May 21, 2013 03:25 PM IST | Source: CNBC-TV18

Limited scope for further re-rating of India: BoA Merrill

Jaipuria feels the Federal Reserve may not hint at a reversal of its loose monetary policy at its meeting on Wednesday. Much of the decline in commodity prices in the last couple of months has been driven by hopes that the US Federal Reserve will start tightening its monetary policy now that the economy is showing signs of recovery.

There is limited scope for the Indian market to get further re-rated, feels Jyotivardhan Jaipuria of Bank of America Merrill Lynch. The current rally is being fuelled purely by liquidity and the upside appears to be capped, Jaipuria said in an interview to CNBC-TV18.

He said there were enough factors that would keep the market in check. The current account deficit is big cause for worry. Also, India’s forex reserves is at its lowest since 1995. Despite softening of crude oil and gold prices, India’s trade deficit widened to over USD 17 billion in April.

Read: Fed may end bond buys in autumn if jobs outlook sure: Evans

Jaipuria says corporate debt continues to be high and would constraint capital expenditure. The capex cycle will take some more time to recover, he says.

The economy is still not benefiting from the repeated cuts in the benchmark repo rate by the Reserve Bank of India. Since last April, the RBI has cut repo rate by 125 basis points. But the average reduction in base rates of banks has been less than 50 basis points.

Jaipuria feels the Federal Reserve may not hint at a reversal of its loose monetary policy at its meeting on Wednesday. Much of the decline in commodity prices in the last couple of months has been driven by hopes that the US Federal Reserve will start tightening its monetary policy now that the economy is showing signs of recovery.

Back home, a steady supply of shares from companies looking to comply with Sebi’s minimum public shareholding norm, is expected to keep indices in check. But this consolidation is good for the market, he says.

Jaipuria sees close to USD 2 billion of share issues over the next 10 days.

Below is the edited transcript of Jyotivardhan Jaipuria's interview with CNBC-TV18.

Q: Do you think the market is ripe for some kind of breather or do you see this momentum continuing?

A: Ultimately we have had a 10 percent move in six weeks. So, to that extent, a breather would be good because it helps consolidate this gain which we have seen.

Also what we have to remember for the next 10 days from now, a lot of these companies which have to meet the 75 percent promoter holding norm will come to the market. We could see some supply over the next 10-15 days which aggregates close to USD 2 billion. So to that extent, that supply may put some pressure on the market.

Q: The most recent investor survey report from you indicated that emerging markets (EMs) are at an all-time high in terms of holding and India is pulling most of the cash. What do you put that down to? Do you see that continuing as a trend?

A: If you look at the survey; in March people were negative on India which is when we had the credit policy come out and the indication that rate cuts may be difficult to come through. In April, oil and gold prices came down; we saw a change in mood for fund managers.

Everybody said, here is a place to buy because it is the biggest gainer from the fall in commodity prices. I was out marketing for last few weeks and everybody seemed to echo the same trend that they put in money once they saw oil and gold starting to come down.

Q: Do you expect any wrinkles to crop up on the global liquidity side because that is driving all markets? Tomorrow when Ben Bernanke speaks, are you expecting him to even hint in any way that Quantitative Easing (QE) might be drawing down?

A: It is not going to happen in tomorrow's meeting but that is something, before we end the year, we will start getting that hint. Markets will probably get worried about QE coming to an end even if it is not or at least slowing down. That remains one of the risks for the market. However, at some point, you want it because it is a good thing. If the economy revives, he is going to reduce the QE because that is what will build a sustainable base for the market.

Q: There were a large number of investors who had politics and its impact on their mind. At this point would you say the market is factoring in any kind of political disappointment either in the form of a fractured outcome or that general election happen much easier and policy doesn’t move as fast as they hoped?

A: Opinion polls would be on everybody’s mind next year. They would think will we do get a government which is in a position to do reforms or will we get a mandate, which is so fractured that policy-making takes a back seat. That is why markets may do better in the early part.

September-October onwards, things may get a little tougher because once we get closer to November elections; everybody will start to get a bit more worried on politics and the outcome. At that time, the focus on what is happening to the economy and interest rates may take a back seat.

Q: Your view has been that earnings will not accelerate in a very meaningful fashion in FY14. Do you expect very large scope for valuation movement on the way up given the global liquidity over the next few months because with every 10 percent move in the market, valuations are expanding now as the support of earnings is still not there?

A: My view still remains that the ultimate cap on the market on the upside is just that much. I don't think we will see a meaningful recovery either in the economy or in earnings.

We are quite negative because earnings for FY14, the growth is going to be more like seven-eight percent; way below what consensus is forecasting at the moment. So, for the Sensex EPS is way below what the street expects it to be.


So based on my numbers, the markets are already trading at around 15 times FY14 earnings. The scope for too much of a rally or too much re-rating is limited because they are already at 15 times. Over the course of the year, markets will start rolling earnings a bit forward. To that extent, one could get a little more of a upward market movement.

However, the upside is capped because till we get the economy moving, earnings going back to 15 percent level, markets will just continue to have a rally because of liquidity. Our expectations are that rate cuts will happen.

Q: What do you hear from investors about the current account deficit (CAD) and the rupee? Does that view still stand or has it been diluted somewhat after the events of last few days?

A: Our view at the beginning of the year was that the biggest risk to India is not so much the growth not happening because people just assume that growth will be slow, but it was that the CAD could just blow up the country which was very high. We had forex reserves, which were extremely low. 

As the oil prices fell and gold fell margins were improving. So it is not like the problems were going away, but it is just that they were getting better.  Investors generally thought that the rupee will be okay because gold and oil prices were falling. The other thing is we saw lot of inflows coming in next month because we have open offer and these are the big ticket Foreign Institutional Investor (FII) inflows. 

People’s expectation was that for sometime at least the rupee may tend to appreciate rather than depreciate, which is not really working out. So to that extent, the whole CAD and the rupee remains one of the concerns for investors. It may come to haunt our market at some point again.

Q: But you do think that you will see enough evidence of rate cuts to support the belief that rate sensitive will drive any upsides in the market from here on?

A: We will see some rate cuts happening because inflation has come down. The other is going to be the expectation that rate cuts will accelerate as we have a new RBI governor coming in. That is going to support the rate sensitive. However, a critical thing so far what we have not seen is transmission to the borrower. 

We have seen RBI cut rates to some extent, but banks have not really been cutting rates to the borrower. More important from the economy and earnings point of view is when we get that transmission coming in. For that we need liquidity in the system to improve. Credit deposit ratio is running at close to 78 percent, which is extremely high. Till we see that number coming down transmission won't happen. This means that though RBI cuts rates, the borrower is not going to get benefit of those lower rates.

Q: How confident are people feeling about the capex cycle? How are you feeling about this entire infrastructure space?

A: Our view has been that the capex is not going to happen in a hurry. It is going to take quite some time before we see another meaningful capex cycle starting. So one reason is obviously is in terms of timing; we are so close to next elections that for a lot of people it may just be that they want to wait till the new government comes in and see what it is like before they commit to any large capital expenditure.

The other thing which worries me is that corporate gearing in India is quite high and with this, it may not be very easy to start another round of capex cycle. So that may be a constraint even after the new government comes in.

Q: Tactically, given what you picked up in your interaction with investors abroad and what you are hearing about money, would you remain positioned for this market to give you greater returns on the upside rather than a sharp correction on the downside?

A: Our view is that over the next few months, you still get a positive return on the market. But it is going to be lower than what we have seen really over the last six weeks. However on the margin, I would still be positive on the market especially because you have to remember that India is not doing well in terms of growth rate, but neither is any other country in the world. If one look at emerging markets the problem is actually the same everywhere, capex cycle is weak across all EMs.

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