Last time we spoke you were still a little cautious and valuations were continuing to look stretched. Now that we have started to see a little bit of pick-up in economic activity and are hearing positive commentary coming from key managements, what is your outlook going forward?
On one hand, we have markets which have done very well in the last three months and which has stretched valuations a bit as you mentioned. On the other hand, the month of June showed us that the worst was probably over in April and May. June did show a good bounce back from the really negative numbers that we saw in April and May. The first week of July also showed continuation of the momentum that we saw in June but now in the second and third week of July, things are probably tapering off a bit.
If we were talking about just a number, minus 50 or minus 60 in economic activity in April and May, probably in June, it was at minus 20 or minus 30 and July is also stabilising at that level. Given the sporadic lockdowns and the stretched recovery, the sharpness of the market move makes me a bit cautious. Though we are on a recovery path, it will probably be a bit of an elongated recovery and not a sharp V as we have seen in the US markets, where the fiscal stimulus has been so large that the economic recovery is a V. In India, we are looking for a little more elongated recovery. We have been having lockdowns in cities like Pune, Bangalore, Chennai, large cities which contribute a good amount of GDP. The sharpness of the move and the elongated recovery make me a little bit cautious.
Would you then continue to stick with certain themes that have already been progressing well? Are you seeing clear signs of growth potential in pharma or chemicals or would you venture into other pockets of the market?
One thing that has emerged and which we have been playing since the last three-four months is that the rural economy is more resilient. It looks like the trickle down of the government stimulus, coupled with a good monsoon last year and very good distribution of rainfall this year, Plus the MGNREGA, etc, has been percolating down and made the rural economy a lot more resilient.
We are also seeing some pricing power in foodgrains, vegetables etc. The rural theme — whether it is two wheelers or four wheelers, tractors, paints, cement, low-ticket items like FMCG — should do better in the market and that is one thing that we are looking at.
Second theme that we have been playing is that developed market recovery probably maybe a bit sharper like in the US and the Europe because of the stimulus that they have taken which means that exporters, especially services providers like IT should do well. We have been bullish on IT for quite some time and even the commentary from the companies corroborates that thesis that the demand for IT services and a lot of other exporting items whether it is auto ancillaries etc, may recover more sharply than the domestic economy. So that is another theme that we are playing.
The third theme which is emerging and probably will get accelerated with the issues around the border is more focussed attention on make in India, reducing the trade deficit and more defence production locally. So those are some of the themes that we are playing which should do relatively better than the overall core domestic economy.
Wanted to get in a view as to how you are looking at this Make In India theme. You spoke of prospects for specialty chemicals and even defence. What is your outlook within these two spaces or even the rural theme that you were optimistic about?
We have been talking about localising defence and import substitution for a lot of items, given the fact that we have been running a very big trade deficit. The problem with trade deficit is two-fold. One of course is it weakens the currency and keeps the local interest rates high. Second is it takes up jobs when you are importing electronics or value added items. So this import substitution of Make In India theme solves both problems, We have a more stable macroeconomic situation in the long term and secondly the large unemployed population will get jobs once we make more and more in India.
The traditional places where India has been good are large employers like textiles, gems and jewellery. But the largest chunk of import over the last few years has been electronics — whether we are talking about consumer durables or mobile phones. These are value added items where the assembly piece consists significantly of consumer durables like AC, refrigerators. These are assembly items — maybe we do not make the components, but the assembly part certainly can be done in India to start with.
Once we have an ecosystem, even the backward integration like compressors, PCBs, chips etc. can come to India. The government has already come out with the package for electronics. It is a turnover based incentive — the more you produce, the more incentive you get. I am expecting something similar for pharmaceuticals and chemicals.
In the next one year, we should see a lot of initiatives by the government to make sure that our import dependence is reduced, We also might see reworking of FTAs and over the next three years more and more companies will start taking advantage of the tax cuts that were implemented in September 2019 to incentivise more investments. So, chemicals, electronics, pharmaceuticals, even textiles, gems and jewellery segments should start to benefit.
On the defence front, while our public sector companies always had the capacity, probably there was no focus but in the last two months, I see a serious attempt to ramp up our defence capabilities and this is likely to become a more permanent situation where our borders will be more militarised and more supplies and stockpiles will be kept in the borders.
For the next few years, we will see more activity for our defence companies which are mostly in the PSU space. That is one thing that I am quite bullish on. The situation around the border will need a lot more increase in activity for defence production and more and more localisation whether it is for missiles, equipment etc.