The debate on liquidity is a tricky one US bond yields have continued to move upm which will eventually pull other asset classes aong with it, feels Pankaj Vaish, MD & Head of Markets-South Asia at Citi. In an interview to CNBC-TV18, Vaish says the exits are not easy when Fed continues with quantitative easing. The carnage seen around the world have genesis in the fear that exits are difficult, In the same breath, he gives example of Japan, whose gross domestic product (GDP) is quarter of that of US and yet the country's central bank has leashed out stimulus worth USD 75 billion.
However, Vaish is most concerned about rupee. The argument about the dollar strength also seems overdone because the dollar hasn’t really moved that much in May. He said the dramatic fall against the dollar cannot be blamed onto excessive buying of gold alone. The currency is the single most important instrument that foreigners look at and for the last 25 years, it has put fear of God among investors.
Below is the verbatim transcript of his interview on CNBC-TV18
Q: Good time to have conference with this raging debate about liquidity. You guys are getting right upfront with it. What is the sense that you get on this liquidity argument? Will they or won’t they for the second half of the year?
A: Liquidity is the most important thing that is driving the risk-on, risk-off attitude in the whole market and this is an important one that shows how when Ben Bernanke was talking about quantitative easing one (QE1) and QE2 in terms of people worries about the exit and he had said that we can shut off the tap within 15 minutes.
This price action in the last two weeks was very good indicator that exits are not that easy. Exits are very difficult, you get the whole world benchmarking to your short end and then if you are doing QE and buying out to 10-30 years, every risk asset gets priced based of that.
Therefore, the carnage that we have seen, not just in the Nikkei but in bond yields around the world except India, has been quite tremendous in junk bonds, in corporate bonds, refinancing for companies, currencies, all of that stuff gets affected.
So, liquidity is important and it is not going to be easy because the US bond yields could head even higher, which means that it will pull along with it a lot of other asset classes also. So, it is a time for a lot of caution.
Q: They have been fairly canny central banks though and extremely sensitive to equity market reactions. It is a probability game right now but what kind of probability would you attach either that QE coming in from the US is likely to slowdown or turn tide also from Japan?
A: The data in US us improving. You have seen that in payrolls, you have seen that in housing, which was the epicenter of crisis - all of that is improving. It means an extraordinary amount of stimulus has have put into the system of buying USD 85 billion a month in securities. And for Bank of Japan to buy close to USD 75 billion with a gross domestic product (GDP) that might be a quarter of US’ GDP and that is a very substantial commitment.
Since data are improving and they are just talking about perhaps slowing down the pace at which they might reinvest the maturing securities - that might be third derivative or something. But it was enough to cause a panic in the market and that should not be underestimated. That is something that perhaps a certain central bankers may have been a bit too comfortable about that this exit is very easy. I think they will have not choice. If the data are improving then you will need to start backing off a bit, because they still are providing tremendous amount of stimulus in the economy. However, that will need to be backed away.
So, the whole readjustment in risk pricing will be meaningful for a company that has junk rating. To be able to borrow money for 30 years at 5 percent even if that is 500 bps over short end treasury, a 5 percent absolute for people to lend to a below investment grade credit is full of risk and that lesson will come back and hit people and there is no getting around it. Nominal prices of risen because nominal stimulus has been tremendous but at the end of the day if the real fundamentals have not improved then you need to go back to real pricing and that is what will come back and haunt peoples’ portfolios.
Q: Holes have begun to show up already in equity performances, you can see it in the Asian market context in the eurozone as well, to a lesser degree the US markets. Would you say at this point there is a significant amount of risk-off or do you fear that is going to come through over the next couple of weeks, which would also then imply sharper downside for markets?
A: Equities have held up relatively okay except for Japan because Japan had also gone up in a somewhat crazy amount. So, outside of Japan, equities have still held up relatively okay. When we spoke on CNBC at the end of April, I was talking about that equities could yet have a blow-off top first and I think that is kind of what we saw there has been this blow-off top, S&P has come off, Indian equities have come off, so leaving Japan aside, equities will still be alright. I don't think there is crash and burn in equities maybe we correct another five-seven percent, but ultimately I don't see a massive crash and burn. The big damage is going to be more on bond yields outside of India and on currencies. Currencies are where you are seeing the brunt of the problem.
So, this bond yields backing up as well as the risk-off in currencies, I think that will be an important way that this is going to manifest itself perhaps less so through the equity's side.
Q: That is actually the overarching theme of the last month or so. Five percent appreciation on the rupee, which basically means in dollar terms India is actually down about two-three percent for the year - for the people who you will be speaking to at the upcoming conference that must be a big deal because they are actually losing money on India position, somewhere they have pumped in a large amount of capital?
A: . Globally, around the world over the last 25 years, it is the currency that puts the fear of god in investors. Whenever people start thinking this could gallop, this could go from two percent depreciation to 10 to 20 percent, then nothing else really matters whether you make 10 percent in the equity market or 15 percent or whether you make seven-eight percent in your bond coupons - all of that is just immaterial compared to the risk that you have on the currency. That is why even on April 29, when we last spoke my concerned was on the currency.
Unfortunately, it has come true that we are looking at a situation where the Indian rupee has weakened even more than the other Asian currencies. There is some amount of worry out there among Foreign Institutional Investor (FII) and they have come and hedged quite a bit. Over the last two weeks we have seen fair amount of activity among FII investors who had hedged end of 2011, because they had gotten burnt then in 2012, they lifted some of those hedges and this year have had to come back and put some more of those hedges on. So, there is that worry and addressing that is got to be one of the most important things that authorities will have to do which they have started doing.
Maybe, there is too much reliance on gold. We seem to think that gold is the reason why dollar-INR is where it is. It is certainly a big culprit and so. all the measures that the authorities are trying to put around it are helpful, the inflation indexed bonds – atleast the first auction went off okay. But I don't think it is just that. There is a overall strong dollar environment but still we are underperforming quite a bit. I think some of that has to do with people being unhappy that the legislative agenda had not progressed, which is what people's hopes were in the middle of April but that has not progressed. They are not sure what the next parliamentary session will look like and they are not sure when the next elections will be. So, we have really not kept pace even with the rest of the world in terms of the currency movements.
Q: The argument about the dollar strength also seems overdone because the dollar hasn’t really moved that much in May. Would you say the rupee is actually symptomatic of a bigger growth malaise which is more concerning because that is really the peg people have been selling India on an FY14-15 basis?
A: That is right. That is exactly what I was referring to that we can't just blame everything on the global dollar situation. We have really not kept pace with the rest of the world's currency movements. Part of that is because people are unhappy and frustrated that the progress that they had thought was going to be made on the legislative side. People are unhappy about that and they want to see some amount of action taking place in terms of these foreign direct investment (FDI) caps getting removed, the Land Acquisition Bill. There were several things that were on the anvil and they really want to see progress on that otherwise they get concerned that they are not sure how the agenda will move forward.
Our growth has decelerated in half; we have gone from 9.5 to 4.7 percent that is shocking. It is just simply not enough for India at this stage of its secular growth, to be going at 4.7 percent. Last time you asked if 6.1 to 6.7 percent growth for the next year was possible - that would be very nice to achieve. but it is a long climb from here, to there.
So, the weak rupee is symptomatic of many issues that on the growth and the legislative agenda side that the FIIs are unhappy about.
Q: That also marries in with a pretty poor earnings performance by the time we wound down Q4, there don’t seem to be that many signs of a big revival of a revival even starting Q1. How worried are you about core earnings growth and how much more sluggish it is going to be?
A: I am worried. According you our strategist this fiscal year we may finish at eight percent in earnings growth, but the next two years should be 13-14 percent. So some amount of acceleration and everybody is talking about margin expansion. All of that is good, but I am concerned that if growth does not get into the five handle or the six handle there could be another round of disappointments. I hope that does not happen and I hope I am wrong about fretting about that sort of a situation.
What has happened now is the burden on the proof is into proving things. We actually have to earn our stripes again, whereas earlier the people would give us the benefit of doubt but that is simply no longer the case. We are on the exact opposite side and we have to re-earn the respect, also companies will have to be able to come through with the earnings because you can see the ones that disappoint get punished pretty severely. So, in almost every sector there are some amount of headwinds and we will just have to prove it before people will jump further in.
Q: The only redeeming feature for our market could be if global growth picks up significantly in the second half and hence lifts all boats including our own - Would you say that is a likelihood or are people going to get extremely selective about the kind of markets and countries they want to get in, and India may not be on that list?
A: Even if that happens, the concern is going to be how much do monetary authorities have to pullback and so how much of a risk-off environment can there be. In a major risk-off environment, India will not be a beneficiary. So, the concern is going to be that if bond yields rise another 100 bps, which on a percentage basis in developed market is very large, you will see, there will be a bloodbath in certain sectors. There will be certain hedge funds that will blowup. There will be corporate bonds whose yields are going through the roof and the ability to come out with new financing is going to be difficult, and that can be a concern.
So, if equity markets don't do very well, they may only sell-off 10 percent or so. When they don't do well, it brings everybody’s risk taking ability to a much smaller level. I worry about that.
However, if equity markets are in a benign sort of growth and they don't have to pullback the stimulus in a major way then that is a traditional sweet spot. In that environment certainly all the exporters will do well and some of the other Asian currencies will do better than the Indian rupee.
We are not a major market in terms of our GDP is a relationship to export. So, we will do fine but I do not think there will be a major panacea for us. I think our problems, and our opportunities are home grown. We need to fix them. If we do a good job of fixing our own problems, the world will come regardless of whether US is growing at 3 percent or 4 percent or 2 percent. We need to get our growth back up to 8 percent, with the first stop at 6. If we do that we will be fine, but right now we are far away from that.
Q: Last we spoke you did point out that if the Reserve Bank of India (RBI) start easing up considerably that could take the market to fresh highs or even to its old highs. can our own central bank still build it or do you think the problems are quite removed now from what the RBI can do in its limited authority?
A: RBI’s actions have been quite important. Exactly a year ago when we were doing our conference in June and Nifty was around 4,900 at that time; I was asked 'When do you think we could make a new high in the equity market?' - I had said elections are in May 2014, so we will make a high somewhere between May ’13 and May ’14 and now, we have come within a few percentage points of a new high. Part of the reason I said that was because I felt that RBI had a very long amount of easing to do. I was very concerned that growth was going to decelerate, but still I never thought it would be 4.7.
Our view was that a) monetary policy large cycle needs to come into place and it will, eventually as soon as there is inflation cover. That will provide the support for the leg up and typically the market starts discounting it early enough. So, you saw the market started rallying in the fall of last year before this year’s easing kicked in. That can still go on, but at 4.5 -4.7 percent, you need the numerator to work also.
So, getting the discount rate lower is fine, but we do not want to get into that bucket where people just start questioning the growth story. At 4.7 percent, we are within striking distance of the pre 2003 boom. We are back to the 3 percent growth rate kind of numbers and that is bad; we want to be nowhere near that number.
We really need to climb back very fast and get into the six number handle.
Q: How do you translate this into a tactical approach on the market where many sectors including rate sensitive on the one hand, high beta, have started underperforming. What is the best way to do this equity wise?
A: The best things have been bonds this year. It's been very impressive performing instrument. So, it's been a good sector to be this year, in the fixed income side. I think that still should be an important part of peoples’ fixed income portfolio.
On the equity side, depending on the profile of the person because institutional investors are going to be little more nimble, they are going to just trade around it. Our strategists think that the banking sector is going to look okay, because also the management is getting a little more conservative and they are pulling back on the tremendous amount of loan growth that was going on. Hopefully that will help on the non-performing asset (NPA) side going ahead.
So, you will have to trade it. When they get to a very high number on price to book, you take some profits. And at these sorts of 15-20 percent pullbacks, you can tip-toe back in - that is very tactical way for institutional investors, not for individuals.
For individuals, I have maintained all along that they should just have a plan that every time the market is selling off or whatever, because they are looking at it for the long run, they should have a plan around it.
Overall equity story is okay, I am not that concerned about it because the monetary policy action will still come through and the growth will accelerate. I hope it gets into the six number handle although I am not totally convinced yet, but it will be enough to keep the equity market okay.
The caveat in all of this is the rupee, and there need to make sure that that is kept under check otherwise people could panic but authorities will do everything in their power to step in ahead of that.
Q: So you are saying high is anywhere between May'13 to May'14, which is a wide range?
A: This was asked of in June 2012, when the Nifty was at 4,900. It was not a trivial call to make at that point in time and luckily it has happened, we are pretty much there. We are just a couple of percentage points below the old high. So, we could strike that any time soon.
Looking at it for the very short-term right now because of the current account deficit and the rupee, all these features that the RBI Governor has mentioned, maybe now they might go a little bit slow again on the easing front.
To make a new high is making a major statement. We do not have the ingredients yet to make a convincing new high. So, that is why it might just waffle for the next couple of policy meetings and then when it looks like that the next ease is imminent, either based on very benign Wholesale Price Index (WPI) or consumer price index (CPI) or slightly improving current account deficit (CAD), which I do not think is on the cards. Although when the gold prices fell last month, a lot of people thought that this is it; we are in very good shape. However, we were not in that camp and we thought gold demand would stay very strong; in fact the price drop would make all these buyers who had been held back because of prices would come out of the woods. So, based on when that next easing happens that is when we will do that convincingly. Short of that, I do not think that will be a convincing move quite yet. That could be a couple of policy meetings out.
Q: What kind of watermarks you think it is going to hold on either end and if the new high is within kissing distance would you say the downside risk as well is limited or do you think we are working in a wider range, bigger amplitude for the market?
A: I think the downside is limited too because policymakers are on the job. If by chance the rupee was to dramatically weaken, which I am not forecasting then you would have concerns on the equity side, but otherwise we will be broadly have the downside is protected as well. The upside risk needs a little more work, it needs more work on the interest rate side, which has the prerequisites that I was talking about, it needs more work on the growth side, which will take time; it will take a quarter or two for us to feel that growth can get into the six handle.
In some sense equity that is why it is buffeted on both sides. Typically we have a strong bullish or bearish bias on this. I think right now it has done the herculean effort; it has come back within closing distance of the new high. It has done that big work and now it will be supported in the very short run.