India macro: Steady as she goes

The decision by the US Federal Reserve this year to raise its benchmark rate by 25 basis points was accompanied by an apology of sorts from chairman Jerome Powell. He acknowledged the stress that the rate hike would cause in emerging markets, but predicted that all countries would benefit from US growth.

Powell’s statement likely came as cold comfort to investors worried that the growing strength of the dollar and increased attractiveness of US equities would cause capital flows into emerging markets to dry up. However, among Indian private equity investors, these fears are viewed as overblown at worst – and could offer savvy players a chance to benefit from those without a cool head.

“These are opportunities that you look to capitalize on when you’re a long-term investor, because you want to either benefit from the fear in the market to buy assets, or make use of the irrational exuberance and liquidate your positions,” says Chetan Gupta, a managing director at Samena Capital. “Nothing in India is as good or as bad as it’s initially made out to be; long-term fundamentals remain among the most attractive in the world.”

Defensive measures

This is not to say there are no macroeconomic factors that concern PE investors: the country remains vulnerable to a shock in oil prices and currency volatility, and managers are cautioned to build protections against these eventualities into their portfolios. But for the most part, GPs are confident in the ability of India’s economy to withstand global uncertainties thanks to its strong growth prospects, plentiful domestic investment opportunities, and steady government stewardship.

“Between the government and the central bank, there have been a host of measures to provide more stability and reduce the risk of bubbles forming,” says Paddy Sinha, a managing partner at Tata Opportunities Fund. “Fiscally, this government is a bit more disciplined, but even the previous government had committees set up with the aim of reducing the fiscal deficit.”

The ties between the government and the Reserve Bank of India have raised eyebrows at times, with the government seen as playing an increasingly active role on the bank’s board and pushing for a more muscular monetary policy, putting it at loggerheads with management. This dynamic is expected to continue through next year’s elections and prevent any major changes in policy for the time being.

“I think we are pretty well insulated – unless something drastic happens, most people expect that in December rates will remain the same, and by February it might be too near the elections for much to be done,” says Sanjeev Krishan, India private equity leader with PwC. “Any movement in domestic interest rates shouldn’t be a factor in 2019.”

The central bank’s fiscal management is also considered to have paid off in reducing the depreciation rate of the rupee to below 4% since 2018, though even this reduced rate remains a drag on returns for GPs. 

PE firms have grown accustomed to planning for the fact that their investments will decline in value year on year – some GPs concentrate on sectors such as pharmaceuticals and information technology that do significant business overseas and therefore receive substantial revenue in dollars. Others, like Samena, use deferred payment structures to avoid paying the entire price of an asset at once, in hopes that they can benefit from currency fluctuations.

Still more downplay the need for currency hedging, since the rupee depreciation rate is a known quantity that is unlikely to fluctuate wildly. India’s consumption growth is considered the best hedge an investor could have. 

“We have chosen to bet on domestic demand for the last 13 years, and we continue to believe Indian growth is one of the stronger economic phenomena on the planet,” says Gopal Jain, co-founder and managing partner at Gaja Capital. “It’s something that we are willing to bet our dollars on – even after converting them to rupees and back, we can still see an exciting return.”

Crude concerns

For most investors, the biggest concern from an economic standpoint is India’s crude oil resources, which heavily depend on overseas suppliers. With prices holding steady around $80 per barrel, even a temporary disruption in supply could send prices to a point that would have a disproportionate impact in India, where consumers have limited discretionary income compared to other markets. 

“There has been a focus on renewables on the part of city governments, but India still imports 80% of its crude oil,” says Tata’s Sinha. “Some of its gets reexported as refined products, but that remains a point of vulnerability – it doesn’t look likely, but if crude ever went back to $90-100 per barrel we would have a problem again.”

While oil supplies are beyond the control of a PE investor, GPs are trying to insulate their portfolios against the possibility of a shock. Gaja, for instance, has sought to emphasize nondiscretionary consumer spending and companies that will likely continue to do steady business in a downturn. The education sector is one beneficiary of this approach. 

Such balancing efforts demonstrate that strong private equity returns are not guaranteed – investors must choose their sectors carefully to ensure that they are in the best position to profit from India’s growth story. However, with other sources of finance still in the grips of a liquidity shortfall and the IPO slowdown continuing, private investment is expected to remain an attractive source of capital for Indian entrepreneurs for the time being.

“With banks not lending, and the NBFCs in the state that they currently are, I think opportunities for private equity investors will continue to emerge,” says PwC’s Krishan. “I am more bullish on growth and late growth, but even for other streams of capital I think we will see opportunities coming in throughout the coming year.”   

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• Topics
• South Asia
• GPs
• Regulation
• India
• Economy
• Samena Capital
• Tata Capital
• Gaja Capital Partners
• PwC
• Commodities