The battle for India and how it will reshape the Sensex
When Indian historians look back at this decade, they will focus not on the ongoing economic slowdown but on the battle between two loose camps (with contrasting philosophies) for control of the world’s second most populous country.
In the Right corner we have politicians with a controlling mindset and they are backed by a growing number of promoters who cannot come to terms with the fact that the “under-the-table” model of doing business has become dysfunctional in India. These promoters would rather that the CAG and the CCI was neutralized as quickly as possible so that business-as-usual can resume.
In the Centre or the Left (depending on what part of the electoral cycle we are in) are a disparate group of determined individuals including seasoned civil servants in key regulatory positions, some members of the ruling party at the Centre, RTI activists and sections of the pro-Lokpal camp. The lowest common denominator for this camp is that they will not let the “old Raj” of a dozen or so promoters and an equal number of powerful politicians turn India into Russia.
Both camps are riven by disputes. Neither camp has as coherent a philosophy as I am portraying them as having. However, partly out of self-interest (i.e. money and power) and partly out of a desire to push forward a dogmatic position (a saffron tinted of view of India in the Right’s case and a strong desire to block the plutocracy in the Centre/Left’s case), each camp is taking up the cudgels as we approach the next General Election.
The next General Election will arguably be one of the most critical in recent years as for the first time Indians (especially middle class Indian) will have to choose between these two ideologies. I cannot opine here on which is the right camp to be in but if you read James Robinson and Darren Acemoglu’s “Why Nations Fail?” or if you read Pratap Bhanu Mehta in the Indian Express, you will understand the economic benefits of the Centre/Left position more clearly.
In their meticulously researched book, Robinson and Acemoglu say the countries which fail to create inclusive political and social systems eventually fail to create inclusive economies. Ultimately such societies become dominated by a plutocracy and fail to generate sustained economic growth. Russia, predictably, and China, more interestingly, look poorly positioned from such a perspective.
This tussle for the reins of power in India therefore will be one which will shape the country’s economic prospects in the decade ahead. Naturally, therefore it will have a bearing on the composition of the Sensex in the next decade.
Gaurav Mehta, Ambit’s Strategist, highlights that of the 30 companies that were in the Sensex in 1992, only 12 survived in 2002 implying a 60 per cent churn ratio. In effect, the end of the “License Raj” in 1991 resulted in a number of these once formidable textile (eg. Century Spinning, Bombay Dyeing) and industrial companies (eg. Premier Autor, Hind Motors) being washed away in the 1990s. (The corresponding churn ratio for the Sensex was 53 per cent of the ten years to 2012. In more stable markets, like the US, the churn ratio is around 30 per cent. Even in other large Emerging Markets the churn ratio is not as high as it is in India.)
The changes in Indian society and politics between 2010-12 – “the end of the Old Raj” according to one of our increasingly muscular regulators - are likely to unleash churn on a similar scale over the coming ten years. We estimate that half of the current Sensex companies are likely to be out of the Sensex by 2022. As political power fragments in India and as politicians and civil servants refuse to play ball with promoters, Sensex companies whose key competitive advantage is political connectivity are likely to fall away.
However, if half of the current Sensex constituents will be out of the Sensex by 2022, where will the replacements come from? My view is that these replacements will come largely from sectors such as Auto & Auto Ancillaries, Consumer, Financials, IT, Pharma and light Industrials (basically, sectors which are able to avoid regular interface with the government in Delhi) and they will be companies whose internal cash generation will be sufficient to finance rapid rates of earnings growth. Hence companies such as Kotak, HCL Tech, Lupin, Dabur, Federal Bank, Exide and Cummins are likely to find themselves on the right side of history in the decade ahead.
(Saurabh Mukherjea is the Head of Equities at Ambit Capital. The views expressed here are his own and not Ambit Capital’s.)