The Reserve Bank of India left its key policy rate unchanged in its second quarter (July-September) monetary policy. However, it cut cash reserve ratio (CRR) by 25 basis points to 4.25%.
In an interview to CNBC-TV18, YM Deosthalee, chairman and managing director of L&T Finance Holdings says CRR cut was the right step. "RBI will not be able to kick start the economy. I think the interest rate environment is, to a considerable extent, sentimental. It is important, but it is not necessarily the only thing that can ignite the economy. So, under the circumstances, it was probably too much to expect rate cut because the inflation continues to be very high," he elaborates.
Credit Policy: Non-committal to rate easing; dampens mood
Below is the edited transcript of his interview on CNBC-TV18.
Q: We have just had the Reserve Bank of India credit policy, the CRR cut was 25 bps, which was slightly below what people had hoped for. There was no cut in repo rates. How important is a cut in CRR rate?
A: Reserve Bank of India’s policy is enabling kind of policy. So, they will not be able to kick start the economy. I think the interest rate environment is, to a considerable extent, sentimental. It is important, but it is not necessarily the only thing that can ignite the economy. So, under the circumstances, it was probably too much to expect rate cut because the inflation continues to be very high. Reserve Bank of India is concerned about the inflationary pressures both domestic inflation as well as imported inflation. Therefore, till inflation comes under some control, they are not likely to do anything.
I think that the liquidity conditions remain comfortable in the system. That is important. We have witnessed, in the last few days, very tight liquidity in the market. Under that liquidity adjustment facility, about Rs 100,000 crore was being borrowed. So, I think CRR cut was the right step. One thought that it could have been a little higher than 25 bps because 25 bps releases about Rs 17,000 crore into the system, given the current situation.
I think the liquidity tightness is likely to continue, given the festive season, Diwali is approaching. Also, the government borrowing programme is continuing. I think, till November end, it’s likely to go on. The liquidity situation is going to be a bit tight. So, under the circumstances, one thought, 50 bps would have been better than what has been done.
Q: But I think that the liquidity situation is tight largely because of the government because the capex cycle still hasn’t caught out.
A: I don’t think that there is any improvement in the capex cycle. Both industrial capital expenditure and infrastructure spending continue to be at a subdued level. Even consumption spending has not been particularly high. Infact it has come down. But given the next few day, when we will be seeing festival activities in the country, hopefully, it might pick up. But current problem is mainly because of the government borrowing programme.
Q: Earlier in the week we had the finance minister say that he was hoping to rein in the fiscal deficit at 5.3 percent, which is admissioned that he will overshoot target of 5.1 percent, but the consensus is 5.7-5.8 percent. Do you think he can bring it down to 5.3 percent? If he does, do you think the liquidity situation will ease considerably?
A: As far as government is concerned today, the most important weapon, which government has in hand, is disinvestment. I think they are banking on divestments. I think there are number of companies where they can come down in terms of their overall holding. If the market continues to remain stable, it will enable government to go ahead with this divestment programme. I think that should help them.
However, given the fact that there is only a marginal increase in the fuel prices and the demand for fuel is going up, the deficit is not going to be a comfortable situation at all. I think it is going to be challenging to maintain at 5.3 percent level, even if they consider very aggressive disinvestment programme. So, I think some more steps are required. Hopefully, they will announced a few more things.
Q: Is life today looking much brighter than it was six months ago? Atleast today there is a feeling that the government is concerned that there is a problem in the economy. So, are you today a slightly happier man than you were six months ago?
A: Yes, ofcourse. There is no doubt at all. It is not a question of being happy. I think there is definitely an urgency. You can feel the urgency. If you meet anybody in the bureaucracy as well as in the government I think there is an eagerness to do lot of things. They also understand the seriousness. While there have been some good steps, which have been announced, I think much more needs to be done. I think there is definitely a realisation on the part of the government and everybody that I think things should move at a much faster pace.
Q: We have seen stock market react positively, we have seen the rupee also react positively. But on the ground, what are you seeing? Are you seeing any green shoots, are you seeing any signs that look hopeful?
A: As far as our business is concerned, it is actually retail lending, wholesale lending and there also various pockets. So, let’s first look at retail lending. In retail lending, we do financing for tractors, cars. Recently, we have acquired an entity for two-wheeler financing. We also do traditional construction equipment financing as well as other financing for equipments like small commercial vehicles required by the rural and semi urban market. As far as some of those areas are concerned, the activity level continues to be good.
Q: You mean the construction equipments in the rural areas?
A: No, I don’t mean the construction equipments. Construction equipments have been very badly affected. I am talking about tractors, harvesters, small commercial vehicles and to some extent, cars. Our portfolio in cars is very small and it is not a problem to grow on a small base, because it is just the beginning. We started that business, a couple of years ago. So, despite the fact that the industry may not grow at a healthy rate, we can still continue to grow, because our base is small. But there is definitely some perceptible slowdown in that space.
What is continuing, is the demand for tractors, the demand for harvester or any rural equipment. There is a good demand even for cars for rural markets. But if you look at the other aspects of equipment financing apart from the general slowdown in the economy, construction equipment particularly, has been very badly affected.
Due to the ban on mining last year, there isn’t any business in many parts of the country. It has just disappeared because mining activity has come to a lower step and the same is the case with large commercial vehicles. So, that has also been a problem. These two sectors in equipment financing are not growing. Infact, there is a considerable de-growth in this. On infrastructure financing, there are some pockets in which we have seen growth. There is very healthy growth in renewable energy. And out of our total portfolio in infra financing, more than 20 percent is in renewable energy.
Q: The result of pure consumer companies was much better in the last and current quarter than the other economy. How do you explain the dichotomy? Is it largely rural driven? How is one pocket, which is a fairly significant pocket, able to sustain in the phase of an otherwise sluggish economy?
A: Consumer financing is totally different than what we are talking about. Even tractors are not part of it, in that sense. Consumer financing typically includes two-wheeler financing or consumer durables’ financing. So that market, continues to do well. The only reason why that consumption financing is still holding alright, is because there is not much of a slowdown in that pocket.
There are two reasons for that. One ofcourse, is the government spending to some extent. But, I think the services industry continues to do well. I think the income levels are at decent levels.
Q: We haven’t seen large scale retrenchment in services companies. Any danger that, that could happen if the global economy slows down further?
A: Even if global economy slows down our belief is that outsourcing business should continue to do well. There will be tremendous pressure for them to reduce cost and more and more off-shoring could take place. We have, as an entity, consciously chosen to be diversified. The reason for that is, diversification in financial services helps in de-risking your portfolio. If you are focused on one sector and if there is any problem in that particular sector, your growth comes to a standstill.
Considering we have decided to be diversified, it doesn’t mean that we will be in all the areas. Initially, we started with income generating assets, now we started with assets which have emotional value as far as the customer is concerned.
Q: We have had the banking guidelines out they are not very different from the draft making guidelines. What is the process from here to the final guidelines coming out?
A: I don’t know whether they have issued the final guidelines. I am not sure. I think there is some talk about it. So, we have to wait till that. It is all speculation.
Q: How under bank is India? Do we really need more banks or can the existing banks need more licences?
A: I think in India the entire financial service sector is under penetrated. The banking is not the only thing. We definitely need more banks and far greater reach than what we have today, be it insurance or mutual fund. Even asset management business is concentrated in large cities. That is why Sebi is giving incentives to mutual funds now, to go to smaller towns. So, penetration is definitely lower in all areas of financial services. If India has to grow at whatever percentage you may say, I think financial services sector has to grow.
Q: How crucial is banking to a company like yours?
A: Financial service is not a short-term business. It is a long-term, perpetual business. If one wants to be in this business for a long period of time it is a natural choice. You can survive only if your liability side is well managed. Then you can provide good quality long-term services to your customers. There comes a time, maybe today we are growing all right, but after five-seven years down the line in a NBFC construct there is a possibility of limitation. But as per banks are concerned, no and that is another reason why it is important to have a diversified portfolio.
Q: Talking about your buy of Fidelity, when you bought and took it over there were lot of redemptions. What is the situation now? Have you been able to get the assets under management back to the pre-buy level or at least close to that?
A: First of all, let me tell you that this transaction has not been completed. The exit window period is on. So somewhere around end November, we will be able to close the transaction.
We need to understand this acquisition a bit more in detail. The first point is the rational behind this. We wanted to build a balanced asset management business. We had a small mutual fund which was more debt oriented. Fidelity offered an opportunity to have a good mix between debt and equity. In terms of distribution also they have a different type of distribution channel. We were largely depended on independent financial advisors (IFA) that also made lot of sense. So, considering all that, we decided to go ahead with it.
However, one needs to understand that when such a transaction happens, till the transaction is over there is no active selling. Considering that we expected some redemption in the normal course and we have experienced those kinds of redemptions. But in the mean time, what has happened is something which everybody needs to know. One is that we have beefed-up our team considerably. Today we have both, in terms of debt and equity fund management some of the finest fund managers. So really speaking as per the industrials is concerned, we are going to have same experience. Finally, it all depends on what are the systems, process and philosophy which we follow. This will be the same philosophy which we follow. In terms of stock picking for equity, it is going to be the same bottom-up approach which our team is going to follow. In terms of overall experience, it is our commitment to ensure that the investor gets the same experience.
Q: How tough is the business because you are otherwise in businesses which give you a fairly high return? The mutual fund business is a pretty competitive market and the policy and regulatory environment has already been unsettling. Did you chose to get into it only for the distribution or diversity or what was it?
A: I think it’s very important for us to understand the rationale and logic. I mentioned in the beginning that we want to build a comprehensive financial services business. Now, if we look at our portfolio, we are largely a lending entity. Therefore the returns will be on spreads, borrowing costs and the lending rates which we charge. We needed to compliment this with fee based activities. On a steady state basis, we should be able to generate atleast couple of percentage point ROE through the fee based activity. So, that is why this particular business made sense. In this business once you reach a particular level it’s a very steady business. Investors generally look for stable performance and once you have it, you need not be necessarily top performer. It’s not possible for you to be always number one or two. But so long as you have commitment to be in top quartile or atleast the upper bracket of the second quartile, it’s a very stable long term business. That’s what we want to build. In L&T Finance, we have also started distribution of financial products and a wealth management business. So along with that this mutual fund is very complimentary. I think if one wants to be in comprehensive financial services businesses, his was an extremely important piece which we needed to build.
Q: So, you want a diversified comprehensive portfolio. What are your missing pieces? How you need to fill it, to fulfill this 360 degree financial company?
A: It’s constantly changing so one can’t say what the missing pieces are. I think it’s important for me to tell you that we made three acquisitions in the last one year. They all were part of our overall strategic vision. Let me explain, we talked about fidelity that was in the mutual fund business. We also have met two small acquisitions, one is the home loan company that was a missing piece. Although the platform is small, it’s an important thing. We get throughout two years advantage. We can start the business immediately and we are actually in the business now. We have recently acquired a company which was in the consumer durable space that is car and two wheeler financing, which was also a missing piece. So currently more or less, all the pieces are in place. At the same time it is possible that we may get out of some products as well, as market evolves. There are newer players coming in to our space, similarly all the banks are also competing with us in many of these areas. So, as the competition increases and portfolio becomes richer, it is possible that some of the areas we may vacant and then some new areas we will get into.
Q: Are you thinking of private equity?
A: No we are not thinking of private equity.
Q: Why is it too small?
A: No, actually because we are working on a slightly modified version of private equity. We are in infrastructure financing company. In the infrastructure space there is a possibility of setting up an infrastructure fund. So, you are working on an infrastructure private equity fund which will be focused on investing in the infrastructure space. So, that’s the specialized area in which we would like to do something. Hopefully in the next few months we should be able to do our first closing.