Feb 16, 2013 06:19 PM IST | Source: CNBC-TV18

Uday Kotak: Growth vs inflation; we have to risk one

Indian market has set its eyes on the move that the finance minister will make in the upcoming Budget. The expectation from the FM has increased after the successful global road show.

Indian market has set its eyes on the move that the finance minister will make in the upcoming Budget. The expectation from the FM has increased after the successful road show to woo foreign investors. 

Udayan Mukherjee, managing editor, CNBC-TV18, speaks to Uday Kotak, chairman, Kotak Mahindra Bank, about the state of the economy and his expectations from the finance minister. 

A combination of fiscal deficit and monetary policy play will determine future market movement, says Kotak in an interview with Mukherjee ahead of Kotak Annual Global Investor Conference which will commence from February 18-20, 2013.

He highlights that Europe, which suffers from high inflation similar to India, has undertaken steps like gradual austerity and at the same time they have eased the monetary policy. India should also take some steps of austerity to reduce government spending and curb the current account deficit and at the same time the central bank should step in with quantative easing to further aid the economy and boost growth.          

Also read: Budget can't solve infra, cap goods woes: Vibhav Kapoor 

Below is the edited transcript of his interview to CNBC-TV18.

Q: Do you think this time the level of expectation is much higher on the backdrop of what the finance minister (FM) has been doing since September?

A: I think FM's global trip has been received positively and investors are eagerly looking forward to the Budget. It is comforting to see the way in which the FM is looking at the Budget deficits, but many issues need to be addressed as we look at the economy.

Q:  How do you think this year will be for the equity market? Surprisingly, last year was good for the market. At the start of 2013, what are your expectations?

A: I think one needs to see how the combination of fiscal deficit and monetary policy plays and works out together. Europe has undertaken steps like gradual austerity and at the same time easing monetary policy.    

India is finally moving towards fiscal tightening which the country needs to do gradually, if the tightening happens too fast, then it can affect growth and at the same time one has to watch how monetary policy will pans out. Unlike Europe, India also lives with high inflation. Therefore, the challenge is, how do we ease monetary policy when the fiscal is correcting gradually and handling inflation. How the policy responds to these combinations? That is the answer to how the market will behave.

Q: Everybody wants to see fiscal consolidation, but what ramifications would it have for growth, as growth has also come off and there is hope that through 2013, growth will get rekindled, many observers are little disappointed with low growth recovery. Will fiscal adjustment come at a heavy price of seeing tepid growth throughout this year again?
A: Whenever the fisc is tightened, there is an implication on short-term growth while the long-term economy gets healthier. It is tricky when the election is one year around the corner and at the same time, Europe has gradually started tightening fisc, but eased monetary policy.

In India, how do we handle monetary policy with large current account deficit (CAD) and high inflation? Do we loosen it with the risks attached while fisc is improving and one year before an election?

Q: If you were in the shoes of the policymakers how would you play it?

A: I think the policymakers may have to take a risk on at least one parameter, either inflation or growth. I think fisc containment should be gradual so there is more moderated improvement in the fiscal deficit.

Q: The FM seems to be a man in a hurry. He has been making promises and is trying to meet or better fiscal deficit targets. Do you think there is a risk that he might do achieve either his promise to global investors or to avert a ratings downgrade he might actually move swifter than you would like him to on the fiscal deficit front?

A: The best time to discuss this is post Budget.

Q: Has the perception of global investors on India improved dramatically? Pre-September the mood that was prevailing in India, do you see a sea change going into your conference next week?

A: We have received very good response from investors and participants. Around 500 participants from various institutions in India and overseas across all geographies will attend the conference. There is an air of expectation that India is finally moving on a more positive track on policy front.

Yes, there are macro challenges, so it is critical to understand what is happening in India at the ground level so investors are coming to feel this pulse directly. We are very happy to see lot of investors will attend this conference combined with the fact that the corporate interest in meeting these investors is at a record high. During February 18-20, around 4,000-5,000 meetings will take place between various participants 

Q: In 2012, India received FII flows of around USD 24 billion which surprised many people. This year started even on a better note. We have already pushed USD 7.5-8 billion in the first six weeks of the year. Do you expect 2013 to be a bigger year in terms of liquidity flows, the way you are reading global markets?

A: Global liquidity is easy. After the Davos summit we can understand that there is relief and no imminent worry of a crisis. Interest rates around the world are low, so liquidity will flow where opportunity is present. How we balance fisc tightening, handling inflation therefore monetary policy and at the same time provide growth to the investors is the real issue for India. It is a very tough combination to handle, but if we are able to handle this, then we will see significant flow of money coming into India. 

India's current account is an issue and trade deficit numbers indicate that we have a run rate of USD 240-250 billion of trade deficit in a year. Therefore, portfolio flows are no longer just welcome, they are necessary for India's sustainability.


Q: How much of these flows will get into the secondary market like it did in 2012 and how much of it will get soaked up by issuance of fresh paper of which we have seen a lot already at the start of the year?

A: The issue of paper should be divided into three parts. First, government companies -- they will have reasonable flow of paper even in the next year, if we will have a handle on our fiscal deficit.   

Second, particularly infrastructure sector companies. Due to high level of debt the equity values at which many of these companies are trading are very thin so most of the promoters will find it difficult to issue equity at this valuation and keep reasonable ownership of their companies.

Third, the banking and financial institutions from where we recently saw lot of paper coming in and more will come in. I think currently investors are more comfortable with this paper and there will be reasonable supply of paper from banks and financial institutions in 2013.  

Q: Do you plan to raise capital?

A: We do not have any immediate plans.

Q: The capital which the banks and the financial intermediaries are raising, do you think they will be able to profitably deploy it? So far, loan growth is quite tepid. Investment plans have not started picking up. Will we see a complete resurrection or a turnaround in the investment climate in the country or do you think that may not happen contrary to expectations?

A: Right now, some banks may need to raise capital which will give a lifeline to many leverage companies. So, some banks may raise capital to provide breather for the real sector which is under pressure, particularly on the leverage side which many real sector companies currently carry.

Q: What sense do you get when you talk to companies yourself, you meet many CEOs and many of them will attend the conference next week? Do you get the sense of confidence in them because the stock market is just eight percent short of an all-time high but somehow CEOs do not seem to be exuding that confidence as we go into 2013?

A: First of all, stock market is nominal value and we are talking about five years later. So, one needs to discount it for inflation and look at the present value. I would be cautious to see the stock market at all-time high in nominal terms to see what is happening in the real economy.

In real economy, corporate India is certainly moving slow. It is extremely critical to give some boost to the real economy. We need to keep the market in good shape to aid the real economy. We have made progress to keep the market in reasonable shape, but still translation of that to the real economy is not happening. 

Q: Do you think it will happen in 2013 or do you think we will have to wait another three-four quarters to see the first sign of a turnaround in the investment cycle?

A: A lot depends on policy. If fiscal and monetary policy are considered as two sides of a coin and we get the balance right in terms of action, then it can happen in 2013.   


Q: You mentioned that it is important to keep the sentiment in the economy up. You run a large mutual fund house; you have a big leg in the capital market business at Kotak. Are you surprised or baffled at the diffident of the entire retail or high net worth individuals (HNI) fraternity this time in participating in the equity market?

A: India is going through a paradox. India is importing foreign savings into Indian equities and exporting Indian savings into foreign gold. On one hand we are getting USD 25-30 billion of foreign savings into Indian market and we are exporting Indian savings into foreign gold.

It is an amazing paradox to see why the Indian saver is not looking at Indian equities and it is a question of bit disillusionment in terms of performance of companies. The Indian market is close to its nominal high but when we look at the breakup, there are many companies which are above the five year highs but there are even more companies, which are between 60 and 80 percent lower than what they were five years ago and that is a problem.

Q: Do you see this trend changing or do you see this story of two halves continues; foreigners being bullish on India but the local investors continuing to be bearish?

A: I think the local investor has a much higher hurdle rate for his or her return versus what equity markets are currently promises to give. If you can get in a system post tax – 8.5-9 percent today through various instruments, which are available in the market place, you are talking about a pre-tax hurdle rate of 12-13 percent for a domestic investor compare that with a foreign investor who is getting very little on his dollar.

Yes, there is a currency issue but let's keep that aside for the moment therefore for a local investor the hurdle rate of return is getting in debt instruments is a significant barrier for him to make a choice into equities. Second, a lot of informal money is now out of equity market. It is moving into other markets, real estate, gold and commodities but we just moved away from equity market. So, this money earlier use to support the Indian equity market four-five years ago.

Q: Coming back to the issue that you touched upon because the currency is a big factor for global investors and in the last three years it has taken away a lot of their equity market returns from India. How do you map the rupee as we go deeper into the year?

A: The rupee is linked to what we do on the macro particularly on the fiscal side and the current account side. The current account is showing some signs of pressure and I don’t either 50 or 60 for the currency in 2013.

Q: Are you expecting a slew of banking licenses this year?

A: I think one has to look at the policy. I think the FM mentioned a possibility of there being 4 or 5 new bank licenses. The process will take around 1.5-2 years before new banks are in business.   


Q: How do you see this year for banking? A large part of your meeting will revolve around this. It is 30 percent of the index. It is clearly the index which most people are overweight on and there too it has been a tale of two halves. The way private sector banks like yours have behaved or performed and the way public sector banks have performed. Do you expect this complete divergence in performance to continue or even get accentuated in 2013?

A: I think the banking business is pretty simple. When you are a significantly leveraged player, equity can be very virtuous or vicious because leverage can change the game for any highly-leveraged institution. Therefore with respect to banks, I think the balance sheets are far more critical than short-term P&Ls. Investors will differentiate where they believe that balance sheets are robust, believe in the book values, believe in quarterly numbers and on relative basis see softer stress levels on the balance sheet. I think investors wants to see this comfort through 2013.

Q: How would you play it as an investor? If you had your own money to run how much of a reduction in interest rates do you expect in 2013 because that helps equity prices, but that also helps bond products, because of the capital appreciation and their returns might actually go up 13-14 percent pre-tax even. Where would your greater comfort lie this year, fixed income or equity?

A: My sense is first on policy rates. My view is that the policy rates by the end of 2013 should be at about 7 percent. That will fuel in the short-run decent returns on bonds, but finally once you come down the curve it will help investors to take a call on equities. But I think the equity markets will also see very sharp divergence between what investors perceive as quality and what investors are cautious about. The quality part of the market is relatively a small segment of the total market, and it is choosing those companies which have a bottom-up approach, as distinct from buying India top-down which is a big difference I see in the marketplace.

Q: What would be your message to investors who are attending your conference today? What is your view on the market? After five years we are pretty much coming back to the starting point. Where in the market phase or cycle are we? Are we at the starting point of a multi-year kind of an uptrend? Can’t you say that with confidence yet? What do you think of the market landscape over the next two to three years?

A: First, investor should watch the macro policy moves closely and take a judgement on what do you think is the likelihood of how those policy moves are balanced. Second, look at stable well governed good balance sheet companies. Third, India will be a bottom-up market for 2013 and it will be tougher for India to be a top-down market in 2013.

Q: We will get closer to elections at some point during the year. Do you see it as a big or defining event for the market?

A: I think elections will be a very important event, because there will be significant debate on the structure of the next government as to how fragmented a coalition versus how strong a coalition and that is the key difference between a fragmented coalition versus a more cohesive coalition which will determine the future of India in many ways as a country over the next five years.

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