Why India’s 11-Month Market Rally Is At Risk
Foreign investors have been selling every day of the month till Monday, October 14, turning into net sellers
On Episode 412 of The Core Report, financial journalist Govindraj Ethiraj talks to Andrew Holland, Mumbai-based CEO at Avendus Capital Public Markets Alternate Strategies as well as Dwarak Narasimhan, Partner at Price Waterhouse & Co LLP, India.
SHOW NOTES
(00:00) The Take: Whose Data Is It Anyway?
(05:00) Markets fall further as cues disappear
(05:53) Hyundai Motors IPO is in second gear
(07:08) Why India’s 11-month market rally is at risk
(17:58) Rewriting the Income Tax Act, 1961
NOTE: This transcript contains the host's monologue and includes interview transcripts by a machine. Human eyes have gone through the script but there might still be errors in some of the text, so please refer to the audio in case you need to clarify any part. If you want to get in touch regards any feedback, you can drop us a message on [email protected].
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Good morning, it's Thursday, the 17th of October and this is Govindraj Ethiraj, headquartered and broadcasting and streaming from Mumbai, India’s financial capital.
The Take: Whose Data Is It Anyway?
Data from India should remain in India sounds like a good national interest pitch.
But unlike nationalistic pitches, this is a little more complex.
On Tuesday, Reliance Jio chairman Akash Ambani pitched for incentives including on electricity for Indian companies ready to set up Artificial Intelligence (AI) and machine learning data centres.
It's interesting and not surprising that he spoke of electricity and thus energy in the same breath. So let’s stay with that.
First, data centres.
Did you know that with roughly half the data centre capacity, Mumbai is considered India’s data centre capital ?
Real estate consulting firm Knight Frank said Mumbai was the standout growth story in date centres in India last year, crossing the 2,000 MW milestone.
Not just in India but Mumbai ranks alongside Shanghai and Tokyo as among the top data centre markets in Asia Pacific with similar capacities as of last year.
So why is this ?
One reason is to do with the fact that many of the global sub sea internet cables land here.
The important reason is reliable power, something Mumbai city has always prided itself in.
Now, here’s the flip side.
According to the International Energy Agency or IEA, data centres total energy consumption could go from 460 terawatt hours (TWh) in 2022 to more than 1,000 TwH in 2026, roughly the same as the electricity consumption of Japan.
It gets more frightening as you go along.
Another academic study by professors from University of California and elsewhere says training GPT-3 in Microsoft’s state-of-the-art U.S. data centres can directly evaporate 700,000 litres of clean freshwater.
More critically, the global AI demand may be accountable for 4.2 – 6.6 billion cubic metres of water withdrawal in 2027, which is more than the total annual water withdrawal of half of the United Kingdom.
Additionally, GPT-3 needs to “drink” (i.e., consume) a 500ml bottle of water for roughly 10-50 responses, depending on when and where it is deployed.
These numbers may increase for the newly-launched GPT-4 that reportedly has a substantially larger model size, the report says.
People may quibble with the specific numbers but there is no denying that massive amounts of water are needed to cool the servers, thanks to the heat generated by the sheer computing power of the high performance machines, particularly crunching AI queries.
Let's go back to power.
Google last week said they will buy power from Kairos Power, a developer of small modular reactors to help deliver on the progress of AI.
Last month, Microsoft signed a deal with a company called Constellation to resurrect a defunct reactor at the Three Mile island nuclear power plant in Pennsylvania.
Look up Three Mile island and see what you find.
Recognise that the demand for power to drive AI applications is so stark that people are willing to revive dead nuclear reactors.
Back to India.
The good quality of power cities like Mumbai are used to will not remain so if data centres gobble up more and more of it.
But the larger issue is calibration of AI wants and needs and calibrating ambitions in the context of sheer energy and water demands of this new industry.
Goldman Sachs said in a report in May this year that data centres worldwide consume 1-2% of overall power, but this percentage will likely rise to 3-4% by the end of the decade.
In the US and Europe, this increased demand will help drive the kind of electricity growth that hasn’t been seen in a generation. Along the way, the carbon dioxide emissions of data centres may more than double between 2022 and 2030.
Countries like Ireland and Malaysia among many others are already bracing for demands from data centres which could go beyond 20% of their country’s power demands, according to some estimates.
It does not appear that India can afford such high levels of data centre consumption without denying or pricing power out of poorer sections of society.
On the other hand, no one will say we don’t want advanced computing.
But our energy needs for data centres cannot be on the same plane as the United States or other developed countries who also have other energy markets to dip into.
The private sector which sees opportunity in both setting up data centres and in generating power for it cannot be trusted to take an objective policy decision that ensures balance between energy needs and energy supplies.
Greater calibration and rightsizing our AI ambitions is important.
The top stories and themes
Markets fall further as cues disappear
Hyundai Motors IPO is in second gear
Why India’s 11-month market rally is at risk
Rewriting the Income Tax Act, 1961.
Markets Lose Cues
Foreign investors have been selling every day of the month till Monday, October 14, turning into net sellers.
Bloomberg says the sales are on track for the biggest monthly outflow since the height of the pandemic in March 2020.
The reasons are along the lines of what we have been discussing, a shift in investments to China as investors race there to ride the momentum there and of course what could be valuation fatigue here.
More on that shortly.
While Wall Street was set to be flat on Wednesday overnight after hitting record highs on Monday.
Back home, the BSE Sensex, and NSE Nifty50 stayed subdued with the Sensex falling 318.76 points to settle at 81,501.36 while the Nifty50 ended at 24,971.30, down 86.05 points.
Not surprisingly, only because we are not surprised anymore, the Nifty Small 100 closed marginally positive though the Nifty Midcap 100 index ended down by 0.24 per cent.
Hyundai IPO
Meanwhile, Hyundai Motor’s IPO is still struggling to gather speed and is mostly on, to stick with automotive analogies, between first and second gear.
Its IPO received 42 percent subscription on the second day of bidding on October 16, according to MoneyControl as per NSE data at 3 pm.
The portion for retail individual investors (RIIs) of the Rs 27,870 crore initial share sale was subscribed 38 percent, while the non-institutional investors category fetched 26 percent subscriptions.
The quota for qualified institutional buyers (QIBs) garnered a 58 percent subscription.
The employee portion of the issue has been fully booked with 1.31 times subscription.
The company on Monday raised Rs 8,315 crore from anchor investors.
Most other IPOs would have been fully subscribed by now if of course they were smaller and were priced less.
Many of the smaller retail investors go by absolute price and small lots particularly if they are punting for listing day gains.
Deciphering The Signals
The stock markets are not transmitting clear signals at this point, likely because there are no fundamental or technical or sentiment signals they can really ride on.
A Bloomberg report says that the run in the markets is at risk with companies forecast to report slowing profit growth.
Brokerages predict that companies in the benchmark NSE Nifty 50 Index will either report flat or low single digits profit gains for the quarter ended September.
Earnings may expand at the slowest pace in more than four years, Jefferies Financial Group Inc. 's analysts forecast for their coverage universe excluding oil and gas.
The indices have dropped almost 3 per cent in October, paring the year’s gains to over 15 per cent.
But the earnings slowdown is being driven by weakening consumer spending and increasing commodity prices, Bloomberg said, quoting an analyst saying there is a visible loss in macro momentum.
Analysts at Sanford C Bernstein & Co and Macquarie Capital Securities concurred and the MSCI India Index is down 2.6 per cent in October, following a record 11-month winning run.
There are other factors reflecting slowing growth from slower goods and service tax collection to fall in passenger vehicles sales.
Both manufacturing and services purchasing managers’ indexes dropped.
The second quarter results seem to drive home the point with both Reliance Industries and Tata Consultancy Services net incomes falling short of estimates.
The MSCI India gauge is trading at a valuation of almost 24 times its 12-month forward earnings, versus a five-year average of about 21, Bloomberg said, adding that is also more than double the multiple for the MSCI China Index.
I reached out to ANdrew Holland, Mumbai-based CEO at Avendus Capital ALternate Strategies and began by asking him how he was seeing the markets right now.
INTERVIEW TRANSCRIPT
Andrew Holland: Just prior to that kind of China move, it was all so easy for India, right? No one liked China. All the reports I was getting from the brokers travelling, there's that, you know, the investors saying, don't talk to me about China, don't talk to me about India.
And, you know, with the domestic flows, you know, everything was hunky-dory, right? Nothing could go, nothing could really change. And obviously, with the Federal Reserve coming down with, you know, bringing down interest rates, that was the extra kind of impetus.
But then China came along and, you know, did a, you know, big stimulus. And I think what happened initially, as you could have alluded to, we could have been caught unaware in terms of, you know, they were sceptical about any kind of decision from China. So when that came about, they had to scramble, they had to get exposure as quickly as they could.
Now, money hadn't really floated to emerging market funds, they didn't have that kind of cash to move around. So they had to find an avenue for that. So India became the avenue.
So they took money off the table in India and put it towards China. They can't miss out on a big rally, because obviously they start to lose their own funds as well. I think going forward, you know, we're still expecting more stimulus from China.
But, you know, say an emerging market fund gets $100, we know the weightage of India and China is about the same, around 23%. So they might do 25% for China and they might do 10 or 11 or 12 for India. So we'll still get some flow.
It's not bad news, but obviously not the flows that I think, prior to China's stimulus, everyone was expecting was just, you know, it was too easy. So we have that. And of course, you have the challenge of valuations in India.
And we have the challenge now of the earning season, which I think will be quite poor. So you have those factors, and there's many other factors as well, which makes me more cautious towards negative on the markets at the moment.
Govindraj Ethiraj: And earnings is a good point, because we've already seen some earnings come out and they have disappointed. Two questions there. One is, to what extent is the market predicating itself on earnings?
Because that's, of course, what many fund managers have been saying. And the second is, was this not expected? Let's say the more negative or the disappointing earnings relative to the street that we've seen in the second quarter.
Andrew Holland: See, I think a number of things the market was banking on, they're not alone in that, in that, you know, after the elections, you're expecting this pickup in capex by the government, followed then by the private capex, which will start to kind of have a multiplier effect. And then obviously, you know, the positive impact on the earnings going into the second half of the year of our fiscal year. Now, that's just not happening.
And you're not seeing that rural growth that I was talking about starting to really kind of, you know, move through in some force, which is helping companies as well. So that 15% earnings growth that we're all expecting is probably now looking nearer to 10. Now, and if you're not getting any uplift in the second half of the year, which is not likely at this point, then, you know, your valuation is baking it at, you know, 15 to 20% earnings growth.
So something will have to change. I don't think it's earnings that are going to change. So I think valuations will have to come down.
And there's many other factors. Listen, we can keep talking about domestic flows and domestic flows, but you know, the actual amount of issuance that we're seeing in IPOs, block trades, QIPs, you know, it's starting to kind of really ease into that kind of domestic flow now. And you're starting to see at the edges, domestic flow starting to slow, not in SIPs, but in terms of just new money going into mutual funds.
Govindraj Ethiraj: So you're saying demand is catching up with supply. Andrew, let me pick up on the flows. So are we saying that now supply in some ways is catching up with demand or demand with supply?
And because earlier it seems to be so supply driven.
Andrew Holland: I look at it from, you know, you have money flowing into mutual funds, and then you have, obviously, the supply of paper from companies and management. And that really is starting to eat into that kind of big pile of flows that we're seeing every month in the mutual funds. And of course, then if you have FII selling so aggressively, it means that there's little, you know, headroom for the markets to move up.
And there's no one particular sector, which is going to drive in the market. Now, we thought it would be banks, because, you know, if you think about the interest rate cycle in the US, we thought maybe the RBI might have that wiggle room to do something in October, definitely in December. But of course, you know, what happened in the Middle East could have allayed that kind of expectation for October.
So the banks are still pressurised under, you know, their NIMS. And of course, the growth is not picking up for them. So you have that double whammy that a great sector, which is probably the better value, doesn't have the growth.
Govindraj Ethiraj: If one were to follow through on the sector themes, what then is looking promising at this point of time, and in the near term, or near to medium term?
Andrew Holland: So, you know, we've been fairly consistent in the kind of themes that we like to play. That's not just a shorter term thing. But you know, defence spending is definitely going to continue, right?
That's not going to go away globally or for India. Renewable energy is not going to go away from us. So you will continue to see contracts being given out, railways will be the same.
But you know, the thing that I like is premiumization. I think that's happening across many different sectors, but particularly in the kind of non-alcoholic and alcoholic drinks. And I think that's the kind of area that we've been focusing on.
It's very early stages. We have a very young population. You know, if I go downstairs, there's coffee I probably wouldn't have paid for, you know, three years back, but I've paid an enormous amount now.
So, but that, you know, that's the way it is, and that's the way it's going to continue. So we like that sector of premiumization in terms of the alcohol and non-alcoholic beverages. We like this kind of leisure industry.
You know, we think people continue to travel. Since COVID, we've seen that, but it's more about experiences now. It's not just, you know, I want an experience as well when I go there.
So spending a lot more on travel and entertainment. So hotels, airlines fit into that. And then the electronic manufacturing sector, which I think, again, you know, if we take an aeroplane, it's probably still in the hangar.
It still has to come out towards the runway. It's a long runway for this sector. It's a bit like, look, going back to where the telecom sector was at the very beginning of the kind of 90s, and you've got that long runway there.
So those are the kind of sectors, you know, we like. And there's the kind of pockets of industries that you look at more. So maybe chemicals could be something that we'd look at again.
But there's more valuation rather, we think it's a big theme that we want to play in the future.
Govindraj Ethiraj: Sadanand, you talked about earnings, and my question really is about looking ahead for, let's say, the two quarters now. I mean, not just the current one or the one ahead. Do you see any sort of rebound turnaround in some sectors, maybe?
Or are you generally wary about the whole market or the entire sort of nifty-fifty kind of portfolio?
Andrew Holland: No, I wouldn't buy the whole market at the moment, because valuations are not supporting the kind of expectations that the market has. So that has to be tempered down. And we haven't really talked about the US elections.
But I think reading, as we all do that, it might be former President Trump that comes in. I just think about, on the positive side for equities, it's going to cut interest rates, corporate tax. On the negative side, it's going to increase tariffs so hugely.
It's going to have a big impact globally. It's going to have an impact on inflation in the US. It's going to have an impact on GDP slowing down in the US.
Yes, interest rates might fall in the US, because you're then chasing an economy which is slowing very quickly. But your long end of the bond yield curve might still remain very high, because your fiscal deficit is going to be really hurting you. And that leads to credit problems in the US.
And that's a big whammy that we don't want to see. So I'm quite negative between now and January, globally. And I don't think, whilst we're saying this is a defensive market, our exports would fall, interest rates might not come down as quickly as we were hoping for.
So there'd be lots of problems, and valuations don't support that type of scenario. And I haven't talked about the Middle East, if a house price was to go to 100, that would send shivers across the world.
Govindraj Ethiraj: Andrew, thank you so much for joining me.
Andrew Holland: My pleasure.
India’s new tax Code. The Core Report Weighs In
The Government has invited suggestions on the Income Tax Act, 1961, from the private sector and tax experts beginning October, as part of an exercise to simplify the direct tax law, the Business Standard reported last week.
The objective is to simplify the language and reduce litigation.
Finance Minister Nirmala Sitharaman in the 2024-25 Budget presented in July had proposed that the I-T law review would be completed in six months.
Considering that the six-month timeline ends in January, it is widely expected that the amended I-T Act could be brought in the Budget session of Parliament.
The Core Report is doing its bit to contribute to the discussion on India’s direct tax code by asking tax experts across the country for the three things they would like to see or not see in the new tax code.
In the second instalment of this series, I reached out to Dwarak Narasimhan, Partner at Price Waterhouse & Co LLP and began by asking him to list out his three tasks.
Dwarak Narasimhan: Thanks, Govind. Thanks for having me on this podcast, and you've certainly made my life a little difficult asking for just three items, considering we plan to rewrite the entire tax code. But just as a starting point, right, just to set the context, the current tax law is over 60 years old, and I think it has been crying for an overhaul.
The main reason is it's just been through so many twists and changes with court rulings and other legislative changes. At this point in time, it's unrecognisable from the law as it was initially written way back in 1961. It's also important that the government reviews this with a view to make it more current and make it in keeping with its own policy objectives, economic agenda, and what we're seeing globally.
So with that in mind, if I were to pick three items which I would like the government to really focus on, first and foremost, close to the hearts of many corporations as well as non-corporates would be ease of doing business. Again, just picking from ease of doing business, I'll pick two items, right. One, if you look at the whole concept of tax deduction and tax collection at source, you have a plethora of rates, variety of different sections.
It applies to so many different kinds of payments and receipts. I think a simplification of the entire TDS and TCS provisions, maybe applying a uniform rate, taking away TDS or TCS on certain transactions, that would be a pretty good thing that the government could do. Second, there has to be some sort of thought process given in regards to consolidation of businesses.
More and more you are seeing businesses consolidating, businesses setting off, businesses becoming global and requiring restructure. There are gaps in the tax law in regard to how the consolidation of those businesses can be treated. For example, when you do a merger, can that merger be treated as, first of all, can you do a merger irrespective of the kinds of entities which are involved?
When there are different kinds of entities involved, can you treat those as tax-free? Can they be treated as tax-free not only for the entities which are involved but also at the shareholder level? So things like that, a comprehensive law to address business restructuring, mergers, demergers, and such like would be extremely helpful.
Third, some form of group taxation that could be introduced will be very helpful for large corporations. We are seeing more and more Indian companies expanding. You have perhaps special purpose vehicles which are set up.
So some form of tax consolidation which will allow companies to ensure that they are able to offset losses incurred in, say, one line of business against profits and another line of business would be helpful. So from an ease of doing business, I think these would be two or three top-of-the-mind issues that the government can address. The second area which I'd like to talk about is the Make in India initiative.
Again, the government's stated initiative. I mean, the government's goals are pretty clear in terms of empowering Make in India. What can we do from a tax reform standpoint to make that a reality?
Two aspects come to mind. One, of course, was the rate of tax for manufacturing companies, which was reduced to 15%, but with various conditions. The government should consider making that a permanent 15% rate for manufacturing and they should apply that irrespective of the form of entity you use for manufacturing.
Second, there has to be a lot of thought given with regard to intellectual property. If you really want to make India a powerhouse, we need to spend time incentivizing the creation of intellectual property. So what can the government do?
You could introduce a stronger patent box regime which would encourage companies to house their IP in India. You could reduce the rate of withholding on royalty payments that India makes or Indian companies make so that it entices companies to use that IP, bring it, and apply it in India. Third, you would introduce some sort of a weighted deduction for companies which invest heavily in R&D.
That would incentivize them to spend that money, get a deduction, because obviously sometimes that R&D does not result in anything tangible at the end of all those years. So from a Make in India standpoint, I think these two initiatives, one on the tax rate and second on… And finally, I think I must touch on litigation, right?
Again, it has been a flash point for so many different corporations across a number of years. The government must relook at overhauling the entire advance ruling process. The process initially as envisioned several decades ago when it started off was excellent.
Somewhere along the line, we lost the plot. So I think relooking at the advanced ruling mechanism, making sure that you provide certainty to taxpayers would be important. The other aspect is perhaps come up with some sort of a charter, a citizen's charter, if you will, and one which is pretty strong, which allows taxpayers some sort of a redressal mechanism, especially since we tend to see a lot of times the tax officials take decisions which are not only contrary to court rulings, but even different in different regions, depending on circumstances.
So I think some sort of sanity in that process, perhaps by way of a taxpayer charter would be helpful. So Govind, I think these are sort of the three buckets. These are doing business, Make in India and litigation.
I think it'll be good if the government were to look at it.
Govindraj Ethiraj: Most of what you're saying, or actually some part of what you're saying lies outside the court itself, including, let's say, the part to do with rulings and so on. Would that be right?
Dwarak Narasimhan: Well, it is currently in the income tax law itself. So I think we should put it within the income tax law. The framework should be brought into the income tax law itself.
Govindraj Ethiraj: Okay. And things like citizen charter are obviously outside. I mean, that's something that you're saying, yeah.
Okay. Is there anything that you feel has outlived its existence completely?
Dwarak Narasimhan: Well, yeah, I think there's, again, there's a number of provisions which I think the government should really do away with, right? If you look at things like the SEZ or the EOU or the STPI regimes, all those are now over. So it doesn't make sense to continue with them.
They should certainly not find their way into the new tax code. You can have some sort of a savings mechanism in the old tax law so that any assessments, et cetera, can continue. So that's something in terms of repealing or pulling out stuff.
But equally, I think the government must think about a tax law for the new age, right? You're seeing new business models. You're seeing new types of entities which are coming up.
You're seeing businesses going global. Another example, there are onerous compliance requirements for non-residents that have transactions with India. That may really not be required, right?
You need to enable trade between India and other countries, and that's not going to happen by imposing onerous compliance burdens. So I think one aspect is taking out some things which are not required, but the other thing is making sure it's progressive as well.
Govindraj Ethiraj: Is there an example of an industry or a sector where you feel is an illustration which says, okay, if you have laws which can meet this industry's needs and requirements, then we would have really reached somewhere? Or encouraged such an industry or sector to thrive, then we would have reached somewhere?
Dwarak Narasimhan: I'll answer that question a little differently, Govind. I think, again, if you look at the last 30-40 years, there have been various economic trends which different countries have benefited from, right? Some countries have benefited from manufacturing.
India, to a degree, has benefited from services. I think we need to be future-looking. For example, if we believe that space exploration or space companies are the next generation of companies, you have artificial intelligence, Gen-AI kind of businesses, then you need to have laws which enable and incentivize those kinds of businesses to set up and flourish in India.
So that's how I would answer your question.
Govindraj Ethiraj: Yeah, and I think that's a good response to that specific question as well. Thank you so much for joining me.
Dwarak Narasimhan: Thanks, Govind. My pleasure.
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