In an interview with Equitymaster, Hugh gave his perspective as an international investor on the Indian Budget, his views on emerging markets and the global economy.
As a foreign investor, how do you view the Indian Budget 2004-05? What has the minister done right and what are the key negatives of this budget?
I would say that the FM has been fairly realistic in several of the measures that he has taken. I think foreign investors should be satisfied with what they get. They never get everything! So, the markets may react too much in short term, but over the longer term, he (the FM) has not given anything away. I think there will be some benefits coming from parts of the Budget.
There is a lot of negative reaction to the turnover tax. What is your view on it?
I think it is very short sighted of the markets to see it like that. First of all, I think for long-term investment, the abolition of capital gains is much more positive. Obviously, turnover tax is affecting the short-term traders, but in terms of the overall economy, their involvement in investments is really quite small. I think what he is really trying to do is look at the long-term growth of the economy.
There seems to be a lot of excitement in the investing community with regard to the opportunities in emerging markets. Do you think it is justified in the terms that emerging market growth is largely dependent on servicing the developed economies? Is this kind of optimism warranted in the long-term?
I think over the long-term, the focus of emerging market economies is going to change. You are right, till now much of the economic activity is aligned with global markets. But clearly, the big story over the next 10-20 years is going to be the economic growth of major emerging markets like India, Brazil, Indonesia. The growth potential lies in other such countries with large populations. So yes, I think such optimism is justified.
How does India fare as an investment destination in the global environment? Do you see India becoming a preferred destination in coming years? If not, what would be the likely impediments?
I would not like to see it in terms of preferred or not preferred. I would just say that India is one of several economies/markets that is interesting over the next 5 to 10 years. I think there is a lot of momentum in India, which if continues (which I expect it would), will actually make India a very attractive place to invest. I think over the last decade, ever since liberalisation started in the early nineties, corporate sector in India has been improving its efficiency enormously and this has started to reflect in the companies' profits and efficiency. I expect that would continue.
But India is attractive at the corporate level. At the national level, there are still impediments, many of them caused by politics and bureaucracy. I don't think they are any worse than they have been in the last 5-10 years. The question is how quickly they will improve and there the jury is out, so we will have to wait.
Which countries are competing to be in the red-hot emerging market slot?
I think its any non-OECD market, not just in Asia. Within Asia, the two big ones are China and India. I think parts of South East Asia, 7 years after the Asian crisis, are looking interesting again, countries like Malaysia, Thailand, possibly even Indonesia. Russia is an enormous economy potentially, because of its natural resource wealth and there is also Latin America.
You have an inside view on China. How do you compare these two Asian giants (India and China)? What advantages/disadvantages does one have over the other? What can India learn from China?
I think India's big advantages would include the following. First of all, a much stronger private sector, because during the Licence Raj, the private sector might not have been allowed to thrive, but it was never killed off, in the way that it was in China after 1949. Secondly, what everyone talks about is the rule of law, which is important. It's very hard to really develop an economy to any level of sophistication, without this. It is not only important business-wise but also as a culture of understanding why contracts, abiding by contracts and being able to enforce contracts is important and India has that.
China has certainly seen the tremendous importance of infrastructure for generating economic activity, as well as promoting growth. I think that although in China, urbanisation and industrialisation is a big trend, it's fully aware that the rural areas are important.
So what I see from this Indian Budget is that the government is just doing things, which have been proven to be very successful in China in terms of stimulating growth.
While investing in stocks, which factors would you give the highest weightage? Is there any advice you would like to give to retail investors on how to go about investing in stocks?
The first thing that I always do when I look at investing is to try and work out what is not priced in the market. Often what it is that nobody looks out beyond 6 or 9 months. So, first of all, work out what's the long-term trend. The long-term trend gives you idea. So, if you can see that there is going to be a lot of construction, then you are going to see that housing finance companies will do well. If you can see that there is plenty of financing, then the auto sector will do well.
Point number two, understand what the long term trend for the industry is. Then go down to the level of the company and try to have an understanding for the quality of management. This is important both in terms of being able to manage the company efficiently as well as whether or not they look after the interests of minority shareholders. Those really would be the first two things I would look at.
Once I have done that and I have a selection of stocks fitted into a particular investment idea or theme, I just look at the valuations. I would always compare the price earnings ratio (P/E) to the percentage increase in earnings per share (EPS). If the P/E is above the EPS growth rate for the next 2 to 3 years then almost certainly it is overpriced.
How do you view the global economic environment at present? Interest rates have been raised in economies including the US recently. What factors need to kick in for a global economic revival, especially with regard to the big 3?
We just have to accept the fact that we have had, for various reasons, the best of this cycle. The question is now how much longer can it go on. We got all the stimulus out of the US over the last 2 years. But rise in interest rates (and they will rise further), will be a head wind. So it isn't going to be easy. The important thing is that whether the government and households to that extent, through their spending pattern are actually able to maintain the growth, not necessarily at the fast pace of the last twelve months, but at a level that will keep the economies going at quite a satisfactory rate. It is hard to expect that there is some magic panacea out there, which the governor will just take and return to being the boost guy.
China has had a huge impact on the commodity cycle in recent times. How do you think this is going to pan out?
You are right. And I think China will continue to have an even bigger impact going forward. But what will be interesting is also to see the impact that India will have. India has only just started. Look at the iron ore statistics for example. On a per capita basis, India consumes only one fifth of what China consumes. As India urbanises just like China that will go up. But China will continue because what we have seen in the last 18 months is really just the beginning of an era, its not going to stop. And what would be pretty interesting to see is that large economies like India and one or two others not quite so large, adding to the demand and to the margin. That really could be very constructive for commodity prices though it has implications for inflation. So, we get back to interest rates. 
One of the pioneers of emerging market research, Hugh Peyman, has been based in Asia for over a quarter of a century. Hugh began Merrill Lynch's Southeast Asian Research in 1984, headed Merrill Lynch's Asian Research and was managing director - Dresdner Kleinwort Benson Securities Asia. Currently, he heads Shanghai-based Research-Works, a company that advises global investors on Asian strategy.
