India May See Some Fiscal Slippage But That’s Okay, Says Andrew Holland


Andrew Holland, CEO, Avendus Capital (Source: BloombergQuint)
Andrew Holland, CEO, Avendus Capital (Source: BloombergQuint)

A slippage in India’s fiscal deficit target that is limited to half a percent won’t be a source of great worry, says Andrew Holland, chief executive officer of Avendus Capital.

It would bode well for the Indian economy, if the government were to spend more to kickstart the economy and “get the animal spirits going”, Holland said on BloombergQuint’s weekly series, Thank God It’s Friday.

Here are edited excerpts from the interview.

Is the global setup really in better shape or is the liquidity bubble a lot closer now?

We have been talking about this liquidity bubble for a long time now, and still, it has not been burst by anything. We saw some comments from the Fed which were a little more dovish. Yes, they are going to increase rates, but some of them are saying yes while some are saying no. There will be a complete change within the Federal Reserve. Everyone is thinking it will be more dovish than hawkish going forward. And that just helps the market ease up from thinking about what it means for higher interest rates, what it means for tightening of balance sheets or reduction in the balance sheets.

I think, it still means that bond yields have to go higher in the U.S. There will be a stronger dollar too. And there could be some turmoil in the bond market because of that. So, we are still concerned about it. But our concerns are not being factored in by markets, which are continuing to move higher. The more we see this, the bubble just gets a little bit bigger and that’s my concern.

How are you reading Moody’s India upgrade?

They have their own criteria to do that. It’s been on the verge of it for some time. India has actually done a very good job over the last 2-3 years. The fiscal deficit has been reined in. And the reforms that Prime Minister Modi has done, we may not like in the short term, but they are very good for the longer term and that’s where they are looking at.

If I look at 2-3 years down the line, I think the economy will continue to move ahead unless there are any other major reforms that may slow us down in short term. Therefore, if you take global growth, which we are all expecting, then Moody’s is probably correct in their assessment of where India is right now and where it could be in the future.

What could go wrong in terms of that rating? If oil prices shot up to say $100 which will then put pressure on the fiscal deficit, inflation and that could slow the economy. So those are the things maybe no one is excepting. So it’s okay. But it is a good boost for sentiment. Good news is that companies could go offshore and get lower levels of interest on the debt.

Are you factoring in a fiscal slippage this year or do you think with the Moody’ s upgrade coming in, the government’s hands are tied now?

I think there will be some slippage and if it is anywhere up to no more than 0.5 percent, that’s okay. We are an emerging economy and still growing very quickly. So, I don’t think we should worry so much, as long as growth is coming through. Corporate capex is really not taking off, so you get a helping hand. But what we are asking for in the developed markets is the same thing. We are asking governments to start more fiscal spending to kickstart the economy a little bit more, to get the animal spirits going. But those countries themselves have a lot of debt. So, we can’t just say this that it is not good for India.

Keeping valuations in mind, how does it all play out? High valuations on one side and expectations of an upgrade on the other side?

The Moody’s upgrade is probably more helpful for the bond market in terms of flows into the bond market rather than the equity market. If we take the view that global growth, which is what we are thinking, will take off, then India is not a warrant on global growth. We are a domestic-driven economy. So, foreign investors while they are making their allocations will say that South Korea, Brazil, Russia which are all warrants of worldwide growth and cheaper valuations than India and that’s why they are expecting to get better returns going forward because you have great returns from India anyway because we are a domestic-driven economy where valuations are.. you can see better valuations elsewhere. That’s why you are seeing a higher shift towards other markets than India.

What are your expectations for the 2019 national elections and Union Budget and what impact can that have on equity markets?

In the Budget, if we will continue in the same direction as we were in the last few years, then we will all be happy. Every industry will want to get some benefit. It is very difficult to say which one should. We always get the same message that there might be some slippage in fiscal deficit. But the finance minister is trying to concentrate on keeping that reined in. As long as we see where the growth is coming from and where they are going to spending the money, I think no one is going to be too worried. In election and the Budget, you see 1-2-day sentiment impact. We have had a run up before or we have had profit taking or vice-a-versa. That’s how I see it.

What’s your opinion on where the interest rate cycle stands?

If global growth is happening then we will see interest rate hikes elsewhere in the world which can mean a strong dollar, euro or yen against the rupee. To my mind, the RBI missed the opportunity last time around. They should have reduced interest rates as they are going to raise interest rates regime going forward. If oil prices continue to head upwards, then it could be inflationary. I don’t see that they have the opportunity to reduce rates. So, probably they will have to raise rates at some point in 2018. So, that’s a bit of disappointment. A lot of companies have tried to deleverage their balance sheets over the last few years. So, don’t think that we are in a balanced position for higher interest rates going forward. Obviously that could have a negative impact on bond yields because we will see them head to 7.35 percent very quickly which is not good for companies who are heavily indebted and also for the banking system which has been enjoying low yields which has helped shore up the balance sheets more than they would have accepted.

How have earnings delivered compared to your estimation?

We have always been factoring in 0-10 percent.  So I think it is going to fall around 5-7 percent this year. In this quarter and next, there may be after-effects of demonetisation, so there might be a lower base for those two quarters to just push earnings a little bit higher than what I am thinking.

But in 2018-19, we are looking at anywhere between 10-15 percent earnings growth and then accelerating that. So over the next three years, with 2018 as the start, we will see earnings grow 30-50 percent.

Do you believe that the oil prices can sustain at $60-65 levels?

In April, we thought that oil prices would head towards $60, which it has done. We had to re-think about the reasons behind that and what we expect going forward. The reasons behind that were that the global economy had started picking up and supply-demand is virtually matched at the moment. So, therefore demand will actually now start outstripping supply again. We think oil prices will head to $70 in the short term.

And when we think about India, the points of pain that higher oil prices will bring. If we look at 2-3 years ago, we benefitted from low oil prices, so the reverse has to happen. Obviously, it will have an impact on quite a number of sectors. But there are also some sectors which will be beneficiaries of the growth. It’s just that re-aligning your portfolio to those. I would have through you will see the markets, if oil prices do hit $70 per barrel, kind of moving away too quickly, but on fundamentals, we should not see a big increase in terms of the expectations of earnings growth because of the margin pressure that you talked about.

Based on that outlook, how would you play oil marketing companies as against Reliance Industries or ONGC?

Both ONGC and Reliance will be beneficiaries. My problem as always with the OMCs is government control. About 3-4 weeks ago, we heard about prices going up and so on. So, there is always a bit of control which I don’t like. From the fiscal deficit view point, the government has to think about..they have benefitted from lower oil price which has helped them, what would happen if oil prices go higher – they have to play these two sides. I don’t think OMCs are the best way to play a higher oil price.

Reliance, in their AGM, had talked about the investment BP had made going into retailing, and maybe they will be a little bit more disruptive going forward in that sector. So there could be a little bit of pressure in OMCs going forward.

What would you sell or go short on now?

In an interest rate rising regime, PSU banks come to the fore straight away. After the finance minister talked about recapitalisation, we are sitting on our hands. We want to see what the full package is first. We know that recapitalisation won’t be enough, so they will have to raise more money through QIPs and so forth. And then we will think about interest rates cycle. That’s one sector which we will be bearish on. At the moment, they have a tailwind in terms of recapitalisation.

Still not sure of the fundamentals of IT and pharma. Tactically we think rupee will get weaker. Therefore, it is a good safety bet in terms of those two sectors. We are sticking away from areas like metals in the short term. We still like the metal sector, but we are not chasing it at the moment.

We don’t think that everything is bad in certain industries but the valuations are scary. It’s more on the valuations rather than saying these are the sectors which are going to go down. The power sector, for example, I don’t see any kind of resolution at the moment. But people are saying that now that the government is done spending on PSU banks and will look at power as the next stage.

Considering the limitations associated with bitcoin, how would you view it now?

For all the hurdles, people are working on it to improve it and it is happening. It may not be happening at the scale that justifies the price of buying one, but it is happening. But I am just going to sit there with my little bitcoin, and see what comes out. But everyone who’s saying it is a bubble, it hasn’t been that way yet. For people like me, it will help understand something going forward. The youth will probably accept this a lot more than me going forward. It is something that they grow up with, they see it and it is easier for them to adjust to it.

Why will you suggest that this may not be a bubble just yet?

If it continues to rise, and there could be technical reasons that why it will fall, I could see how it is displacing. It is like a fintech to me, it is trying to challenge something. Gold is one area which it is being compared with it as a new means of payment. Increasingly as more and more institutions accept it, the more and more acceptance will it get. That’s where we are. If all of this was with no acceptance, then I could say it is a bubble. But there are more and more institutions, high net-worth individuals, not just in India but globally, who would say that I believe in this technology or currency. It will be some form of payment currency going forward.