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"India is a big buy. India is on sale."

Jul 21, 2008

Ajit Dayal is Director, Quantum Advisors Private Limited. Ajit is the founder of Quantum Asset Management Company Pvt. Ltd. and also Equitymaster & Personalfn.

The stock markets are at their volatile best. And in our view it is an opportune time to get in a rational view on how you should deal with this situation. So, here it is! In an exclusive interview with Equitymaster and Personalfn, Ajit Dayal offered his views on the markets and what investors should do in present times.

On the Economy...

Equitymaster: What are your estimates of economic growth in India, both in the next couple of years, and from a very long term perspective?

Ajit: We believe that India’s GDP will grow by 6.5% per annum for many years. This is a view we maintained when many others were talking about a 9% and 10% rate of growth in GDP. This is a view we maintain today - while others are busy “downgrading” India’s rate of growth in GDP. In the near term, which we would describe as one to two years, it is possible that the rate of growth in GDP may slip to even 6% - or below in an extreme global environment. The extreme situation could be oil staying at USD 200 per barrel for many months. Then, I would say, all estimates need to be reviewed.

In the very long run - maybe 5 to 7 years from now - it is possible that GDP could grow by 8% or 9% each year for maybe 10 years. But that will depend on how rapidly we have built out the infrastructure. Investing in infrastructure adds to current GDP and, by having better power availability and roads and airports, it enables the growth of future GDP.

Equitymaster: What do you think are the biggest challenges we face going forward?

Ajit: The challenges are educating the hundreds of millons of poor people and then creating jobs. Every time I read that the government has created some sort of programme directed to the poor, I applaud it. The critics complain that there is a “leakage” in the delivery systems and that corruption prevents the deserving from getting the benefits. Fair enough, I think we all accept that - but what is the solution? The solution is not to shut down the programme but to make sure it has better delivery. Maybe the critics should stop complaining and use their resources to monitor the efficiency - that would be a more constructive response. The challenge is to get 500 million moving up the education and income ladder. And we probably have 10 years to show concrete results.

On the Stock markets...

Equitymaster: The stock markets, globally, have been in a sell off mode. Valuations have corrected sharply. Do you see this as a buying opportunity?

Ajit: When you invest in companies, you must take a 3 to 5 year view. Otherwise keep your money in a bank account or under your mattress. Having said that, yes, you are correct. The global equity markets have taken a beating. The various stock market indices in India are back to where they were in March, 2007. This is a fantastic time to buy into stocks in India. We have seen 3 huge buying opportunities in recent times. In April 2003, the SARS disease gave us a great time to buy. In May 2004 when this existing UPA government won the elections we were given a second chance to “buy in” and then in May 2006 - when the interest rates were increasing in USA - there was another opportunity to buy. This, the meltdown in India due to P-Note money heading out the door, is another opportunity.

Equitymaster: Can you explain why you blame P-Notes for this meltdown?

Ajit: It is not that P-Notes are the sole reason why the Indian stock markets have been battered but, in my opinion, this backdoor pool of money - from totally unknown sources exagerrated the rise in the markets and is now exaggerating the decline in the markets. Foreign investors can buy stocks listed in India once they are approved by SEBI as what is known as an FII. But this is a time-consuming process. And time, as they say, is money.

Since 2003, the hedge fund industry has grown from a few hundred billion to a reported USD 3 trillion force in the global capital markets. Now, if even 1% of this pool wishes to enter India - which has been a “hot” market in the years 2004, 2005, 2006, and 2007 - that is USD 30 billion. This is 3x all the foreign money that entered India between 1992 and 2003! The managers of this pool of money get paid on the basis of they do every year. Their incentive fees - their share of profits - gets reset every year. So, if a market is hot, they want to be in and ride the incentive gravy train. If the market turns “cold” - and India is freezing right now - they want nothing to do with the market. They get no incentive fee for losing money for a client.

The P-Notes was basically the end result of the brokers wanting to earn their 1% fees on a USD 30 billion trading book and the hedge funds wanting a piece of the Indian “action”. Unfortuntely, our policy makers fell for the story and allowed P-Notes to flourish. The Reserve Bank of India was the only group that warned against the danger of taking P-Note inflows. India is a country trying to build for the long term. India should fund this build out with long term sources of global capital - and they exist in plentiful amounts. But, we chose a short-term pool of capital to build a long term economy. Should an individual borrow from the local money-lender at a daily rate of interest to build his home? Well, we fell for the trap. It was sweet on the way up with every one ya-ya-ing each time the Index broke a new record - now we are folded over in pain and shock with the sharp decline.

Equitymaster: How do you see the Indian stock markets faring going forward?

Ajit: In our view the assumptions investors should make are pretty simple.
They should plan for a 5 year investment horizon to start with.
Investors should assume that bank deposits - and other avenues to get a fixed rate return - will generate about 9% per annum over the next 5 years.
Stocks should earn anywhere between 15% and 20% per annum.
Real estate will earn you something in between then 9% and the 20%.
If investors put this simple framework in front of them when they make their investment decisions, then everything will be fine.
But there is greed in the human system and there is a network of financial companies whose job, it seems, is to make simple investment decisions sound like rocket science. The greed of investors allows the financial services industry to earn large fees based on a continuous rotation of the assets of their investors and clients. This creates outsized boom-bust cycles. So, unless you take away greed and you limit the fees of financial services companies - freeze salaries to what a school teacher gets, for example - stock markets will always be bumpy. So they will fare well and they will fare badly - depending on whether the markets are in a grip of fear or ruled by greed. Markets are markets - and the disciplined investor can stay away from all this noise and use the markets for what they are supposed to do which is, to supplement an individual’s main income.

Equitymaster: Are you putting more money to work?

Ajit: I tell my investors that not only am I willing to pound the table to get their attention and convince them to invest more, but I am happy to tap dance on the table to get their attention and convince you that this is a very good time to invest in Indian stock markets. Not that I am a good dancer….But, yes, this is a great time to invest. I said that when the Index was hovering between 14,500 and 15,000. It has declined by 10% since then. I have no idea what the “bottom” is or whether the Index could crack through the floor and sink to 9,000. If there are more sellers than buyers, it will fall. If there are more buyers and fewer sellers, it will rise. That is what determines share prices in the short term. But we know nothing about the short term. We recognise the underlying value of the businesses and, based on that - India is a big buy. India is on sale.

Also Read:

  • Jim Rogers - "It looks to me that this is the right time for a bounce..."
  • Dr Marc Faber - "I would be interested in investing in the physical goods space..."

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