. We don’t doubt that. We are actually fully invested for the clients that we have, for the portfolios that we manage. But, at the same time we recognise that there is a certain environment that is being created with interest rates rising in the US, and with capex plans that will come to fruition over the next 12-18 months. We have to be cautious. So, on a very macro view, I would say that if you have Rs 100 to invest in equities, invest half of it now, put it to work, and wait for the other half. And one should basically adopt a kind of a systematic investment plan where you have got a certain allocation to Indian equities. In that sense, give me half of the money to manage now and give me the other half when the market cracks. So it means that you should keep on investing every quarter for the next year, and you should be fine.

    I do believe that the market will crack not only on account of dollar flows or interest rates. It is also the fear factor. There was a very small article in a leading daily recently which had a four liner and it said that the Left front met to see whether that they can create a third alternative front to the BJP and the Congress. And a few days later you had the Bihar election results. This was the fear factor of politics. That, coupled with the fact that you have the structural issue with the stock exchange ownership the way it is, with FIIs owning a substantial chunk of equities, being the biggest buyers and sellers of stocks. And if FII money flows back for whatever reasons, it may be political, it may be US interest rates, or a combination thereof, and the markets could crack. That risk has not gone away. We saw that on ‘Black Monday’, May 17 2004. So, it could happen again. But again, I would like to clarify that we are fully invested. We hold stocks of the company we believe in the long-term, recognizing that there could be a short-term market mishap.

    Eqtm: What should the strategy of a retail investor be, not only restricted to equities? Where are you investing your money?

    Mr. Dayal: We have, for the last 4-5 years, looked at expanding our product profile. Quantum Advisors is known mainly for equities. We have now expanded that to fixed income and real estate. We are okay on fixed income. We believe that interest rates will go up. So we recommend that investors keep all their money in near term because we believe that interest rates are going to re-price and investors may get a better coupon rate if they wait out for some time. And we believe that interest rates will rise in India by at least 100 basis points this year. So the government bond, which was 6.25% will go up to 7.25%.

    At the same time, we believe that real estate is a wonderful opportunity for those who have the capacity to hold for a long time and also the capacity to invest a significantly large amount of money. You can buy a mutual fund for Rs 10,000. As of now you cannot buy a mutual fund for real estate for Rs 10,000. You have to buy a portfolio of real estate assets, which may run into a few crores. So, unless you have a few million dollars or that equivalent, you cannot really look at real estate as an alternative. But we would strongly recommend real estate as an alternative.

    We believe that the real estate story in India as an investment perspective is yet to unfold. We believe that the long-term is absolutely fabulous and the volatility in real estate returns will be less than the volatility in returns that comes from investing in stocks. So it provides a more predictable rate of returns. It is more illiquid by definition and by nature, because of the large amount of investment required and only a few people buy and sell properties of that size. And we also would like to caution people that there could be a mini bubble brewing in real estate in certain locations.

    There are bunch of funds being launched in India and overseas. And Quantum is part of that effort. But we believe that it could already be a bubble because there is too much money in the funds relative to where it is trying to get into. While India is huge country, everyone is focused on three or five pockets of real estate. And when too much money chases that small pocket, that is when there could be a mini bubble. So it could be a bit like the tech bubble that you had seen or the PSU bubble that you recently saw where everyone was going after one sector.

    I am not bullish on gold. I was bullish on gold at US$ 280. I have been a seller or not been a holder of gold since US$ 430. Gold is exactly where it was a year ago. I think the days of people investing in gold in India are limited because there are other investing avenues, which retain value. And stocks and equity investment is one that retains value. Equities have been a wonderful hedge against inflation. Property, in many cases, has been a wonderful hedge against inflation. So you don’t need to have gold. I mean you can live off dividends from equities, you can live off rent that you make from real estate investments. What can you do for gold? There’s no yield on it. So, I think gold is a nice thing to have 2% or 5% of your money in, but I don’t think it is something you should spend much time on.



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