India In Macro Sweet Spot, To See Sustained Growth, Says Baring PE's Rahul Bhasin

Rahul Bhasin: Look, I think all your guests would have articulated that India has been in a sweet spot in terms of macroeconomics. I think the balance sheets of the government, the balance sheets of the banks, the balance sheets of the corporates are all in very good shape. That's a recipe for sort of ongoing growth.

You also have a situation where I think the real estate cycle which you know, stuttered after the global financial crisis, and then showed some false starts in 2016, 2018, 2020 and then got sort of knocked down again during Covid. You're seeing a very strong revival in that and post RERA cleanup, etc., I think that has a lot of multiplier impacts. So high capex by the government, good balance sheets, revival of the entire real estate sector, and also the entire push of the government towards the early stage businesses, the disruptive technologies and the very vital linkage of industry with academia that one has seen, to my mind bodes very well for an ongoing resurgence and a sort of great macroeconomic environment for a long time to come.

I think the real challenge is that if you look at it, a lot of this is already well-understood and a lot of this is in the pricing, which is why, you know, in terms of multiples we are probably among the highest in the world. We are probably 23-24 times earnings as a market as a whole.

On top of that, you have a situation where you have high multiples, but you also have a lot of high uncertainty in the world. You know, we all extrapolate earnings and sort of value businesses on the basis of an environment that we know and understand. But geopolitics is changing rapidly. And that can throw up curveballs from all kinds of places and the way trade works, the globally integrated supply chains can have disruptions.

There are also issues around the fact that there is this huge cascade of debt which is there in most developed markets, especially in the U.S. and there are a lot of risks, which are also abound. So I just think that a macro perspective is not an easy one short call that this is a one-way bet. I think one is going to look ground up and sort of be certain that what you're investing in and how you're investing makes sense.

You talked about valuations in the private markets. Private markets tend to be very fat-driven much more than the public markets, very strangely. One would expect that in a market that is more driven by institutional players, one would not see that but human beings are human beings at the end of the day. So, whatever becomes fashionable tends to become overvalued. But you've got to look at the areas which are not so fashionable, but which afford a significant amount of growth.

I think the very strange thing that I see is that when you had zero cost of capital from 2008, until virtually about three years ago, that whole period engendered a lot of disruption, a lot of investment in core technologies, etc. A lot of the impact of that in terms of disruption to whether it's in the public markets or the private markets, one will see. And I think that impact has not been felt fully. That will play out over the next 5-7 years, going forward. And I think, that will again create new winners and losers. So I think the landscape is evolving and changing quickly and one has to sort of be on top of that entire disruptive landscape to be able to make any kind of reasonable long-term bets.

Rahul Bhasin: I think, let me address this since you have alluded to the private markets, that we address this first in that context.

Private equity is a sort of all encompassing word. It's like, using the word manufacturing. In most of the developed markets, private equity is largely a financial engineering product. And as a consequence of that, there's often a high use of leverage. And when you have high use of leverage, when rates go up, I think the impact on the overall equity value tends to change a lot more.

In India, the private equity is largely facilitation of growth. So it's a very different kind of market. It is not a financial engineering product. It's much more about catalyst and as a part of an ecosystem to enable accelerated growth in businesses. I think that's really the difference and therefore the impact in India and Indian private equity will be much less than it is in the west or in the areas where one tends to use a lot of leverage. That's almost absent in the Indian context and therefore, the impact is much more muted. Having said that, ultimately if rates are higher, that's the discounting mechanism. Of course, it will pull the value of all asset prices down and quite rightly so.

Rahul Bhasin: I think India is in a sweet spot and I think India will continue to stay in a sweet spot. I don't think that that's changing in a hurry. But the reality is that you know, forget the Indian ecosystem. I think the Indian ecosystem has seen very rapid change in the financial saving mix. If you think about it, as recently as three years ago, only 2% of financial savings went into mutual funds. That number has jumped to six. Now, you know, 6% of financial savings, right for the mutual fund industry or for equity allocation, I don't think so. Especially in a younger country like ours, may be that number should be much higher. But these changes tend to happen much more gradually. So I think you might have some leveling off, as far as that is concerned. You know, two to six is a big jump.

The second thing, according to me, is that 35% of the free float in Indian markets is still held by FIIs. And I think the issues and challenges in the overseas markets are still very high. As a consequence of that, you know, you might get volatility and I think the biggest direct concern from the Indian context is the fact that if you look at the U.S., the U.S., adopted the zero-rate policy, easy monetary policy, loose fiscal policy, kind of after the global financial crisis.

But about four or five years ago, they changed tack and they've gotten tighter monetary policy and looser fiscal policy. Now the problem is that their aggregate debt is so high, that they have to keep on borrowing more and more, and it's actually widening the fiscal even more. So it has become what I call an unstable equilibrium. The big challenge is that a lot of that borrowing is actually happening in very short-term money by the US.

I think that once that mix were to change a little bit, you might actually have a strange situation, even if they lower rates, the long end of the curve might steepen and as a consequence of that, that is typically the benchmark with which you sort of add an equity risk premium, I think you might have a lot of cost of capital increase worldwide and you might have outflows from India.

Now remember that we are the most expensive market in the world. So we are that much more vulnerable. I mean, this is one place where people are making money. So the probability that they might pull out more is higher. And that risk is something which is a reality that we have to live with.

Rahul Bhasin: It's not just rates. I think the real issue is the fact that the point I made about the almost zero cost of capital for a period of, you know, 12 or 13 years in the world economy. I think that's been unprecedented. You juxtapose that with the fact that you have more engineers and scientists living and working together than you had cumulatively in the history of mankind. I think those two things together are going to lead to a lot of disruption.

The way disruption works and the way it happens is that you end up with two kinds of disruptions. You end up with the incremental disruptions, which mean making something a little more efficient, little cheaper, a little better, or more productive at a certain price point. And usually, the incumbents tend to win those games.

Then there is what I call the disruptive change, which is really a new way of doing things in a new sort of understanding. And that is usually the incumbents because they're protecting their old turf, and protecting their old capital assets and trying to enhance that return on capital employed there…

I think that the frequency with which you will see these disruptive parts will be much more, at least for the next decade or so. Now a lot of this also comes from understanding. So let me take one example. We lead our daily lives and we sort of aspire to grow. And a lot of the growth has been, the aspiration has been to sort of get the standard of living in the west. I think that that's a great aspiration as far as the country is concerned.

But what's also becoming apparent is that it's not sustainable. And it's not sustainable in many ways. I mean, let's take agriculture for example. If you look at agriculture, the sort of model which has been followed around the world is to shove a lot of fertiliser on the soil. Use sort of high-yielding crops, use monoculture, systematise and grow plants at scale. Now, it is becoming apparent that, that depletes the soil. It kills the earthworms and the natural organisms which make the earth more fertile and over a period of time, it actually destroys the ability to grow crop in that area at all.

Now, you know, then came in incremental innovation, which said that you know, what instead of using fertiliser, let me use nano fertiliser, so that the efficacy of absorption of nutrients is higher. And you know, therefore you will use less fertiliser and you know, the agriculture will be therefore better.

But then there's a next level of disruption. And the next level disruption is that why do I need to use fertiliser at all. Why don't I use natural microorganisms and I can epigenetically modify them to fix more nitrogen in the soil and more phosphorus in the soil, etc., and release those microorganisms and you know, small capsules, which would then do the same job, but not kill the ecosystem of the earthworms, etc., not deplete the soil. So I'm saying, you have multiple layers of technology. Now, does this happen overnight? It doesn't. But there's a clear path in understanding where this will go, as the understanding around this keeps evolving and changing.

Similarly, you know, when we look at things, we tend to look at it from what I call a political economy only, whether you look at this agitation on MSPs, etc. But if you look at it from a sort of add on sustainability oversight on it, you know that in places like Punjab, etc, the water table is falling every year and you know that the this method of subsidising and giving MSPs in cash crops which use a lot of water is not sustainable, which means that the whole ecosystem has to change. So there are new winners, new losers. I'm just pointing that out as an example of how in every industry, this same kind of paradigm is playing itself out.

The most well-known example probably is this whole movement from IC engines to EV engines and the challenges around that. But you will see this everywhere. I think the one other big place where it is inevitable and likely to play out, is in energy. No civilisation can work or evolve without a lot of energy, which is not from us as human beings. If you look at the amount of energy we consume, and over the last 200 years, which is really where humankind has had the most development, our consumption of energy has gone up considerably. It makes sense. So it's not that we are going back to a situation where we don't have energy. So I think clean energy is going to become more and more vital and at least to me, it's very apparent that you know, solar and wind will play their part, but nuclear will have to be part of that solution. And then there is this entire value chain around that, which gives you good investment opportunities, and there is an entire value chain which gets destroyed. So that's another kind of example in terms of how to think about some of these things.