The RBI's liquidity tightening measures impacted cost of funds for banks and it cannot walk away from increased interest rate now despite the fact that the rupee did not strengthen, says Arvind Sanger of Geosphere Capital Management. He says the economy will feel the pain of the increased rates and the only sectors that are holding the markets right now are the consumer sector, IT and pharma.
The only positive factor for the Indian economy has been the good monsoons. But even increased rural demand won’t be sufficient to carry the entire economy and hence a 5 percent GDP growth looks rather optimistic, Sanger told CNBC-TV18.
He feels that the markets are on such shaky grounds that even a modest selling by FIIs in the safe haven sectors could cause a pretty sharp downward correction.
Another issue according to him is the strengthening US economy. As long as the US data is good, emerging markets will continue to underperform, he says. Besides good US data also means Fed will be on course to tapering its bond buying programme.
Below is the verbatim transcript of Arvind Sanger’s interview on CNBC-TV18
Q: The Indian data points have been quite awful as you would have noted. Do you think this market will manage to hold out here or could it be looking at sub-5500 levels this time around?
A: As you were saying a little earlier there is nothing magical about 5600 where it should hold. I guess a few weeks back I was among the optimistic, saying that the range would hold and the bias over time could be on the upside, but I think with this Reserve Bank of India (RBI) needing to defend the rupee and I assume they needed to, India is really in a box right now. The rupee has not strengthened.
The RBI cannot afford to walk away from its increased interest rate that they have put on the short end without collapsing the rupee, so they are stuck with that which means that the economy is going to feel the pain for the fret of higher rates flowing through both to corporates and to consumers and I would say if there are two or three sectors that are holding up this market, one of those is the consumer sector, the others obviously are IT and pharma.
IT and pharma are largely foreign facing, but the consumer sector is very much domestic facing and based on the new service data, we already have manufacturing data that is very weak, now the service data is showing significant weakness and you may have said this earlier in the programme, monsoons are not one magic wand that is going to fix everything.
How much rural demand can carry on its back the rest of the Indian economy, not much and therefore I think that at this point 5 percent is looking like an optimistic growth target for the next fiscal year or the current fiscal year and therefore the next down leg in the market could come if some of these consumer stocks that are trading at astonishingly high multiples were to correct to what would make more sense, then that is your downside in the market of getting the next leg down.
Q: Up until now we have not seen any kind of large scale pull out by Foreign Institutional Investors (FIIs) from the Indian market. Do you fear that the next leg of this market will see a big pull out by FIIs, especially in some of these sectors that are holding up that is some of the defensives?
A: The reality is I think the market is so fragile, you do not need to see a big pull out, you need to see even a modest pull out, cash withdrawal by emerging market (EM) investors and if they start selling some of the market leaders in the consumer space or in anything else, if people are hiding they are hiding in consumer and they are hiding in IT and pharma and of those three the consumer sector is the most vulnerable and if it saw some selling I am not sure there are any significant domestic investors looking to buy into these sectors.
Therefore I think the risks are that the market is on fragile enough ground that even a modest amount of selling pressure could really cause a pretty sharp downward correction. So my view right now is the market is on extremely shaky grounds.
Q: What is the global set up right now? The India story is looking very shaky, but sometimes even in these bad patches we get bailed out because EMs generally are in flavour. Next couple of months do you think that is going to be a difficult trade, EMs to eke out any significant outperformance or attract major flows?
A: As long as the US data keeps staying reasonably good and therefore the Fed tapering looms closer and closer to that September expected start of their announcement of tapering I think EMs are facing a bit of headwind unless the EM data turns dramatically better which we don’t see happening in either India or any of the other major EMs.
So therefore the backdrop is that between the looming tapering and the continued sluggish EM economic data I just do not see the underpinnings for an EM rally. If anything, the European data is getting a little bit less bad and maybe some money going in that direction, but EMs clearly seem to be on an island by themselves and nobody is swimming to that island right now.
Q: Do you see anything in the global environment that can trigger off a phase or risk-off? Markets seem very complacent about global risks over the last few months. Europe has almost been off the radar that nothing bad can come from there. The US is in a great situation. Do you think there is a possibility of being surprised by any kind of global risk that comes to the fore because markets have generally priced in the absence of any kind of tail risk?
A: Absolutely. The problem with some of these tail risk events are that they are almost always unexpected and come from left field. I am not sure if Europe is the most obvious one. There are elections coming up in Germany and there is always some political turmoil in Europe that could cause risk to re-emerge if one of the governments fall in Spain, Portugal or somewhere else and things get shaken up because of ongoing political turmoil in some of the peripheral countries that is obviously a risk.
I would say there are other geopolitical risks. The Iran nuclear programme is continuing and Israel has not been doing much sabre rattling lately but if they were to do something on that front that will be a major risk-off for global markets. I do not see other than European political risk or something geopolitical either a major event like Israel-Iran situation which causes oil prices to spike. Something like that could tip the balance, other than that anything else would have to be an unexpected event which we can forecast today, but I am not spending too much time worrying about it.
Frankly, for global investors, US continues to be not necessarily the cheapest market in the world, but a safe haven in terms of predictable visible growth, but even there, there are risks looming that in September you could have a bit of a tussle between the Congress and the White House on debt ceiling and budget deficit issues coming to the fore again and there is some chatter that things could hit up and they may not be the same kind of kicking that can down the road that the two parties in Washington have agreed to do for the last couple of times it has come up. So that would be the one other risk that is US specific that we are keeping an eye on.
Q: Coming back to our own markets, how do you approach a space like financials now because many of these public sector banks have lost almost 40 percent of their market cap since the start of the year, now if there are more liquidity squeezing measures, do you see another leg of a downside for financials?
A: At this point from a historical valuation standpoint, you would have to say that this is a time where with any long-term perspective one should be nibbling at some of these banks which look very cheap on price to book relative to historical multiples. But the problem is, the quality of the book value is hard to tell because we have not yet seen the full effect of whatever might come if this slowdown is going to extend out as it looks slightly in terms of the economic slowdown.
You are going to get more infrastructure/power type of write-downs. That is what the market is concerned about. I would say that with the medium-term to long-term view, some of these financials saw the large public sector undertaking (PSUs) could be getting to very close to trough valuations, but they could stay at these valuations just because they are close to trough valuation doesn’t mean they can hang around for a while. So I don’t see the next leg in the market down coming from a big sell-off in the financials, but I don’t think that financials are about to see a big rally either.
Q: In that context, what do you see as the Reserve Bank of India’s (RBI) next move, in its last policy it almost appeared to contradict the thrust of its policy to sort of stabilise the rupee, how do you see the RBI balance the act going ahead?
A: In my opinion the RBI may have lost the plot a little bit. From saying what may worry about the rupee from 50/USD to 60/USD to suddenly into this panic two step process of tightening short-term liquidity smacked of a little bit of not enough foresight, so suddenly from worrying about growth, it is worrying about the rupee.
At this point I am not sure because this RBI governor is obviously on his last month or so. There is a new RBI governor coming in. I am not sure if the new RBI governor is going to come in and first start to be dovish but I think the RBI as an institution not withstanding the personalities at the top is right now in a tough spot because they cannot afford to be dovish given that they have spent so much ammunition to defend the rupee.
Therefore, they have decided to sacrifice growth to save the rupee and I don’t see from the corner that RBI has painted itself any easy way out other than to see the government do some policy action and unfortunately already whatever policy action that the governor is doing now whether it is FDI in retail or FDI in insurance or whatever else, the steps they are taking, the currency markets are just yawning and saying too little, too late. So I just think that the magic bullets left either for the RBI or for the government seem to have shrunk quite a bit and therefore I am not sure that the RBI is going to be able to do much at this point.
Q: Is it getting more difficult for a global investors to justify a long-term position in India given the pace at which growth is coming off because it is not a two quarter blip any longer, numbers are marked down pretty much every quarter?
A: I think it is becoming hard to make a big bull case for India. Let us take the short-term and the medium-term and long-term perspective. The short-term if you say for the next six months, I don’t see any reason to be in India. From an investors standpoint of view, don’t have to be – I would say that from a six-twenty four months if I were taking the horizon or beyond that, I think a lot of things can change, you will have a new government in place, you would have the global environment maybe more settled even if the Fed has done its gradual withdrawal of QE, I think that the market will have digested that. So a lot of things can change.
So it always looks doom and gloom at the bottom for an extended period of time. I do see reason for fundamentally buying into the doom and gloom and be pessimistic for the next six months, but beyond that there is a lot that can change. So we should hold judgement beyond that, but for the short-term, for the next six months, I certainly don’t see much reason to rush out and be part of India.
I think the risk for India is that some of the long onlys who have hung in there with a long-term view, some of them give up and will come back later and that is because domestic investors have given up on the Indian market a long time back. So if some of the foreign investors, some of the long onlys did pullback from the market then that would be a watch out for the market.