Why inflation has remained under control in India

Hello, I’m Chris Salih, investment research analyst at FundCalibre, and today I’m delighted to be joined by Ajay Tyagi, manager of the UTI India Dynamic Equity fund. Ajay, thank you very much for joining us today.

[00:12] Hi, Chris. Thanks for having me here.

So, let’s get straight into sort of macroeconomics first. I mean, a lot of the news has been focused around the US and the UK recently. Could you maybe give us some insight into the macroeconomics in India and where it is in the economic cycle at the moment?

[00:29] Sure. I think that’s a great question to start with. You see, I have to dial back a bit to kind of tell you the current macroeconomic situation here in India.

You know, once the pandemic broke out, the advanced nations like US, UK and few of the other, you know, developed economies, really had the firepower to actually give out doles to the population at large or the deserving population at large. Now, this had its own consequences because of excess savings, there were consequences in terms of inflation, many people didn’t show up to work even when the restrictions were lifted. And all of this led to massive price hikes. It also led to certain supply chain bottlenecks because, you know, economies were not operating at the right kind of capacity utilisation and so on.

That wasn’t the case in the developing world, and I can say that certainly wasn’t the case here in India. The government, during the period of the lockdown, did support you know, the poor section of the society, but not by making money transfer to their accounts, but by basically pushing out essential day-to-day items like food grains, like edible oil and so on. As a result, when the economy opened up, people immediately showed up for work. If you really ask me the reason why inflation in India never reached to a level that we saw in the western world, the big reason is that people never had the luxury of the huge savings that many people in the developed world had. And I think that actually has been a very big positive for a country like India.

You know, if you look back at our inflation over the long range, I would say the average number works out to somewhere around 5%. At the peak, we barely touched 8%. We are already down to 5% today. So, in a way, we are already down to our long-term averages, and that’s why the central bank here is not so fussed about increasing interest rates. In fact, they are just trying to get cues from the Fed and start reducing interest rates here in India as well.

So, in this backdrop, I would say that while the whole world has been talking about high interest rates and high inflation, India actually has seen, in this current cycle ,interest rates which were lower than the previous cycles of the last 10 years, so let alone a four decade high interest rates, interest rates here in India in the current cycle were even lower than in 2016-17 and lower than 2011-12, the previous cycles where interest rates were increased.

So, I think we are doing fairly fine in terms of both inflation and interest rates. The rupee has been fairly stable, of course, like other currencies, the rupee too went through a bit of a depreciation against the US dollar, but has been well behaved over the last six months. And you know, the current account deficit is also pretty much under control.

Last quick point, which I wish to make here, is if you look at two vectors; health of the banking system, then you would look at the non-performing assets as a percentage of advances – they are at a two-decade low. The second vector is health of the corporate sector. If you look at the net debt to equity of the corporate sector here in India, that is at a multi-decade low. So, I think economic perspective, banking perspective, and corporate India, all of them seem to be doing fine right now, yeah.

So, let’s turn to the fund, which is going to be brand new to a number of our viewers. So, you target quality growth companies at a good valuation, I understand. Now looking at India as a whole, there’s so many sort of trends that are in its favour, you know, good demographics, strong corporate governance, growth in the online economy, politics as well [is] quite stable. On the other side, the one thing that perhaps is against it is often that it’s seen to be quite expensive. So, how do you sort of find value in a stock market that tends to be seen as expensive most of the time, at least in the short term?

[04:40] Absolutely. No, Chris, that’s a great question. And I would say your observation is right. If you just try and value India on traditional parameters, compare that to other emerging markets, you would always find India expensive. And I’ve been meeting overseas investors for the last 20 years, and I just know that the usual grouse that most investors have is that, great long term story, but it’s so expensive – how do we play it?

You know, I just have one or two observations here. Number one, you see valuations themselves are a function of sustainability of growth. If growth rates in India, both at the economic level, which obviously will translate into corporate earnings growth, are expected to remain strong over the coming decade, you would find India continuing to trade at a valuation which is higher than other emerging markets. But of course, if at some stage people feel that maybe India cannot grow at 6% real GDP growth, maybe this number is to come down to a level of 4% – 4.5%, that’s the time when we would start to see de-rating of our multiples. So, growth itself is a very big driver of relative valuations measured in terms of price / earnings multiple or EV to EBITDA multiples. And I think the Indian economy, because of its sustainable growth, basically always trades at a premium. That’s my number one.

Point number two, because your question is more about how do you find companies in a market which itself is so expensive? Here again, Chris, truth be told, we are not looking at buying a business worth a dollar at 70 cents or 80 cents. We are more than happy buying a business worth a dollar give and take at a dollar itself, because the framework here is that which are those businesses which will grow their intrinsic value from $1 to $2 or maybe $5 a few years down the line? And even if we pay a fair price for them, even if we buy them for a dollar, that intrinsic value increase will take care of our returns over our holding period. So, all that we are trying to do is find out businesses, which can take a very strong ride on India’s growth. They have a profitable business model, which is a winning business model, which has strong moats. If that be the case, even if you buy it at fair value and not at a discount, we will still make money and wealth for our investors over a full cycle, yep.

OK, let’s turn to the nature of the portfolio. I mean, you’ve got companies of all sizes in there. I mean, a lot of people would say, you know, longer term if you want the best sort of growth that often comes from small caps; how have small caps in India done versus other parts of the world? Maybe give us some insight into how you look upon small caps in your part of the world?

[07:30] Sure. So, I think Chris, it’s true here in India as well, we do want to catch these companies very young. We do want to catch the winners when they’re very, very young and at a very early stage of their evolution. But what we don’t do is we never compromise on the core economic characteristics that we look for in a business. So, even if they are young, they are fledgling, they’re at a very early stage, we do want to see signs of cashflow generation, signs of generating return on capital higher than cost of capital, ability to actually exploit growth opportunities using internal cash flows and reinvestment of these cash flows and so on. So, yes, we do have a focus on the smaller companies because, you know we’ve observed over the last many decades that smaller companies do have a very, very long growth runway in front of them, so it’s often very, very remunerative and lucrative to buy them at a very early stage.

As far as our own experience is concerned, small caps are volatile, much more volatile than large caps. I would say that there was a correction in 2022. The last two, three months, small caps have been on a roll. So, like we’ve seen [in] small caps in the US starting to move up very sharply, so has been the case here in India. But rather than getting influenced by their price behaviour from one year to the other, we are always focusing on their business models and their sustainability of growth.

And just lastly, you also look for industries with secular growth prospects and companies that can use market slowdowns to strengthen their positions – that could be through expansion or consolidation, that can take a number of routes. Could you maybe give us an example of a company in the portfolio that’s done this?

[09:23] Sure. I think I’ll take the example of one of my favourite companies. It’s part of our top 10 holdings as well. This company is called Avenue Supermarts [Limited – commonly known as DMart]. It basically runs the second largest chain of food and grocery retailing here in India. So, maybe you should think about the Tescos and the Carrefours and the Sainsbury’s in Europe.

So, this company basically started business 20 years back, [it] started its business from just one single city, [and] slowly and gradually has been expanding to multiple cities and multiple provinces here in India. [It] Still just about covers 60% of the geographical area here in India. And the motto of the company, the objective of the company is very, very simple; it believes in providing branded goods and products like, let’s say a Colgate toothpaste or a Nestlé milk or let’s say a Dove shampoo to its customers at a price which cannot be matched by anyone else. And to deliver this price, they basically have this entire focus on sourcing them from the manufacturers at the lowest cost possible. So, the business model is buy at the lowest cost and then actually transfer these savings to the customers and provide them these products at the lowest price. And that lowest price itself is the mode for the company – and they’ve done it.

[CS: I was going to say, the expansion has been slow and steady, hasn’t it?] The expansion has been very, very steady, I would say. They’ve grown at more than 20% CAGR over the last 20 years, and their profits has also grown at a number which is similar to this, in fact, slightly higher than the 20% growth in revenues.

And one quick comment which I wanted to make about this because you did talk about how our companies and how our industry is shaping up in terms of consolidation and so on. So, you see, the beauty about this industry is that it’s a $700 billion dollar industry, and only 5% of it is organised. 95% of this industry is controlled by the ‘mom and pop’ stores, the corner shops that you see, and I’m sure once upon [a time] you would’ve seen in UK and other parts of Europe. Which is not the case today because the majority of the market is controlled by the organised players. In India, players like DMart just have 1.5% share of the overall market. So, there’s a long runway for growth. The business model is robust, it’s profitable, and I think it’s basically businesses like these which will act as consolidators in the market. And, by the way, the food and grocery market in India itself is growing at about 10- 11%.

So, you know, these are the kind of businesses that we love to own from a longer-term perspective. Even if you buy them at fair value, it’s fine, because we know that their intrinsic value will keep growing over the many years and decades ahead.

Ajay, thank you very much for spending some time with us today.

[12:25] Thank you, Chris. Thanks for your questions.

And if you’d like to learn more about the UTI India Dynamic Equity fund, please visit FundCalibre.com.