EM equities: when 5% growth feels like a recession

6 members of our emerging market equities team was on the ground in India recently to understand the slowdown in India.

10 Oct 2019

Key highlights :

  • Slowdown in India caused by a number of factors, most recently liquidity issues in the financial system
  • Long-term structural changes ongoing, government recently implemented more immediate measures
  • Good quality franchises are more easily able to differentiate themselves from the pack in this environment
  • Roughly neutral exposure to India in our global emerging markets / Asia equities portfolios
  • Key exposure being high quality private sector banks which should be able to further pull ahead of their peers when the tide is low
  • No urgency to add to our India exposure at the moment, we expect to better buying opportunities in the near future.

Is 5% growth a recession?

Rest easy…….we aren’t talking about China…which hasn’t hit 5% yet. We are talking about the land of diversity, the other country with over a billion people…India.

India printed 5% GDP growth in Q2 this year and spooked markets and investors who were expecting much more. As our esteemed colleague who covers ex-Asian Emerging Markets put it however:

You don’t know what a recession is till you you’ve seen a negative 2% GDP growth!

referring to the likes of Brazil and Russia in difficult times.

Nevertheless, the mood on the ground was sombre at best.

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Street view: Sale of two-wheelers in the slow lane

This was best exemplified in a meeting we had with a two-wheeler manufacturer in Delhi, whose capacity utilisation was down from above 100% to 65%.

Monthly sales had declined from ~ 70‘000 units to less than 55‘000, and inventory had increased over the same period. time.

In its segment, the manufacturer has a 90% market share, so its woes seemed representative of the situation on the ground.

But we are getting ahead of ourselves. Let’s start at the beginning.

Six of us started our trip in Mumbai, meeting mainly CEOs and senior management of financial institutions. This trip was designed differently from our previous ones and had a more macro focus given the concerns over the slowdown. The reasons for the slowdown seemed fairly clear: it was a confluence of a number of issues which had come to roost this year.

What’s causing slower growth in India?

  • The implementation of the Goods and Services tax in 2017, while most likely a long-term positive, negatively impacted small and medium business who had to scramble to comply.
  • A consumer lending boom over the last few years was also taking a breather from its hectic pace, partly impacted by liquidity issues in the financial system
  • Bad loans made by the public sector banks in past years, resulting in high NPLs and (overly) cautious lending practices now
  • The supreme court’s diktat to implement tighter emission standards (BS4 to BS6) for the auto industry as of 1st April 2020 caused a slowdown in auto sales – after all, why buy a BS4 vehicle now when one has to adhere to BS6 in 6 months?
  • While the 2019 union budget announced in 2019 struck a reformist chord and maintained fiscal discipline, it was perceived as being market unfriendly by increasing taxes on the highest earners and foreign portfolio investors, and introducing taxes on share buybacks
  • A liquidity freeze in the non-banking financial corporations (NBFCs), sparked by a leading infrastructure financing firm defaulting on its obligations last year, had choked the flow of credit through the system

On the last point, what we heard time and again on the ground was “there is ample liquidity, but little confidence and trust”. This was referring to the fact that the NBFCs no longer had unfettered access to the wholesale funding markets because banks didn’t know which NBFCs had sound balance sheets and which didn’t.

And hence our conclusion that till such confidence returns, not only is a strong recovery invisible, but the chances of a mini-crisis or flare up in the financial system remains.

From Mumbai to Delhi

We then moved to Delhi where we attended a macro conference with senior government and corporate representatives in attendance. The government representatives emphasized the need to look beyond the short–term and focus on the longer term structural changes taking place.

After all India had jumped from 130th in 2016 to 77th in 2018 in the World Bank’s Ease of Business rankings. They reiterated the emphasis on:

  • Maintaining fiscal discipline and keeping inflation under control
  • Further improving the ease of doing business
  • Public sector divestments and asset sales
  • Opening up the FDI regime
  • Driving digitization

India is now one of the highest users of data

On the last point, there is certainly somewhat of a digital revolution taking place in India. Within the span of 4 years , India has gone from being one of the lowest consumers of data to one of the highest in the world, on a per capita basis!

This has been catalysed by the India conglomerate Reliance launching dirt cheap data plans a few years ago – which has led people across the country, from rural to urban, from toddlers to grandmoms, to fall in love with their smartphones.

This has also spurred a multitude of tech startups across the sepctrum, from agriculture to fashion designing. One interesting factoid we heard was that over half of the graduates of the prestigious engineering institute, IIT (Mumbai) , were either joining startups or starting up on their own. While there aren’t many listed companies in this space yet, the picture could be very different in a few years.

India has rolled out plans to boost investor confidence

Perhaps mindful of John Maynard Keynes’ quote: “In the long run we are all …” , over the past few weeks the Indian government announced more immediate plans to revive growth and boost investor confidence. These recent measures include recapitalization and merger of public sector banks (PSU), rolling back of higher taxation on capital gains for foreign investors and cuts in corporate tax rates.

That is not to ignore the many significant challenges that still abound in the country, including:

  • Developing the manufacturing sector and penetrate global markets – and be able to catch some of the shifts in supply chains due to the trade conflict
  • Job creation
  • Gender parity in workforce: less than a third of women work
  • Agricultural reforms: over half of the Indian workforce is still employed in Agriculture
  • Labour and land reforms

These challenges and the current issues do however create an environment where well managed and good quality franchises can more easily differentiate themselves from the pack, providing investment opportunities for long-term investors.

While we have a roughly neutral exposure to India in our global emerging market portfolios, a key element of this exposure is high quality private sector banks which should be able to further pull ahead of their peers when the tide is low. We are in no hurry to add to our India exposure at the moment and we expect to have better buying opportunities in the near future.

We are in no hurry to add to our India exposure at the moment and we expect to have better buying opportunities in the near future.

Two steps forward and one step back

While we certainly can’t say that the worst is over, and the risk of a flare-up or mini-crisis in the financial system remains, the case for India continues to be what some of us in the team have believed for long: two steps forward and one step backward.

And in this world of low growth, that’s not a bad thing.

Boots on the ground

Members of UBS Asset Management’s EM Equity team during a property site visit in Gurugram, India, in September 2019. 

From left:

  • Projit Chatterjee, Senior Equity Specialist
  • Kelvin Teo, Analyst, Financials
  • Geoffrey Wong, Head of Emerging Markets and Asia Pacific Equities
  • Urs Antonioli, Head of EM EMEA and Latin America Equities
  • Manish Modi, Portfolio Manager, Asia ex Japan
  • Princy Singh, Analyst, Consumer / IT services

Street View: travel notes from our emerging markets research team

On the ground research trips are important to our investment process.

Visiting factories, walking around the shop space, talking to management and customers allow the team to test if the assumptions in our valuation models are likely to be achieved.

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