India’s Service Sector Runs The Risk Of Slowdown Under GST, Says Crossbridge Capital

Despite potential teething problems, India is going down the right path with GST, Crossbridge Capital says.

Manish Singh, Chief Investment Officer, Crossbridge Capital (Source: BloombergQuint)
Manish Singh, Chief Investment Officer, Crossbridge Capital (Source: BloombergQuint)

The Goods and Services Tax (GST), once implemented may have teething problems, but India is doing the right thing by going down the path of tax harmonisation, says Manish Singh, chief investment officer at Crossbridge Capital. India’s services sector, however, would be at risk of a slowdown as a result of the new indirect tax, he warned on BloombergQuint’s weekly series Thank God It’s Friday.

Here are edited excerpts from that conversation.

Benchmark indices are at record highs. Markets are clearly in risk-on mode. What is the biggest fear or risk that can reverse this trend?

There is a certain lack of momentum as you can see in the U.S. What can really reverse it is going to be a big crisis either in Europe or in U.S. and by that I mean that, yes some people have talked about impeachment which I think is a very far-fetched thing but if you were to add political risk to it that than would be worse for the rally we have seen recently. Economic data wise, I don’t think we are heading to a recession mode yet because the PMI numbers will be slowing a bit but you could still have some short-term rallies but it is political risk which could damage the equity market more than anything else. And with respect to what could help is if President Trump was to enact his tax policies, which he has talked about in the past, that could really boost the markets again. So I’ll be looking at political risk, more than anything else, if I am looking to see if the markets will turn.

Assuming the Federal Reserve sticks to its interest rate guidance, how would you read valuations of U.S. indices for now? Are they overpriced?

I would say they are not overpriced, but fairly priced. If look at U.S. housing starts which has predicted recessions in the past, that housing starts is currently at 1.2 million. The average housing starts number going back to 1950 is at around 1.4 million, so you are still below the peak. And if you adjust for the population increase going by 1950, that number should be at 1.9 million. So I don’t think that the data is too hot, which clearly means that the valuations are not very hot, so there is a room to run. I would rather say that the valuations are fair. Of course the valuations in some sectors, like financials or healthcare, is based on follow-up from Trump in terms of his fiscal policies. So I would say if he was to enact those policies and if you were to see some inflationary pressures, then I think you’ll come back to where people will think maybe valuations are too high and markets will sell off. But I do not see the immediate risk of that.

The Modi government completes three years today. How will you rate this government and its efforts to push reforms?

I think the Modi government is doing a great job. Yes, there are challenges that the Indian market has and there are political challenges. Remember, last year when the Modi government had some electoral challenges and it didn’t win some states, that didn’t make his life very easy.

If you have 20 major problems in India, and Prime Minister Modi has solved even four or four and a half of them, you could feel joyful that something is happening and we are moving in the right direction. Or you look at the 15 other and feel despondent that nothing has happened, So it's a glass half full or half empty view that you take. In my mind, they are doing a very good job, they are working towards turning India around with their reforms and godspeed to him. There is a lot holding him back – political challenges, media discourse – which will always be there. But I look at it in terms of what's happening, like the GST Bill getting implemented from July 1. He is doing a good job. Yes, he could have done better but I will give him good marks for what he has done so far.

GST will go through many challenges, especially when it comes to implementation. Can you talk through some of them, especially the ones which may have an impact on corporate earnings, especially in the near term.

I think the Indian service sector constitutes at least half the economy. And this is clearly going to impact the service sector. So instead of having one rate that we had in the past, we will have four rates which I think is a good idea. The impact will be in terms of how long it takes for the corporate to adjust to this, if that leads to decrease in sales revenue or earnings then that is not a good thing because that will have an impact on jobs. If you take the case of the hospitality industry, if the if the business starts feeling that they’re not making enough money but they’re paying high taxes, that could lead to a slowdown. You do run the risk of that. And given the importance of the service sector for India and the service sector in general, any slowdown in that will impact GDP growth numbers. But we have embarked on a change and the change is never going to be easy and there will be some teething problems but that should not deter us from going down the path of harmonising taxes. What I would not want is for this to result in another license raj, where you have government or government inspectors interfering with businesses. This whole policy is about getting rid of that. But if we are able to measure taxes, levy the right tax on businesses, streamline it, and make it easier for businesses, not just to comply but also leads to increase in government revenue, that’s a good thing. So I think you will have some challenges, but I am hopeful we are on the right path and it will lead to tax harmonisation which is a great thing. We have all complained about so many layers of taxes in the past. This is de-layering of that and making it simple for people to comply and businesses to follow. So I see some problems but I wouldn’t be worried about the repercussions.

Where would you place India in the pecking order of emerging markets. What are you doing with your India allocations?

I would place India right at the top in the emerging market pack. It is not to say that I am negative on other markets. The whole thing about BRICs nations which was the flavour many years ago, only China and India have really come out well out of it. Brazil is falling apart. They have a huge case of corruption going on with the government there. And Russia is always an also ran in terms of how they are run. Between the two, I think India has a lot of catch-up to do. So if I am an investor and if I am taking a medium-to-long-term view on where the economy is going to perform, where on per capita GDP you’re going to see increased numbers, I pick India. Of course, you back those growth numbers based on political stability. I have no reason to believe that we are not in a politically stable environment. Emerging markets always come down to political stability, not a very strong dollar. And what is also in India’s favour is low oil prices. Oil prices are not going to go anywhere for a long time because the high oil price of the past was being delivered by a cartel-like behaviour of OPEC and that got broken. We have a new supplier in Shale oil and oil prices are not going to go higher. So governments should make all the changes as soon as it can, and really benefit from this this this great tide that India is on and make the changes locally to benefit from it. So on that basis, I would place India very high. Political stability is very important. We are not seeing a very strong dollar. The world is stuck in a 2 percent growth environment in the U.S. And these things are going to help. And rates are going to fall fast in India, we are already seeing that in sovereign yield. So I would place India right at the top but India has to maintain political stability. That’s number one. And it has to come up with policy which are not regressive, it should be forward-looking. Especially in taxation policies which have been criticised in the past.

Oil has extended the biggest loss in three weeks after the OPEC supply cuts disappointed the market. What’s the way forward for crude oil?

I see a rangebound [trade] or more downside to oil. If I take a 12-month view then I don’t think oil is going to break out. I see the risk of oil being at $40 per barrel or lower than $50 per barrel. The reason I am saying that is, in the U.S. we are in a high cycle, we are ending a big cycle, look at the loss in momentum on the PMI side. I am not bearish on the U.S., but I think I am not looking at an extremely high growth scenario. The second, as we mentioned just now, is that the supply side will continue to be the problem. New supplies will continue to come on board. In the U.K, we have an election and if we look at the Tory manifesto it is very clear that the government is going to allow fracking which means even more supply. In the Middle East and OPEC, they are trying to cut supply but you haven’t seen that having as big an impact because there has to be a buyer. If Europe is growing still at 1-1.5 percent and U.S is growing at 2 percent and you continue to have the same supply or increased supply, there is little room for oil prices to go higher. So, I would say it is most likely to be in the range of $40-50 per barrel and the risk is more to the downside than the upside.