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“The buying opportunity has begun…”

May 15, 2004

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 an interview with Equitymaster, Ajit shares his views on the current political scenario and its effect on the stock markets. He also shared his views on the crude oil price rise and gave a perspective on what should be the investor’s strategy.

EQTM: Do you think that the fall in the markets is justified and that this has been triggered by the concerns that there will be change in the continuity of reforms?

Mr. Dayal : One thing clearly is that stock markets move on perception and react to facts. If you remember, we had given a talk to over 200 people in March 2004. One of the questions that were asked to the audience was – “Do you think that there will be change in the government? Those who believe that raise their hands.” If you recall, not even one person raised his hand. No one believed that the NDA government would go. This was the general consensus four weeks prior to the elections. Markets are concerned that what they expected has not really happened.

Do I think the reforms will continue? Well, it depends on what you mean by reforms. I think, the fact that the government is opening up, allowing private capital to do a lot more things and allowing people to do a lot more things with their money, that is all reform. In terms of delivery, if you look at what the NDA has delivered over the last 5 years, there has been a net loss of 0.6 m jobs in the organised sector i.e., government companies plus private companies.

India was shining to some extent for urban India, but I think that for a lot of people India was not shining and the government was caught up in its own ‘urban-centric’ euphoria and believed that everything was hunky dory. At the end of the day, India is its villages, its farmers and that is really what counts. In Andhra Pradesh and Karnataka, you have seen the effects, where, if there droughts or local issues were not tackled, the state government paid the price.

I do not believe that the continuity of reforms is a concern, but I clearly believe that whatever the reform path that was taken in over the last few years was good for urban India but not good enough for rural India.

EQTM: Do you see the correction in the markets continuing in the future? Where do you see a turnaround? Is there a level in your mind?

Mr. Dayal : We have already witnessed across the board selling. You look at the FII flows. About US$ 7 bn came into India in calendar year 2003. In this year - from January to April - the cumulative number was around US$ 3.9 bn, which is an absolute record – it is like US$ 1 bn every month. But if you look at the month of May till date, there is already an estimated US$ 400 m – US$ 500 m outflow. So you see, the only people buying shares over the past one year and few months were foreigners. And because they were buying, the punters were buying ahead of them, and the markets were up. And now that the FIIs are selling, the punters will sell ahead of them and there is no one to buy. The UTI is a buyer of last resort. The government may use the Life Insurance Corporation of India (LIC) to step in as a buyer of last resort. But there are certain restrictions that the LIC will have because it is governed by a regulatory body that will look at its investment profile.

So, the markets will fall to whatever levels, till the foreigners clear out. Keep in mind, that the story in 2003 was a weaker dollar, lower interest rates. Borrow in US dollars and invest anywhere in the world and make money! There is a reversal in that now. Interest rates are expected to rise, and have already started firming up quite rapidly, and because of that the cost of carry, i.e. the finance charge for a speculative investor, has gone up. The risk that the dollar is going to rise makes it more risky for him to invest in a non-dollar economy. So, money is going to be sucked back into the US. And as money gets sucked back into cash assets in US dollars, there will have to be an all around selling in the emerging markets that have done better than the global equity as a whole in all of 2003. You do have this issue of getting back to the home country, which is the US.

So, a decent part of a decline in markets can also be attributed to the fact that global money is going back, which will get accelerated by the fact that the foreign buyer was the sole buyer in India in all these months.

EQTM: Would you like to take a call on the BSE Sensex in terms of when it could bottom out or when it will become attractive again?

Mr. Dayal : We do not anticipate it falling below 4,500. For our clients, we are already recommending that we start buying even though it is not yet at 4,500. So, as the stocks become more attractive, we being long-term investors, do not worry about the stock prices falling by a few percentage points in a day or a week.

EQTM: Coming back to the impact of the global trend, how much of the fall in India over the last few days would you attribute to the dollars flowing back into the US?

Mr. Dayal : The dollar flowing back to the US is a story that really begun in February or March 2004 and is accelerating every day. And if you add to that the uncertainty or the shock results post the elections, it is clearly the foreigner who is selling. The statistics are showing that. And when the foreigner sells, it gets magnified on the downside because the punter is selling ahead of the foreigner.

But please keep in mind, even at this level of index today (5,070) the Sensex is about where it was in November-December 2003. It has fallen from a peak of 6,000 plus, but it is pretty much where it was 5 months ago. Which may be people should question, was the rise from 5,000 to 6,000 justified on fundamentals? We believe, no.

EQTM: Could you share with us your long-term view on the stock markets?

Mr. Dayal : The long-term view is that there are companies in India with very good managements, very good businesses, and we are very much stock pickers. So we are optimistic on that. We also believe that long-term money flow into equities as an asset class will increase. We do not believe that equities as an asset class will ever be dead. Equities are probably the preferred asset class for most investors over the long haul. So we are optimistic on money flows of market. It is not for us to make a comment on day-to-day moves in the market.

EQTM: What would your advice to retail investors be at this point in time?

Mr. Dayal : It depends on what kind of retail investor you are talking about. If the retail investor was a punter (speculator), I have no advise for him. Because you know, he has to bear the risk of punting, taking short-term bets on the market.

But for retail investors already trying to build a long term portfolio, I would say that either do research on equities themselves or else go out and seek professional advise on what to do with their portfolios. If you are a long-term guy, you should not panic. Long-term investors never panic.

EQTM: What sectors an investor should look at from a long-term perspective?

Mr. Dayal : I think that any government that is in power, will have to spend on infrastructure, will have to satisfy consumer demand, will have to earn foreign exchange for the country by giving exports the chance to thrive. I think that the track record of the Congress party in reforms is fantastic. The first budget given under Rajiv Gandhi’s Prime Minister-ship, and Finance Minister V. P. Singh in 1985, which was itself a path-breaking budget. You had in 1991, Narsimha Rao’s Congress led government’s budget, under the stewardship of then Finance Minister, Manmohan Singh, which was probably the best budget ever given, in the sense it opened up India completely in many ways to the world. And then, very quickly after that, between 1991-92 you had 3 IPOs or 3 privatisation programs, led by the Congress government – VSNL, MTNL and IPCL. The chart below highlights that.

The Congress government has done reforms, as has the NDA coalition, but any reforms that have been done from 1991 till today has to create jobs in the rural areas. I think there has to be a serious consideration of that. The family planning issues have to be addressed. I think there was an interview with Mr. Sitaram Yechury. He has not said that we’re going to shut down privatisation. What he has said, and I am going to quote him, and I think it is a very, very sensible strategy. He said, “The Vajpayee government tried to categorically dismantle the public sector. Profit making public sector undertakings will no longer be sold for a song.” He has not said that he is not going to sell. He has made a fantastic statement that they will not be sold for a song.

There is the need to compare and contrast China with India. What has China done with its PSUs? They have not sold them. China has issued effectively non-voting shares for investors, local and foreign primarily, who have no power in changing the Board. They have raised capital. They have taken Huanang Power as a champion power company. They have made China Petroleum, China Life, China Properties, China Mobile – they have made all these companies champions in their sectors. And the way they have done it is by raising capital from foreigner who is willing to invest and has given his capital. So, this is exactly what Mr. Yechury said. He said, “Navratnas should not be sold off to private players.” China is not doing that and it has brought in billions of dollars of FDI. Just because the government does not sell VSNL to the Tatas does not mean that money will stop. It is a different strategy, a strategy that China has adopted and has been successful in building champions.

So, it may just be that the NDA had a wrong prescription. I will again quote Mr. Yechury, “An attempt to revive loss-making PSUs should be made.” Bring in private capital, public-private joint ventures may be pushed in. If it does not work, then you can sell it. But to sell it for a song effectively was, in my view, the wrong strategy. I think they could have sold those companies for a much higher price if they had continued to build up businesses. But that is a qualitative judgement call.

EQTM: The crude oil has hardened in recent times. How do you see this impacting the Indian economy?

Mr. Dayal : I would like to use crude oil as an example of the reform process. We talk about the NDA government being a champion of reforms. Oil has gone from US$ 30 to US$ 41. That did not lead to a substantial hike in gas prices in the domestic market. Were the NDA punished for that? No. India was shining and the Sensex was at 6,000. They, like every country in the world, had some form of subsidy for its local population. It could be agriculture for the local population in Europe and US, or it could be oil and power in India. In that sense, I don’t think the NDA government in itself was an extreme champion of the free markets.

To get back to your question, crude oil hardening is bad for everyone because it is a sign of inflation, which will cause interest rates around the world to rise. For countries like India, which import 70% of their petroleum needs, it will be an even bigger blow. It is not that we do not have the foreign exchange to buy it. But it is going to have an impact on margins of companies, it is going to have an impact on cost of production, and it is also going to make the consumer prices of India (CPI) rise. I don’t think there is a moment in history, when oil prices have gone up and inflation across the world and in India has not followed.

EQTM: What do you think the incoming government should be focusing on?

Mr. Dayal : Job creation in the rural sector. The statistic that 0.6 m jobs have been lost in the last six years, not only in the NDA tenure, but when Congress was around. This is worrying. You have to create 5 to 10 m jobs a year. You can shout all you want about BPOs and outsourcing. But that is going to create only 0.5 m jobs spread over next few years.

EQTM: Just to sum up, you had said in January 2004, “Wait, don’t buy. There will be another buying opportunity” to the investors. What’s your message to them now?

Mr. Dayal : The buying opportunity has begun.


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