BackLack of skilling red flag amid positives in India: Aseem Arora
Silverdale Capital president on hurdles to growth and why international investors are increasingly confident on India
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Singapore: India has a lot of positives going for it, including a favourable demographic, increasing investment in infrastructure, a decisive and stable government, and falling interest rates led by declining inflation, which has enabled the country to become a preferred investment destination.
In the current year, foreign portfolio investors have invested about $8 billion, making India one of the top three investment destinations in Asia, Aseem Arora, president of Silverdale Capital, Singapore, managing Silverdale Funds, said in an interview.
Edited excerpts:
India is seeing an initial public offering (IPO) boom—about $2.93 billion worth of listings have already been completed and a further $2.9 billion of IPOs is in the pipeline for 2016. Does this imply upbeat economic sentiment?
We believe the IPO boom does represent upbeat investor confidence, especially given the larger issue sizes. ICICI Prudential’s IPO of Rs60 billion (Rs6,000 crore) was the biggest IPO since Coal India, yet it was oversubscribed well over 10 times. Many of the IPOs are sale by existing investors, such as Dr Lal Pathlabs, Equitas Holdings, and Mahanagar Gas. The investors have matured to take it as a “positive" since it does not dilute the equity through fresh issuance, (and) at the same time, ensures basic corporate governance due to the presence of professional investors.
While domestic investors are natural investors, led by mutual funds who are sitting on over Rs15 trillion of assets, including the last Rs1 trillion which came in less than 6 months—it is interesting to note that about one-third of large IPOs has been picked up by sovereign funds such as the Abu Dhabi Investment Authority, Kuwait Investment Authority, Government Pension Fund Global of Norway, and the Singapore government. Further, many of the firms getting listed are major companies in sectors under-represented on the stock market such as diagnostics: Dr Lal Pathlabs, small finance bank: Equitas Holdings, and insurance: ICICI Prudential. These companies, being significant multibillion dollar players in their respective segments, are likely to be inducted in the indices in future, thereby adding to the attractiveness of their IPOs.
India’s foreign direct investment (FDI) inflows appear stable. Does this show international investors are increasingly confident on India?
India is the fastest growing major economy, outpacing China. It has a favourable demographic profile, increasing investment in infrastructure, a decisive and stable government, and falling interest rates led by declining inflation. Hence, India has increasingly becoming a preferred investment destination.
In the current year, foreign portfolio investors have invested $8 billion, making India among the top three investment destinations in Asia. This year, FDI in India is expected to cross $60 billion, which is about 25% higher than that last year. In contrast, other countries are seeing a fall in foreign investment: Brazil received over $60 billion in 2014 but received only ~$55 billion of investments last year.
India’s share in the world market capitalization is now at 2.5%, above its long-term average of 2.4%. In the past 12 months, world market cap has increased about 10% while India’s market cap has increased about 12.5%. Also, India has jumped 16 places to the rank of 39 out of 138 countries on the World Economic Forum’s Global Competitiveness Index. This has attracted several hundreds of billions of dollars of investments into India, from global giants such as GE, Siemens, HTC, Toshiba, and Boeing, which have announced the setting up of factories in India. Foxconn, which makes iPhones for Apple, plans to set up seven factories in India. Along with the earlier points on IPO boom, all these demonstrate the increasing international confidence in India.
Has India moved to a phase where it can have a commodity consumption-led intensive growth? If so, how can investors capitalize on this commodity demand?
Investment into infrastructure is indeed commodity consumption-intensive, be it factories or ports. Given the infrastructure thrust by the government, it is not surprising to see an increasing intensity of commodity consumption. For instance, road construction, which was about 3.7km per day under the previous government, has increased to circa 13km per day. The average electrification of railways last year was up 46% over the average for the previous five years. As a result, India’s coal consumption has grown over 35% in the last five years.
India, which had been a chronically power-deficit country, has technically become a power-surplus country. Cement consumption in India has more than doubled in the past five years. As a result, this year, during the monsoon period, for potentially the first time, cement prices, instead of declining, have actually increased. All major steel makers are ramping up capacities to cater to a potential increase in demand, be it Tata Steel or SAIL (Steel Authority of India) or JSW, all of which are increasing capacity by around 3 million tonnes per annum each. The low-risk strategy to ride this commodity consumption boom is to look at commodity producers, or still better, to focus on “users" such as automobile manufacturers and white-goods producers.
Again, between all these positives, has not India been neglecting an important aspect—should not the country’s priority be skilling, because, despite several attempts in that direction, the outcomes have not been desirable?
Yes, this indeed is a red flag. Over 240 million youth will join the workforce in the next 10 years; however, fewer than 150 million jobs are likely to be created. On top of it, India currently faces a severe shortage of well-trained and skilled workers. Less than 2.5% of the workforce in India has undergone formal skill training as compared with over 50% in the US, 75% in Germany, and over 95% in South Korea.
Indian workforce readiness is one of the lowest in the world. Most of the educational and training infrastructure is irrelevant to industry needs. It is not due to a lack of investment, but grossly inefficient execution.
There are over 20 governmental bodies in India running skill development programmes with no synergies and huge overlaps. India has around 700 universities, with circa 40,000 colleges, and over 10,000 stand-alone institutions. Yet, less than 20% of “engineering" graduates are employable; the 80% which are not employable demonstrate the quality of these institutions.
The IITs (Indian Institutes of Technology) and IIMs (Indian Institutes of Management) are touted as centres of excellence; how many of their faculty members have won Nobel prizes or written a path-breaking thesis? The credit is to the students and the mercenary selection system, not the “institution". Talking about the industry, as per the World Bank, about one-third of employees are offered formal training in India as compared with four-fifth of employees in China. This is a market failure where the employers are not investing to skill employees, and employees do not have avenues, ability or willingness to pay for skilling. In Singapore, the government provides 400% deduction for amount spent on automation as well as on training of employees. India needs to provide similar incentives to employers, and be catalysts to create partnerships with industries to run skill development programmes. We do see a ray of hope in the National Skill Development Agency. Under the chairmanship of S. Ramadorai, ex-managing director of Tata Consultancy Services, in just three years, it has been a catalyst in creating over 4,500 training centres, and has trained over 88 million people, including providing jobs to over 33 million people.
Among the positives, analysts always talk about demographics advantage. We boast of a young population. This window is there for the next 20 years. How is the country positioned to use this demographic dividend?
Demographic dividend is not a divine doctrine, and can become a demographic disaster if the soft infrastructure in terms of skills, as we discussed earlier, and hard infrastructure in terms of enterprises are not available.
With that caveat, given that more than half of the country’s population is below the age of 25, India is well positioned till 2040.
India can leverage its prowess in the services sector, to serve the world, filling the gaps due to an ageing population of the West, and capitalizing over the decline in China’s population from 1 billion to less than 900 million in the next 25 years.
Today, a lack of legacy systems has enabled India to technologically leapfrog, moving from no-telephones to mobiles, skipping fixed-line generation, from 2G to 4G mobile telephony, jumping over 2.5G and 3G—moving from a village economy to e-commerce, wherein non-metro sales exceed metro sales on the Internet. With a downpour of cheap monies, especially venture capital and private equity, India can be a hotbed of technological innovation. This can be further aided by India’s technological proficiency from nuclear power to satellite manufacturing, from on-the-spot innovation ‘jugaad’ to blockchain and genome sequencing. Let me conclude by pointing that we have not seen demographic dividends in several countries from Brazil to South Africa, and from Mexico to Turkey; even for China, the impact was limited. Hence, for India to reap benefits, it needs to act now.
India is trading at about 18 times forward PE (price-earnings). Our earnings trajectory is not that great. So why are valuations so expensive?
The Sensex trades at 18.7x FY17E earnings, as against its long-period average of 16.9x. At 2.6x, Sensex P/B (price-book) is near its 10-year average of 2.7x. Given that the earnings are at their trough, valuations of Indian equities remain attractive. It may seem to be expensive, but let’s not overlook the fact that the RoE (return on equity) of Indian companies at around 15% which is almost 50% higher than those of Chinese, Russian or Brazilian companies.
Also, the abundance of global liquidity and adjunct lower risk-free-rates have brought down equity premium, resulting in higher P/E ratios. Furthermore, whenever the economy turns around, the PE ratio appears to be significantly higher, the stock market front-runs the earnings growth.
Why is corporate loan growth in India at a record low despite the festive rush?
India is making efforts to develop its bond markets, so banks can free up their capital and drive investment. The value of Indian corporate bonds outstanding was equivalent to only 9% of gross domestic product in 2014, compared with 46% in China and 88% in South Korea.
There are several reasons for it, besides relatively low demand; the key reason is 84% increase in corporate bond issuances, with almost doubling of number of issuances. Today, best-rated firms can raise CP (commercial paper) at 6.5% as against the 9% marginal cost of funds based lending rates by bank. As a result, the amount of issuances of commercial paper has risen by almost 50% this year. Thus, the dependency of corporates on the banking sector itself has reduced.
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