Capital spending cycle: Rate moderation expected, not severe rate cut cycle, indicating problems with growth and capital spending, says Vinod Karki

The Supreme Court on Thursday rejected requests by telecom companies to recalculate adjusted gross revenue (AGR) amid ongoing disputes over government dues. Vodafone India, Bharti Airteland others argued that the Department of Telecom made a mistake in calculating the licence fees and spectrum charges. This particular news that is coming out is not too positive for Vodafone Idea or the telecom sector as a whole. Do you have an opinion on the telecom sector?

Vinod Karki: Overall, the telecom sector is coming out of a lot of trouble. Initially, there was a lot of competitive intensity, followed by regulatory issues, then court orders and the like. Finally, the sector itself is seeing tariffs rise after a long time. That is good overall.

Cash flows are going to improve and earnings are going to increase and they will be able to invest, which is not happening because tariffs are not increasing. So, overall, the sector is good. Individual stocks will have their own stories to play out. I am not going to comment on individual stocks, but the sector as a whole is in the process of repair and is improving.

Let’s talk about what exactly is happening in the defensive sector, because if you look at this sector, valuations are close to their highest level in two decades. What would that actually indicate? Is a potential correction likely, given that valuations are quite high for the defensive sector?
Vinod Karki:Historically, we have seen that this will play out as the market and the economy progress. If you look at the period immediately before the global financial crisis, the investment rate, all industrial companies, capital goods companies and all balance sheet-driven companies, were having a wonderful time in terms of significant growth, the real estate sector and everything, accompanied by these industrial companies and the corporate banks. So, what essentially happened was that investors flocked to these growth assets, which were growing very fast, faster than the economy, because of this inclination towards these sectors that are traditionally valued but growing very fast. They turned out to be growth companies. And during that time, defensive companies, which are traditionally seen, that is, throughout the cycles, the very name defensive companies means that their growth is not volatile. So, in the sense that when there is a big bullish cycle in the economy, they would not participate in terms of high growth basically. And when the economy is in recession, they will not participate in the recession itself.

So, overall, they will remain fairly resilient. But when you get an uptrend in the business cycle, the relative growth of cyclicals tends to be much higher. And currently, we are seeing some growth concerns from the defensive side as well. Not only are cyclicals growing faster, we have growth concerns in, say, the IT sector, we have seen growth concerns and a lot of concerns in the agricultural and rural economy. This year, we had a massive heat wave and now a lot of rain. The temporal and spatial distribution has been quite uneven, so the outlook is not looking very good. IT services and consumer have seen some kind of growth problems across the board. Valuation seems to be at an all-time high. So, there is a possibility that even though cyclicals are quite expensive, there may be some changes there.

Cyclicals are experiencing strong growth, but they remain expensive. There are still some sectors that could be rerated. Which are these sectors and what could be the factors leading to this re-rating?
Vinod Karki: Of course. Overall, we are in a bull market valuation. Market cap to GDP ratio or any other metric like price to book, we are in a bull market valuation. Only the sectors where valuations are moderate and close to average or even below average are banks and large financial institutions. There are no signs of a bull market valuation at the moment.

Similarly, some of the commodity companies need to be analyzed based on their price-to-book ratio, because we cannot analyze the price-to-earnings of these companies. The price-to-book ratio is high, but it has not reached all-time high valuations like the rest of the market. So, from a valuation perspective, these are the financials, energy, and utilities companies. Although utilities are rising, they are not at extremely high levels yet. But these are some of the sectors where valuations have not yet reached the peak valuations of the bull market. They are not extremely cheap, but like the rest of the market, they are not at the high end of the valuation band yet.You also mentioned that private capital spending needs to increase significantly for the bull market to continue, but we are not yet seeing any significant signs of recovery when it comes to private capital spending. What are you understanding and what makes you so confident that private capital spending will increase?
Vinod Karki: There are a couple of things there. One is the narrative. When you say private capital spending is not increasing, you look at the actual cash spent on capital spending by these companies, which is close to their financial statements. That amount has not yet increased significantly, although it has bottomed significantly and is starting to increase. There is absolutely no doubt about that.

The growth is not significant, but it has clearly bottomed out. In terms of announcements, the narratives of planned capital expenditures for the next two to three years look very promising. In most large industrial companies, everyone is preparing large capital expenditure plans. But, as you rightly pointed out, this will be reflected in the financial statements of these companies in terms of actual cash spent on capital expenditures only with a lag, so that is the question.

Overall, India Inc. is currently doing just maintenance spending, so that is another indicator that while the narrative is strong, GDP is hitting a growth rate of over 7%. To participate in this growth, companies will need to make investments, which they are talking about but are not yet reflected in numbers. So, these are some of the factors that make us more confident that we are at the bottom of the market. capital expenditure cycle. He NPA cycle GDP is at an all-time low, so it will take several years before it starts to pick up in the business sector. Industrial credit is just about to pick up, so there is no overheating in that sector. And cyclically, we have seen upward revisions to GDP, so businesses will certainly participate in this growth rate, and to do so, they need to invest.

One of the key reasons would also be what happens in the interest rate It is an ideal scenario for corporates to go ahead and participate in this capital expenditure cycle, isn’t it? The Federal Reserve has gone ahead with a big rate cut of 50 basis points. What is your view on the Indian market? When and if the Monetary Policy Committee will move in that direction?
Vinod Karki: If I go by empirical evidence, interest rates are necessarily low. To begin with, low interest rates are useful, also in the previous cycle, between 2003 and 2008. At the starting point, interest rates were low, but as the investment cycle progressed, in fact, interest rates started to rise and reached the highs of the cycle. We are coming from a very low interest rate environment. In 2022, there was a peak of inflation globally and countries like the United States recorded inflation of 9%.

At present, in the US itself, the massive 50 basis point rate cut is misleading in the sense that interest rates are very high in that country. They cannot sustain interest rates of 5.5%. So, if you look at the dot plot, the trajectory that emerges is as follows: and the bond market itself shows that interest rates in the US over the next few years will be 3.5-4%, which is quite high considering the ultra-low interest rates in economies like the US.

The interest tariff moderationThis is not a cycle of severe rate cuts, which in practice means that there is some kind of problem with growth and then with capital spending. The signal should be that we should have robust demand that allows people to forecast slightly higher interest rates. So there will be some moderation in interest rates, but very sharp cuts are not possible.