The 2017-18 Union Budget has the shortest list of bad news for the markets in nearly two decades, said Ridham Desai, Head of India Equity Research and India Equity Strategist at Morgan Stanley.
Speaking to CNBC-TV18, Desai that unlike his predecessors, Finance Minister Arun Jaitley had resisted the temptation to plant bombs in the fine print of the Budget.
Desai said that clarifications on Foreign Portfolio Investors and indirect transfers were positive developments for transparency, and said the only cause for concern in the Budget was the divestment target of Rs 72,500 crore.
He said that India had retained its macro stability reputation and was ahead of its peers on this count.
On the markets, Desai said there was an upside rise to global growth this year and that as long as global factors remain supportive, India would be okay. He said that India was actually under-performing in comparison its emerging markets, especially at a time when global growth is on the upswing.
He said that valuations relative to equity markets and bonds remained quite attractive in India, and that global investors should invest in the country.
Below is the verbatim transcript of Ridham Desai’s interview with Latha Venkatesh and Anuj Singhal on CNBC-TV18.
Anuj: Last time you were here, you told me that we will have a big top down rally, and of course we have seen part of that play out. However, for those who have missed the bus, is it too late or you can still catch this bus?
A: So far as global factors remain supportive, I think we are okay. 80 percent of this move which we have had since December, is global and it continues to be global. Actually India is underperforming, the underperformance shrunk a bit, but it is still underperforming. So, imagine what other emerging markets (EM) are doing. We don’t keep paying attention to that but you should put up a chart.
Commodity prices are not rising at the same price anymore. There is a spillover of improved growth environment globally. The global growth is inching; it was at 4 percent -- it ended 2016 at 4 percent. All forecasts for this year are around 3.3-3.4 percent. There is upside risk; we wrote about it last week. There is upside risk to global growth. This is not an environment we have enjoyed since the crisis or maybe briefly in 2010 we had a little bit of a spark in global growth.
It spillover into emerging markets and in fact if you see since the middle of November, EM has outperformed developed market (DM) which wasn’t peoples base case scenario because they thought EM was challenged by rising dollar, by the new policies that were going to come because of President Trump. All that has not played out in that fashion because growth is strong. So, if global markets remain supportive, I think this market still has room to go.
On India per se, valuations relative to EM, are quite attractive. We are at November 2013 levels which is post Fed taper scare. Relative to bonds, we are at August 2013 levels. So, if you are a local investor comparing equities to bonds, equity is clearly preferred. If you are a global investor comparing India versus emerging markets, India is clearly preferred. So, it sits at the top of our pecking list on the EM asset class and I would certainly think that the markets have relative upside from here.
Latha: This global growth that certainly came about in the last few months of 2016 that you speak about, can the picture blur because of Trump’s policies?
A: Those are the risks. This is a very typical global market that is climbing a wall of worries and the wall of worries are a lot.
Latha: But the action seems to be not cutting taxes in the US, it is not about spending on infrastructure, it is all about trade wars and protectionism. So it looks like a zero-sum game which is being snatched from somewhere else.
A: I think it is too early to comment on that. We have not seen any action.
Latha: It is certainly early, it is 15 days since the President took over or even less, so, I am not denying that it is early days, but I am just worrying if we are also celebrating too early.
A: I would say that until those worries are there, the markets are okay. When those worries disappear then I might get worried about the markets. So, right now I think there are enough people worrying about what is going to happen. It is very hard to tell what will be the sequencing of President Trump’s actions, will he focus on local economics first or will he focus on global trade first.
I think we will see that sequencing and that sequencing will be very important for US stock markets and then global markets. We don’t know that as yet, so, that I think is the global picture.
Anuj: The key point which has distinguished this market from say previous markets been the kind of domestic buying that we have seen, Rs 13,000 crore matching dollar for dollar the FII selling do you think that trend could continue or could we have goldilocks scenario where both domestic liquidity is there and the foreign liquidity comes back?
A: I have said it many times in the last two years that it will continue for next ten years and it will accelerate. I think equities have become more reliable asset class for domestic balance sheets. Domestic households just to recap the numbers, we have said it on this channel many times before but I will recap the numbers because people keep getting these doubts about domestic flows. Saving by households on an annual basis is about USD 400 billion. If they put 5 percent of that into equities that is USD 20 billion. So, that is I think a very reasonable run rate to assume for domestic flows. Therefore the consequences of that are that midcaps get bid and however much I worry about midcap valuations and they are trading at a fairly rich premium to largecaps a little off the highs in October but still at a rich premium that may sustain for a while until it blows up.
The other thing it means is that these corrections are proving to be shallow and swift because the nature of money that is coming in is systematic. It is monthly commitments that people are making, three quarters of the money flows are in SIPs. So, it kind of insulates the market in that sense. Now this will not continue forever, I mean at some point in time this story will break. But the flow into equities and given households exposure to equities which is quite low in their balance sheet, we estimate that it is about 5 percent of household balance sheets versus gold which is close to 20.
That asset allocation shift is happening on a more structural basis. The opposite of what happened 25 years ago when households used to invest 25 percent of their incremental saving into equities and not that much in to gold and we saw a fillip through the 90’s because of low returns and because of the successive scandals in the market households preferred gold. Now we are seeing a reversal of that. So, there is a structural undertone to this.
Latha: Would you worry about domestic growth story, certainly it was workmanlike like Budget as some people have described it, it had no bad news, but is there a growth bullet or are we going to be mired in a modest growth even in FY18?
A: I think credit to the Finance Minister that he resisted the temptation that is previous predecessor have succumb to which is put bombs into the fine print. So, I think that is one big takeaway. Obviously, I think the market is looking joyous because there was a wide scale expectations about the capital gains tax which is a minor item from a Budget perspective. The market had made a big deal out of it, so that is not there. There is a clarification on indirect transfers which is another positive for the market, so the market has hung on to these few things because the market wants to go up.
In another situation, in another circumstances the market wanted to go down then it would have focused on the things that went wrong. I look for them by the way and I found four things and it is a struggle. This is a shortest list of bad news in probably two decades. So, what did I find? I found that there is lack of corporate rate cut, but that was in versus expectations. It is not about the fact that it should have happened. It was that we were expecting it to happen it didn’t happen.
We found that there is not enough set aside for public bank recapitalisation. I think that is a positive, but there will be other people in market who may thing that is not such a positive. I think the only thing which I am a little bit, I would say wary of is the divestment target, in the sense that if it is achieved, it portends a USD 11 billion issuance pipeline. If it is not achieved then it puts the Budget numbers at risk. So, it is kind of you are stuck between a rock and a hard place as far as that number is concerned.
Latha: The tax revenue assumption is only 12.7 percent higher which is also modest so what he loses in divestment, he may make up.
A: That has got two parts to it. There is a 25 percent increase in personal taxes and there is a subdued number for indirect taxes because there is goods and services tax (GST) implementation baked into the numbers. So, that is the other thing that you take away which is that the finance ministry is assuming that there is a GST coming and there is a loss of revenue on account of that.
Latha: Which is a careful thing to do. Personal income tax is probably premised on the fact that there may be a larger tax base because of demonetisation.
A: So that is an assumption, and that could get challenged, we don’t know and it will be a good result if we get 25 percent growth. We are finishing this year with a very strong number but there were some one-off this time. There is a greater emphasis on compliance, clearly the Budget is all about transparency, it is about reducing cash transactions, I think we are making headway in that direction and hopefully that translates into higher personal tax collections. So, per se on the numbers, I don’t think we want to debate.
Now, going back to your point on growth, I think there are three pillars on which India’s growth story is standing. One is government or I should say public sector spending – that remains quite rich relative to gross domestic product (GDP). We are probably going to cross all-time highs this year and nothing in the Budget actually prevents that from happening. So, the Budget continues to support that.
The second is global growth which is a new thing that has come into the game. It wasn’t there for the last two years, so, that is supportive. So, you will see exports will do better, exporting companies will do better, and they have been struggling for the past three years.
The third is as a consequence, consumption is actually looking quite okay. So, there is and you could see that in December, the worst that was expected on the demonetisation, did not happen because the underlying consumption demand is strong. I also think that demonetisation leaves a little bit of an upside risk in the system because of the liquidity that banks have. This is very basic economics, if you have that supply of liquidity, what are you going to do with it. The banks will lend it. So, lending standards may drop and it may end up in a bad situation three to four years later, but today, I think you get loan growth.
So, I am actually bullish on loan growth, both corporate and retail, for this year and that essentially means more consumption and as all these things happen, utilisation rates go up and eventually translates into private capex which may not be the story for this year, but it may be next year’s story. All four cylinders are firing, so, this automobile is moving forward.
Anuj: A lot of this could be in the price. Maruti Suzuki yesterday made a lifetime high, Rs 6,200, Eicher Motors almost there, we have seen IndusInd Bank, Yes Bank, HDFC Bank, Kotak’s of the world nearly there. Do you think these engines could still fire from here onwards?
A: That is a very good point. I don’t think they are in the price right now. I made the point that valuations are actually quite okay relative to bonds and emerging markets, and the growth that has been priced into the market today is a lot less than what it was pricing in two and a half years ago. In the middle of 2014, the market was pricing in a 20 percent CAGR in earnings growth; we didn’t get that.
Subsequently we have had time loss of money and that has basically mean that there has been a reset in market expectations for growth which is why this surprise that has come in certain sectors, in certain companies, is producing such a big reaction on share prices. So, I think that is because there is not that much growth pricing. Of course down the line the markets will get excited and a lot of that growth will get priced in, but we are not there right now.
Latha: What are the market leaders now?
A: I think in terms of consumers, you want to back the discretionary guys; I think they will do well. In financials, I think NBFCs I would prefer them over retail banks because in the retail banks there will be some net interest margin (NIM) compression as a consequence of the lagged effect of the rate cuts. The NBFCs liabilities reprice a lot faster, so, I think they will face lesser pressure. Loan growth will come I think almost everywhere. So, the ones without the NIM pressure will probably deliver better earnings. So, we are more skewed towards NBFC over retail banks.
We still like select private sector retail banks from medium term growth story. I think technology because stocks are really battered and I think you want to step in and buy these stocks. I said that a month ago and they are actually lower, I don’t see any reason to change my view as yet. I think people have become a little all-to bearish about US policies and I think that is really the three big sectors you want to bet on. I am still not so enthused about industrials. I think it will take a little while.
Anuj: What about telecom because that has made a huge comeback and just looking at shareholding pattern for example of Bharti Airtel, not too many Indian retail shareholders have any kind of exposure to telecom stocks if four large players becomes three which is now almost a reality, do you think there could be more rerating?
A: Consolidation is positive. So, I think the worst may be behind us for these companies. However, there may still be a little bit of pain left to be absorbed. So, I don’t have a strong view actually, not as strong as the view I have on the other three sectors I mentioned.
Anuj: Because they have had multi-year bear market, you think maybe bottom is in place but they will still not give you big returns?
A: Probably, I don’t know actually. There are some things that I cannot see very clearly, not that the things I see clearly I go right on, that is a different debate but I am not able to see it clearly.
Latha: How much more gains are left this year for the market?
A: When we met in December, I argued that we are heading for double digit returns in 2017. So, I think we are on course for a 15 percent upside from where we were and that has not changed really because I think the growth environment is getting better. The Budget doesn’t contain anything to upset that. People ask me about state election results; I don’t think the state election results either are going to upset that.
Equities want to buy growth and if growth is coming in, all these things will be overlooked. They will find positives even in a bad state election result. So, there is a bid, I think that is okay and it will so happen as you rightly pointed out which is that at some stage we may go ahead of the fundamentals and then we will come back and check.
Anuj: 9 percent of that 15 percent is already happened with only one month gone.
A: Very good point which is that all absolute terms have to have a context and the context is where India stands in a relative situation and the world returns are also running ahead of expectations. So, as I said at the start of this conversation, if that framework remains, then this 15 percent may prove to be conservative. This 15 percent is not in isolation, it is not in vacuum, it is in context of a global picture.
Anuj: You are confident on IT but not so much confident on pharmaceutical or is that also a contra bet for you?
A: I am not confident on IT in that sense, I am just saying that when you don’t feel so good about it, it is always a time to check and I think IT stands in that situation.
Pharmaceutical is more stock specific. It is not a sector call I want to make. In IT you can make a sector call. All the businesses have similar models, they will be driven by the similar factors, and there are very few idiosyncrasies. Pharmaceutical is very idiosyncratic. The companies are quite distinct, so, they are not going to be driven by the same thing.