Moneycontrol
Nov 23, 2016 12:05 PM IST | Source: CNBC-TV18

Mkt not ready for switch from monetary to fiscal move: Deutsche

Speaking to CNBC-TV18, Abhay Laijawala said the there will be a transition from monetary policy to fiscal policy for which the market is not prepared and expects the market to remain volatile with a downward bias for the near term.


The December target for Sensex is cut to 25,000 from 27,000 due to global macro scenario and not on the back of demonetisation, says Abhay Laijawala, Head of India Research for Deutsche Equities.


Speaking to CNBC-TV18 he said the there will be a transition from monetary policy to fiscal policy for which the market is not prepared and expects the market to remain volatile with a downward bias for the near term.


Going forward, Laijawala remains overweight on banks but underweight on financial institutions like NBFCs.


He is also overweight on the IT sector due to the steepening yield curve in global markets.

In the same interview Kaushik Das, Economist at Deutsche Bank said that he expects a 25 basis point rate cut from RBI in December, 2016 and see next year’s fiscal deficit target to stay at 3.5 percent instead of the earlier estimated 3 percent.

Below is the verbatim transcript of Abhay Laijawala & Kaushik Das' interview to Latha Venkatesh, Sonia Shenoy and Anuj Singhal.

Latha: Let's start with the macro and the number we do not know yet, the gross domestic product (GDP) number. How have you changed your macro estimates both growth and inflation?

Das: A substantial amount of risks have risen as far as growth is concerned. If you see today's newspaper, the government is saying about 5.3 percent growth possible in October-December. If you extrapolate that into January-March as well, possibly you could end up with 6-6.5 percent growth handle for this year. Our estimate is 7.5 for next year. This year the growth risk is much more. We were already conservative about growth estimates next year, consensus was about 8 percent; we are at 7.5. So possibly there could be further downside risk to that.

I would like to make a broader point that output gap would be 1-1.5 percent at today's rate and the second point that I would like to make is that when you do economic policy making, there are always tradeoffs, so possibly we are paying a price for getting more transparency and that is playing through in this quarter and next quarter but if you consider it from a long-term point of view, this makes India's long-term growth story even more credible.

Anuj: Even before demonetisation, I remember, you were cautious on the market, you had spoken about it in our last show, and you have further cut down your Sensex targets now. What is your broad genesis for this call and do you think we can get lower as well?

Laijawala: One of the key reasons for cutting the Sensex target is the global macro situation. It's less the demonetisation. The demonetisation is going to have a near to medium-term impact. The real reason for cutting the Sensex target has been the worry over the global macro situation.

However, as we have been highlighting consistently since July and August that macro uncertainties are increasing and we were very concerned that we were reaching the end of the road on global monetary policy. Monetary policies globally, as I have been highlighting consistently, have rather become ineffective. So we are going to see a transition from monetary policy to fiscal policy. Are the global markets prepared for that transition from monetary to fiscal - no. Therefore, the transition is going to be rocking. So the key reason for cutting the target is the concerns above global macro and the uncertainties that emanate from President Elect Trump's dollar positive policies, US growth positive policies and of course the Fed turning less hawkish.

Sonia: What do you see now as an impact of demonetisation because at that time, I remember, your only worry was global, largely global and no one saw this coming? Now that this has come through what do you think the impact could be on earnings growth and would you revise your earnings estimates downwards for various sectors. If yes, which ones are you most cautious on?

Laijawala: Our research team has done an extensive analysis on Friday and they have looked at all the sectors threadbare, they have looked at near term impact, medium-term impact, one year impact and sectors that we obviously linked to the cash economy, sectors that are reliant on discretionary consumption. Those sectors are going to be impacted in the near to medium-term, for example in consumer discretionary, our analysts have slashed estimates from about 4 percent to almost 21 percent. Jewellery companies, for example have seen a slash of as much as 20-21 percent. Auto companies, we have seen a slash between 4 and 14 percent to our estimates and this is more for FY17 and less so for FY18. Real estate, for example have seen big cuts. Consumer staples have seen relatively lower cuts and a sector that is standing out is public sector banks, where our Bank Analyst, Manish Karwa has raised earnings estimates. So earnings estimates for certain public sector banks have actually been raised, which is very contrary to the rest of the sector and on Sensex basis our year-on-year growth -- Sensex earnings per share (EPS) now is about 10 percent for FY17 against 16 percent couple of months ago.

Latha: What have you been telling? How much are you expecting in terms of inflation curve in FY18. What is the rate cut action you are expecting. What is the fiscal action you are expecting? Is this is a massive fiscal expansion because you get some big dividend from RBI. What are your macros for calendar '18?

Das: It's very easy to answer. You can use three words - lower for longer. We expect 25 bps rate cut in December and possibly that could be even 50 bps, if RBI wants to be pre-emptive.

Your question about inflation - our FY18 inflation forecast, average consumer price index (CPI) was about 5 percent. This demonetisation could potentially lead to 50 bps downside risk to inflation. Therefore, if you do the mathematics that if you have 4.5 percent average inflation, if you apply 1 percent odd real interest rate on top of that. You could potentially come down to 5.5 percent on the repo rate. So possibly today you are at 6.25, so you could come down to 5.50 by mid next year. Therefore, I guess bond markets have already priced in that, bond markets are pricing in almost 50 bps rate cut.

On fiscal, the question that you asked - our view is different. We think next year's fiscal deficit target would be kept at 3.5 percent of gross domestic product (GDP). We do not think it will be brought down to 3 because even if the government gets a lot of extra resources either from non-tax or tax, they will probably use it to ramp up public spending, which is required to support growth and possibly some relief from income tax front. So we think that 3 percent target that was there as a plan for next year would be pushed into FY19. So 3.5 percent for next year on fiscal but bond markets would be possibly looking into the fact that there could be more rate cuts coming.

Anuj: We spoke about the fact that you have downgraded the Sensex target but looking at your portfolio strategy you are downgrading financials which has been the big leg of this rally and you are upgrading the two underperforming sectors, healthcare and IT services?

Laijawala: In financial services the downgrade is coming primarily on account of non banking financial companies (NBFCs) but we are positive on the public sector undertaking (PSU) banks. Therefore, we are overweight banks but underweight financial institutions.

As far as IT services is concerned, indeed we have moved the sector to an overweight after a very long gap, in fact for almost all of this year we have been underweight IT services, we raised it to a neutral a month ago and we raised it to an overweight on Monday and the basis, the rational for this overweight on IT is attributed to a steepening yield curve in global financial markets.

The yield curve being flat, negative interest rates, all of this has hurt the banks the most. As the yield curve steepens, you will probably see the global banking and financial sector report better earnings in addition President Elect Trump's policies also talk of less regulation and therefore the terms of trade may probably be shifting in favour of the banking and financial services sector. So IT discretionary spending which has been held back on account of banks, financial services & insurance (BFSI) sector globally being in a tough position, will incrementally start to see some of the held back orders beginning to come back and remember BFSI constitutes 40 percent of IT sector's earnings.

Sonia: So from market's point of view what do you see as something that could change the sour sentiment post demonetisation because there is so much talk of a big fiscal stimulus perhaps petrol price cut, excise duty cut, interest rate cut is expected. Do you think any of that could change the sentiment?

Laijawala: I think you answered the question. We also think that despite whatever is happening in India, the policy bias of the government remains growth positive. To us as analysts and this is a message to all our investors is that watch this, the policy bias of the government of India stays growth positive. So we do believe that therefore the stick approach at this point in time will be followed with the carrot approach. Now how that is articulated, we will have to wait and see. Does it come outside the Budget, does it come in the Budget but yes, it could take the form of increased public spending, it could take the form of tax cuts, it could take the form of more social inclusion, whichever way we do believe that this will be approached with measures to stimulate and boost the economy.            

Latha: What is the bottom of the market and what is the top in 10-12 month frame?

Laijawala: Your guess is as good as mine. You have been looking at market for as long as I have and you will agree that there is no point in hazarding those guesses. All I will say is that in the near term market is expected to remain volatile with a downward bias.

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