Neelkanth Mishra on link between market and government’s commitments towards road, defence & railways

Neelkanth Mishra, Chief Economist, Axis Bank; Head of Global Research, Axis Capital, says coming to “investment themes, I am observing that because everyone wants to invest in defence and railways, there is a very steady rise in price-to-earnings multiples without an appropriate visibility on what is happening with their own order books. Will they be able to participate in this? Will they be able to compete in this? Even on something like electronics, there is a very good probability that India's electronics ecosystem will continue to grow.”


Capex seems to be focused around infrastructure development. Road has been a resounding success. Now it is tilting towards defence and railways. While the shift is happening, equity markets have been mighty excited. We know about the rally in defence, railway and shipbuilding stocks. What is the right way of understanding these government commitments towards shipbuilding, road, defence, railways? Can you connect the equity market outlook?
The central government can control these sectors directly. National highways, railways, defence are central subjects and this is where the central government can play a big role. On the road side, it is unreasonable to expect that if you are already doing 15,000-16,000 km a year, you will be able to do much more than 18,000-20,000 km a year. So incremental growth in terms of the pace of construction at the national highway level may not really accelerate from here.


What can happen and seems to be happening, is that in state highways, a lot of work seems to be happening in Maharashtra, Uttar Pradesh and several other states. That is where there can be some acceleration but if you have 2 lakh km of national highway network and you are repairing everything once every 10 years, it is very hard to envisage it, unless you are doing a lot of fresh alignments and big expansion beyond 20,000 km a year.

On the railway side, the scope to do work is quite significant. The Railways share of freight had been falling since independence. In the last two years, that number has started inching up. It has to rise substantially from where we are now and that requires a steady pace of investment, and not just on the freight side. There is enough investment that is necessary on the passenger side to improve the quality of travel, the comfort level, and all that.

The problem so far has been that the railways struggle to invest and so the availability of fiscal resources is not a constraint. It is their ability to execute. But very hearteningly, in the last two years, we have seen there is a pickup in pace as well. Defence is a medium-term opportunity, meaning that we know that there is going to be more focus on Atmanirbharata that is more self-dependence.

Globally, spending on defence is starting to go up. When we think about defence, we have to think beyond just the final assembly of submarines or the final assembly of planes. It has to be the whole ecosystem, special types of casting, special types of forging, special types of materials, software, electronics. So there is a lot of stuff that goes into defence procurement. What we are seeing in the markets is that people do this top-down macro investing and they say okay, I think defence is going to do very well. And therefore, let us go and buy the few stocks that exist.

There are many of these stocks we do not cover. And I do not think it is appropriate for me to talk about specific names. But as a theme, I am observing that because everyone wants to invest in defence, everyone wants to invest in railways, there is a very steady rise in price-to-earnings multiples without an appropriate visibility on what is happening with their own order books. Will they be able to participate in this? Will they be able to compete in this?

Even on something like electronics, there is a very good probability that India's electronics ecosystem will continue to grow. There will be a higher share of value-add in five-seven years. There will be lots of new activity and fascinating activity that comes up. But does that mean that every electronics company needs to trade at 45-50 times earnings? Given that their share of value-add is low, they will have to take a lot of business risk. Those are the questions that the markets are not asking appropriately. There is quite a froth in many of these names.

You were one of the few who called out the Covid recovery right in terms of the shape. You said it would be a divided recovery. And that is visible now. It is a K-shaped recovery. Rural under stress, urban and ultra-luxury doing exceedingly well. If the economy has to grow at 6.5% to 7%, it needs full participation. How long can this divided picture last? We seem to be staring at a fractured economy right now?
The picture is a bit different from the way you characterised it right now. While that may have been the case about maybe six, eight months back, that system is shifting. We have discussed this in the past. When you have an economy forced into a lockdown and consumption of services slows down and construction slows down, you see a drop in the number of jobs that pay the Rs 8,000 to 15,000 a month.

So when you come out of the lockdown, as the restrictions are eased, there are savings among the rich and deficits among the poor. Because the poor had to still survive, still pay for food and basic clothing and basic telecom etc. And therefore, they had to shed assets or take on debt and there was a lot of savings here. Now, as the rich then start to spend on travel, on tourism, on eating out, on coaching, on construction, the savings start to flow. The economy then starts to become more balanced. We are seeing that.

The biggest takeaway from the June quarter results and that has continued into the September quarter results and business momentum as well, is that even the independent home builder has now come back and is starting to construct. That is very clearly visible in the demand for cement, tiles, PVC pipes, cables and wires. If all of that demand is going up that means that construction activity is also going up.

No one is just going to buy these and stock up, right. And construction jobs are exactly in that bracket. We are seeing a sharp recovery in travel and tourism. And therefore, the bottom end of the key that you were talking about is starting to lift up. One important overlay we must put on that is what is happening to the commodity prices and food prices and so on and so forth. So for example, if India is buying oil at $20 a barrel higher when oil prices went from say $80 to $100, then we are talking about a $30 billion hit to the economy on an annual basis and a reasonable part of that starts to flow through to the poor, through the plastics, the packaging.

There was a big surge in global sugar, wheat and edible oil prices. As those have corrected, now, we are seeing an early part of the increase and we need to be very cautious about extrapolating on the decline. But at least so far, before the recent hike happened, there was clearly a drop in prices. Look at biscuit demand. It is rising like 15%-20%, because biscuit prices have started to normalise.