 "Mukul Kochhar, co-head of equities, Investec India")
Cost of equity capital has risen in India because of the introduction of new taxes, said Mukul Kochhar, co-head of equities, Investec India. The government should take steps to improve business sentiment, which might weigh on India’s valuation premium to other markets, Kochhar told Samie Modak. Edited excerpts:
What factors are responsible for the latest sell-off?
The latest correction has both global and domestic elements to it. On the global front, the escalating trade war is threatening to push the major global economies into a recession. A weakening yuan typically sparks capital flight from emerging markets (EMs), which may put the rupee under pressure in the near term.
The most disappointing part of the Budget has been the tax on buybacks, which structurally increases the cost of equity capital, and thus will have an impact on equity valuations. This follows the introduction of long-term capital gains tax last year, which has a smaller, but similarly negative impact.
The signal to equity investors, therefore, has not been too encouraging. We need to realise that high equity multiples allow corporate entities to raise cheaper and larger amounts of capital, allowing higher investment, growth, and eventually tax revenue — much higher than what would be generated by double taxing corporate profits.
The market is also reflecting an economy grappling with near-term adjustments in the wake of various reforms introduced over the past three years and the liquidity crisis in non-banking financial companies.
Foreign portfolio investors (FPIs) are continuous sellers. Besides the FPI tax, are there any other factors weighing on FII sentiment?
More than the FPI tax, it’s the broader EM sell-off that is affecting India — both MSCI EM and NIFTY are down over 5 per cent over the past month.
Multiple interactions with foreign companies have revealed that India’s historically aggressive stance on tax collection has become a deterrent to attracting investment. For instance, oil and gas discovery and development has significant potential, and India would do well to create a predictable investment environment for companies.
Will the stronger dollar or a currency war further fuel an FII sell-off?
That would be a likely outcome, since competitive currency devaluation can be very damaging to EM assets. Dollar, being the safe-haven currency, will see substantial inflows. On the other hand, EMs could see outflows from both equity and debt. A worsening situation here will clearly not be a good outcome for risk assets globally, and India should be no exception.
Are FIIs finding other EMs more attractive at this juncture? How do valuations compare?
Despite all its warts, India is still a preferred EM destination, because of higher uncertainty elsewhere. India is attractive because of the quality and diversity of companies on offer. This has historically reflected in premium valuations for India, and that remains, at least for large-cap indices. The premium, therefore, reflects a superior sector mix — a higher proportion of capital-light businesses and private businesses than other EMs, allowing for a higher aggregate valuation. However, the government does need to start making some business friendly noises to allay emerging concerns.
How do valuations look like after the latest correction?
India’s macro situation looks pretty stable — low current inflation, declining inflationary expectations, low fiscal deficit, manageable current account deficit, range-bound currency, monetary policy flexibility, and a rock-solid government.
One would not have thought valuation to be at risk in this backdrop, but the recent Budget has soured investment for equity investors. There is also a growing frustration amongst the business community that the government is displaying unwillingness to take feedback and course correct. In case business sentiment continues to worsen from here, valuation dropping below longer term averages is possible.
However, we are beginning to get excited by the opportunities on offer today as stocks correct, especially small and mid-cap stocks, where valuations are becoming close to reasonable again after a frenzied bull run from beginning of 2014 to early last year. One has to remember that lower interest rates will eventually start seeping into asset prices, and equity bargains come by only during challenging times.
Do you expect the Kashmir move will lead to more uncertainty and panic among investors?
At present, Kashmir seems to be contained with Pakistan failing to garner much international support for its position against India’s move in Kashmir. Given the status quo, one is not concerned. Having said that, Pakistan has been known to destabilize, and use unconventional means to achieve its end. Therefore, we will remain watchful of the situation, even though risks seem pretty contained at the moment.
Which are the sectors and stocks you are positive and negative on?
We continue to like the larger private banks with good deposit franchise, like ICICI Bank, and Kotak Bank.
Life insurance companies like ICICI Prudential, and SBI Life also screen attractive on valuation, and are well protected against the current cyclical slowdown.
Amongst manufacturers, select chemical and agro chem companies, and two-wheeler companies like Bajaj Auto should also be fine given their diversified exposure to exports, and the domestic market, and reasonable valuation.
Select mid-cap stocks in the industrial space are also screening reasonable post recent correction.
