The Indian economy is in far better shape compared to peers as well its own historical performance, Nilesh Shah, managing director of Kotak Asset Manangement said on BloombergQuint's weekly series, Thank God It's Friday.
Farm loan waivers can hit fiscal deficit by about 0.2 percent of GDP but the Goods and Services Tax may cushion some of that impact, he added.
Here are edited excerpts from the conversation.
Fitch Ratings recently said that farm loan waivers could lead to a slippage in fiscal deficit. India's trade gap remains high. And the RBI recently refrained from cutting interest rate, saying they did not want to take any pre-mature action. How are Indian macros shaping up in your opinion?
I'll recommend Fitch to read a report published by Neelkanth Mishra [of Credit Suisse] on farm loan waivers. According to him, between the announced amount and the actual amount, there is always a gap. Based on past experience and current environment, the hit to the fiscal deficit will be roughly about 0.2 percent of GDP over 3-4 years. It's a large number but not something which will destabilise our ratings.
Secondly, we are in a far better shape today than most of our peers as well as based on historical performance. Fiscal deficit will be at 3.2 percent next year and hopefully with GST it should come further down. From a current account point of view, with oil prices remaining soft and coming further below $50 per barrel, it should bode well for this year as well as for the years to come. Inflation, which was our bugbear is now 2.18 percent for May, and should go below 2 percent in June. That's also quite reasonable. We are experiencing inflation at par with the developed world. RBI didn't cut interest rates in their June policy, but the market is expecting them to cut rates in the August policy. If they can achieve that 4 percent inflation target, which looks quite achievable now based on current trajectory, then there is obviously scope for interest rates to be cut. So, whichever way we look at it, fiscal deficit, trade deficit, current account deficit, inflation, we're in a far better shape.
Is everything perfect in India? the answer is no. There are two main issues which we need to sort out. One is the NPA. Clearly there is a huge build-up of NPAs in the banking system and we are in the process of solving some. We need to increase the pace at which this can be solved. The second thing is lack of private sector investment. Clearly investments are falling apart. Rather, they have declined reasonably, so it's not a matter of grave concern but it is certainly a matter of concern. If I want to achieve double digit growth, the current pace of investments will not work. Now, how do we revive investments? One could be bringing down interest rates so entrepreneurs will be comfortable taking leverage. The second could be increase in ease of doing business so they may set up their projects. The third and the most important thing will be to create demand so that the current capacity can be utilised properly.
India's problems remain around investment revival and NPA resolution. Barring those two, I think we are in reasonably good shape.
What will drive earnings over the next two years because there is still time for a turnaround in the capex cycle...
Today there are sectors like automobile, auto components, chemicals, specialty chemicals, building materials and home improvements, domestic pharma companies, oil marketing companies where profit growth is coming in at a reasonably good pace. Our problems are issues related to leveraged business groups which have too much of debt – telecom where there is too much competition, and PSU and private sector corporate banks which are writing down non-performing assets (NPAs). Those NPAs have not been created in this quarter. They were accumulated over the years because we didn't provide for them in the past. We are providing for them today. So when you see broad market earnings, it is looking subdued, but in pockets earnings growth is doing well.
As I mentioned, we have to resolve the NPA crises. NPAs can be returned provided we can provide capital to the banks. The government can't give capital to the banks beyond what they are giving because of FRBM constraint. Banks have to become innovative to raise capital. We can follow the China model which used $60 billion of their foreign exchange reserves to recapitalise their banks in 2003. We can follow the U.S. model where the Fed provided $700 billion under TARP to buy out sub-prime loans and prime loans and so on and so forth. Or we can create an ingenious Indian model. The banks have investments in insurance companies. Today they have blocked their capital to run insurance companies. Why not liquidate that and offer their retail franchisee as a bank assurance partner? That would get them more capital and unblock their blocked capital. So we have to create innovative solutions to provide capital to the banks so that they can write off NPAs. Once they have written off NPAs, they can restart the credit engine. And obviously we have to ensure that we don't make the same mistakes which we made in the past by building up NPAs.
The second thing which is really necessary is the ease of doing business. Compared to global standards, we take a little more time in setting up our projects. Many of our NPAs have happened because instead of taking three years to complete the project, we have taken six years and in the process the interest during construction has become substantial. So how can we improve the ease of doing business on the grounds that my projects may come up as fast as the Delhi Metro Rail project or Indira Gandhi International Airport in New Delhi. How do we create that sincerity of execution across India rather than in a few pockets where because of the pressure of Commonwealth Games, the work was done. If we can manage these two things then slowly and steadily demand will accelerate and with acceleration of demand, capital investments will revive.
Absolutely. It's just a question of when.. in all likelihood we are going to see all these processes follow like .. and it's going to be a gradual process and that's the reason why we are seeing a slow pickup and all of these.
It's a test match. It's not T-20. You can't expect every ball to be hit for fours and a six. Even if you take one-one run and wait for that lose ball to come which you can hit for a four, then that's good enough. Q: Speaking of the test match and you recently said that if you are under weighed equity, then you may you might not want to put a lump sum into the markets right now.
You recently said that if one is underweight equities, one may not want to put a lump sum into the market right now, but if one is overweight equities, there could be a possibility that you could at least partly book out. What are the challenges and what you would advise accordingly?
Before that statement, there was one more caveat. If you are Kumbhakarna, you can put money into equities and go to sleep for 14 years. If you won't question NAVs, you won't question prices, please put 100 percent of your money into equities and go to sleep. But we all know post-Ramayana, and we have never met Kumbhkarna. Which is why we are saying, if you can't be Kumbhakarna, follow a disciplined process. If you are underweight equities, its time to invest. But this is a fair value market, it is not a cheap value market like in May 2013 or October 2008. So don't put a lump sum. Let's say you have a 20 percent allocation into equities, and you're desire based on your risk-return profile is 50 percent. So that 30 percent divided into 24 installments, invest it over the next 12 months. You invested today, you invested after 15 days, but let's say after the 30th day, the market has corrected, then you advance a couple of installments to average yourself into a lower level of the market, lower valuation of the market. But if you are overweight equities, you are running leveraged positions, it has worked very well for you, you are in tremendous profit courtesy the super run in the market, it's time to take some profit out because this is not the time in the market where you run leverage, this is not the market where you remain overweight because this is a fair value market.
What do you see as some of the biggest global risks which could lead to a bump in India market rally? Will the Fed's balance sheet unwind of its balance sheets hurt Indian markets or is domestic liquidity way too strong to let it hurt the market?
In terms of flow, domestic liquidity is bigger than global liquidity. To sell an IPO you don't have to go to New York, Hong Kong, Singapore or London. You can sell it sitting in Bandra Kurla Complex, Lower Parel or Chennai. But in terms of size, foreigners are much bigger than local institutional investors. Compared to mutual funds they are four times bigger. Compared to mutual funds and insurance put together, they will be twice as big. So it's a question of size versus flow. Prices come down when there is more supply pressure. Foreign portfolio investors will sell if they find some other market attractive vis-a-vis India. They could be selling if there is general risk aversion because of some global political event or economic event. Or FPIs will sell if they believe that India is not on the course they were expecting it to be.
Today, from an economy point of view, I don't see too many risks. The central banks are unwinding, undoubtedly, but they're not going to unwind in a manner which will derail economies. They've put in enough effort since 2008 onward to put economies back on track. They're not going to be in a hurry to unwind, they will be very calibrated. Geopolitics is anybody's guess. What will North Korea do, what will China do, what will Qatar and Middle East do, who knows. But all these things are today known to the markets. So events there are reasonably priced in. But if something extraordinary happens then obviously there will be an impact. For us the real worry is, are we on course to meet the expectation of investors.
Clearly, investors are expecting higher growth, they're expecting higher earnings, they're expecting better governance and those expectations have come based on our performance over the last three years. So as long as we are on that growth path of overall economic growth and earnings, over a longer period of time investors will remain bullish.
When it comes to rotation currently. Where are the funds going from and what pocket is it going into?
The market is now reasonable diversified. On global FII side, you have family offices, multi-family offices, emerging market fund, India-dedicated fund, charitable or endowment funds, hedge funds. On the domestic side you have mutual funds, insurance companies, EPFO, new pension scheme money coming. You also have retail and high net-worth investors. Each of these people have a different time horizon, each of these people have different compulsions. Some endowment funds won't invest into, say coal companies because they believe coal is dirty. But retail or HNIs might be happy to invest in coal. So we have a fairly well diversified and balanced market. What we are seeing is that for every buyer there is a seller. But if we see institutional flows they are going towards the ESG concept, which is Environmental Social and Governance. Retail and HNI are probably not that concerned about ESG but institutions are definitely and especially for it.
The second thing which the market has done is that they are putting money without looking at market capitalisation, but more focused on where they believe earnings growth will be superior. The pedigree of the company, the sector in which they operate, the capitalisation which they enjoy, they all are inconsequential. If those companies are not able to deliver earnings growth.
There is focus on earnings growth, there is focus on governance. I think this is where institutional money is moving.
Retail money is also fairly matured. Unlike in the past when markets were on a bull run, we used to see many companies getting lapped up by retail investors through various manipulations. Names will change, SMSs will be float, operators will be involved in it and so on. This time all those activities are a bare minimum, not that they are not there, but they are very low. So the market today is becoming mature enough to go for governance and growth.
If I were to bring your theory of Monkey to Gorilla to King Kong, right now assuming that most of the companies are at the Gorilla stage, which are those sectors or sub-sectors which are likely to become monkeys and others which are likely to become King Kongs?
Among the sectors where we are worried is telecom because of competition, real estate because of the governance-related issues, and commodities because of cyclicality. In these sectors we believe only an exceptional performer will get you rewarded. On the other hand, there are certain trends which are like a rising tide. As long as you stay on your boat, you will be lifted. One big emerging trend is physical savings moving to financial savings. Liquidity is strong in the market, everyone who can be a part of the financial ecosystem will get lifted by the rising tide. It could be banks, insurance companies, NBFCs, microfinance institutions, stock broking companies, intermediation companies like distribution companies. So this is one big trend.
The second biggest trend which is emerging because of lack of private sector investment is government spending. Wherever the government is focused on spending, we see enough opportunities. Road construction, railways equipment supply, defense contracts, social and urban infrastructure – this is where government's priority seems to be.
The third trend has happened on account of three factors. Firstly, formalisation of the Indian economy. One, Indians are becoming extremely brand conscious. Second, demonetisation has adversely impacted trade settlements in cash - they've not been eliminated but the window has become narrower. The third is GST, which is putting huge pressure on the informal sector of the economy which is competing with the formal sector by evading taxes. Now, this is going to create a situation where slowly and steadily, businesses will shift from the unorganised sector to the organised sector. This trend will be visible in auto components, chemicals and specialty chemicals, it will be visible in building materials and home improvement, it will be visible in domestic pharma, textiles, garments. So a host of sectors which are listed, large companies will benefit because of the shift of market share from smaller companies. So these are some of the trends on which if you build your portfolio, the chances are, monkeys are becoming a gorilla, and chances are one of the gorillas will become a King Kong. On the other hand, if you have invested in telecom, real estate, power, PSU banks which are writing off their NPAs, you will have to struggle to get a winner.
Has the pick-up in the pace of NPA resolution led to a shift in your preference in retail versus corporate lenders?
PSU banks can be multibaggers provided they get the same administrative flexibility as private sector banks. Today most of the private sector banks have people who started in PSU banks. So the banks have manpower, but the environment is curtailing their freedom. Give them the freedom, give them the capital. NPAs have accumulated over the years and need to be written off. The baggage needs to be removed from the back of the PSU banks. Give them the capital, give them administrative flexibility, they will become multibaggers.
Is there visibility of those things happening? The answer is no. Recently we saw SBI chairman's compensation much lower compared to private sector peers. In such circumstances, how will you attract talent, how will you retain talent? Everyone can't be Mother Teresa and work for charity. There are people who work for their family, they have family responsibility. So give them administrative flexibility, give them appropriate compensation, give them capital, PSU banks will become multibaggers because none of this is factored into today's prices. But till that happens, private sector banks and the NBFCs are growing at a much faster pace. They are able to adopt technologies, they are able to take faster decisions, their credit standards, especially in retail focus private banks, is superior, and that gives them the edge in valuations.
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