Each time we have interacted in 2020 you have been making a case that one should not be outright bearish and my compliments that the call has worked like a charm. What is your view on economy and demand?
The template remains the same. Once we understand what happened in 1918 or 1958 pandemics, you realise that most of these events invariably do not leave much scarring in the economy and which is why back in April-May also I argued to many and to you as well why we would have V-shaped recovery. In a sense, it is empirical, in a sense it has happened many times over and over again but we do not seem to learn these lessons and which is perhaps why there are opportunities available in the market every time such events occur.
Now what would be the way forward for 2021? We are going to see a breathtaking recovery throughout 2021 and our assessment is that our growth will be 13% plus and there is scope for outperformance. The Street is broadly getting it wrong and they argued that it would be only 8-9% growth and that is what the Bloomberg estimates suggest for street economists. It is mostly going to be driven by the capacity utilisation returning to 2019-2020 levels.
Labour market was demobilised. To a certain extent is back on line in construction. We have argued about this many times and as long as there is no great scarring on consumers and altered behaviour of consumers is not there, we will chug along and we would see a very sharp recovery. The bigger question is what happens the year after because this year is set. Most policymakers would also be worried that if such a sharp growth returns, it would mean some inflation is returning to our economy or the world economy. The kind of fiscal and monetary stimulus that has given us this sharp reversal of pandemic times, could also potentially mean aggregate demand can turn red hot and return in terms of inflation.
I do not think inflation is going to come back in a meaningful fashion. You will still continue to have slack in the labour markets to a certain extent throughout ‘22 and ‘23 and that would keep a lid on inflation.
US bond yields are up 20 bps in the last 10 days. Inflation has made a comeback. Food inflation is way above RBI comfort zone. Is not that the single biggest risk?
The space for capital gains is pretty much over. It is very unlikely that the interest rates will back in a meaningful fashion because of a lot of plumbing we still have to do in terms of ensuring.
While the economy would recover, I presume the monetary and fiscal policies would remain supportive and for that, this financial repression would continue. In summary, the big picture view for bonds is that it is sideways and perhaps would begin to deliver positive real returns for the next one year. But that is largely because the inflation would start to dwindle. Having said that, people have to accept that over the next 10 years, if one were to invest in India, government bonds are yielding you 6% and good AAA are yielding you 6.50-6.60%. I would not be surprised if India’s inflation is somewhere between 4-4.5% or the worst case scenario 5%. That still is 100-150 perhaps 200 bps real spread on inflation. So unlike what you are seeing in OECD countries, in the US, returns on treasury is there.
If you invest there in AAA bonds and the treasuries, the real returns in those territories are sharply negative. In the US the breakeven inflation is 2% and the US treasury is trading at 1% that means if you invest in a 10-year treasury, you will earn minus 1% return over the next 10 years. In contrast, in India, you would earn 1.5% real return in India or 1%, 1.5% or even 2% real return if we are able to achieve 4% inflation over the next 10 years.
So in some sense, India is one of those few places where the real returns are likely to be very high and that also explains why FIIs and the dollar is weakening and a lot of money is actually beginning to chase emerging market assets. Out there in the US, Germany and many other places, the returns for treasuries are sharply negative in real terms. While it is true that the nominal returns in India in fixed income are low, we would deliver far better positive returns than the majority of the developed markets.
The consumer in a sense has been bitten by the COVID crisis directly or indirectly, how do you see that changing?
I am not a big fan of aggregate demand theorists. India’s per capita is so low, that in everything from ACs to housing to clothes to footwear, our consumption is far lesser than even the emerging markets that we like to compare ourselves with. I am not far too worried about demand’s return. India’s Achilles heel has always been its supply side and the good news of course right now is that the government’s design thinking today is remarkably different froma anything than I have ever seen.
Design thinking is the supply side thinking that lets us build in India because to get people to consume is far easy in India but to build a supply chain in India is very difficult. Can I build my ACs and TVs and mobile phones and everything that I consume exactly the way I have built my auto, cement and steel?
That is a big problem to crack India not the demand side. But on the demand side in 2021, many economists have argued that this is a pent up demand and it would wither away. But track the December numbers. It is tracking even more and faster recovery than November. So, a) I do not think that what you saw during 42 days of festive season was a pent-up demand. I think this demand is natural. It is here to stay and would perhaps start to dial up further as we move into 2021 and which is why we put out our growth targets at 13-14% in FY22.
The chief anchor of demand in India incrementally is housing. Given the higher level of affordability, very low levels of real interest rates and interest rates, access to mortgage loans and subsidised loans for affordable housing, it is very attractive for people to go and buy houses. Every time you buy a house, there are a million things you do; you buy your curtains and furniture and 20 other things.
The chief anchor of India’s demand recovery not just in 2021 but for the next many, many years is going to be housing and I think the stage is set for a very sharp recovery in housing. Unlike China and the US and perhaps even Europe, India has had a bust in the housing market over the last five-six years.
Our real estate prices have actually gone nowhere and the income levels have risen. So the affordability is very, very high. It is not just in charts but in reality if you go and buy a house today, it is very high especially in the tier II, tier III towns.
My sense is that housing is the one which would weave India’s great demand recovery and the growth recovery over the next many years. Today the conditions are fairly benevolent to promote good housing growth.
