Moneycontrol
Oct 05, 2016 04:26 PM IST | Source: CNBC-TV18

Scope for meaningful rate cuts going ahead: Neelkanth Mishra

Credit Suisse' Neelkanth Mishra expects repo rate to fall to a decade low in the coming quarters. He says that beginning December the market may see a robust and widespread pick-up which may boost indices.

The Reserve Bank of India on Tuesday cut interest rates by 25 basis points to 6.25 percent due to availability of a headroom to cut rates. Even though an RBI rate cut in October was surprising, there is scope for meaningful cuts in the next 12 months, said Credit Suisse's Neelkanth Mishra.

Mishra added that he expects the repo rate to fall to a decade low in the coming quarters. He said that beginning December the market may see a robust and widespread pick-up which may boost indices.

Mishra said that he expects food inflation to fall as new crops come in November-December and March-April period. He attributed the decline in food inflation to structural change in momentum and said fiscal discipline exercised by the government is a driver of low inflation.

He said the brokerage is optimistic about sectors like housing finance and construction. He added that lower rates may affect PSU banks due to their pension liabilities.

Below is the verbatim transcript of Neelkanth Mishra’s interview to Reema Tendulkar and Latha Venkatesh on CNBC-TV18.

Latha: So many of your calls now being followed by the market, you were the first to turn a bull on metals, to turn a bull on steel, now the rest of the market is following. You have also spoken about 100 basis points (bps) cut from the Reserve Bank of India (RBI). What did you make of their -- what I thought -- dovishness yesterday?

A: Food inflation coming down as the crops hit the market, so as the Kharif crop hit the market in November-December and as the Rabi crop comes in March-April, you will see food inflation coming down. I quite agree with the sentence in the monetary policy statement yesterday that the decline that we have seen in food inflation is not just because of base effects and that this is a structural change in momentum and I fully agree with that.

It does create challenges for policy makers in terms of what to do with the surplus manpower in agriculture. Agricultural productivity is starting to rise very sharply, which is a good thing but it creates other set of problems. So, this creates the room for RBI or interest rates to start coming down. So, I was surprised that the rate cuts happened in October but there is room emerging and we can see meaningful cuts in the next 12 months.

Reema: So, does that mean the best way from current levels, we should play the rate sensitives and if yes which ones would you recommend?

A: The rate sensitives is a very broad set of sectors and stocks. So, the problem also is that I don't expect the private sector capital expenditure (capex) cycle to revive any time soon. Most of the heavy lifting in terms of the infrastructure investment will happen from the government. So, what we have been advising is that we would buy the housing financing companies, we have been positive on them for almost one and a half years now but we have recently increased our weight further on them because as rates fall the mortgage demand growth picks up. If the rates don't fall they see wider spreads -- either way they win.

We have also for the first time in my experience as a strategist gone overweight construction. So, we think that labour -- I also think that low inflation and low rates and we also think unskilled labour wage growth will also remain subdued, which again is a challenge for the government politically. But from the perspective of the construction companies where 40-50 percent of their cost base is interest cost and labour cost this can actually mean much more improvement in profits. We have also raised our weights on some of the more corporate focussed private banks and this we have funded by cutting staples to neutral. So, we had an overweight at all the times that I have been a strategist for the longest time and for the first time we have cut our overweight on staples to neutral. We have also gone deeper underweight on IT and pharmaceuticals.

So, yes, interest rates if they fall by 100 bps -- now by 75 bps in the next 9-12 months the rates will come to a level we have not seen for a decade. So, we need to make some adjustments but we need to be very cognisant about the fact that the traditional investment cycle is not reviving. So, we have to buy companies that have very high interest costs. We have to buy companies that will see a pickup if interest rates were to fall and so on and so forth.

Latha: How much do you expect rates to fall to? You said lowest in a decade, that is what you expect the repo would go to 5.75 - 5.5?

A: 9 years or 10 years is not much of a difference. So, there was this phase that we have not seen after 2007-2008. So, we said 100 bps in mid-September by about September 20 and consensus -- the truth is that everyone is talking about falling inflation. It is consensus that inflation will fall. It is also consensus that rates will be cut. But like what happens on inflation expectation -- why are they are so sticky on the upside and on the downside. So, everyone assumes that inflation will come back up because India has a very high inflation economy so on and so forth.

So, if you look at consensus expectation they had come down in the last 15 days but the rate cuts was still quite benign that were being priced in. So, we said 100 bps in the middle of September, now 25 bps has happened. So, maybe another 75, maybe there is more. Let us see how inflation progresses.

But what is also happening you have to keep in mind is that the fiscal discipline that the government is showing is also a driver for low inflation. So, historically India has had a very high inflation and one of the biggest reason was that India has always had high fiscal deficit and it used to be monetised by the RBI and therefore inflation used to be very sticky.

What we have seen this year despite all the concerns around state fiscals is that the combined fiscal deficit is likely to be the third lowest since 1980 and that creates the room for low inflation to start to become more structural and we could be in a range for much longer than people currently think.

Reema: What about steel as well as metals from here on? You all were the first ones to be bullish on steel and metals and from those levels so many of the Indian listed stocks have more than doubled. From here on how are you reading the scenario, what does it mean for the companies that are listed in India, should we continue to stay invested in them and what is your outlook on the global steel prices now?

A: From our perspective 12-18 months is a trading call. So, yes, it was a trading call and there is still room left. There is a very classic sign. So, what we are starting to see is the Chinese growth numbers are starting to pick up. For the first time in several years we have seen gross domestic product (GDP) growth numbers being revised up. Only a few basis points but that is itself a big inflection.

We are seeing also the global destocking cycle. Since there are some very classic signs like coking coal suddenly spiking up. Now we all know the reasons for that, some rains somewhere, Chinese cut downs and all of that but when you see a sharp spike like that it shows lack of material. We have seen iron ore sustain at USD 60. So, all of this cost push inflation on the steel prices, it is going to be very supportive and in particular Indian steel companies we generally have access to very cheap iron ore it is going to be very supportive of profits.

So far it is assumed that this is all because of minimum import prices (MIP) but you know what India has become a net exporter of steel. So, at the margin we are benefitting from higher global steel prices and the protectionism is not a factor that is supporting Indian profits right now.

So, we stay constructive. Aluminium stocks have moved a lot. But yes, on the ferrous side, we are still quite constructive. What you have to also keep in mind and we keep flagging this and I am sure you are aware of this but it is still important to keep in mind that what we see is the stock prices but the marketcap but what matters is the economic value. So, while some of the stocks may have gone up 50 percent, the economic value may have gone up 10 percent, which means that earnings before interest, taxes, depreciation and amortisation (EBITDA) expectations have gone up 10 percent. We have very heavily leveraged names they are also going to be beneficiaries of lower interest rates. So, yes, we remain very positive on metal names and they are also still under owned, there is a very low conviction among investors on holding those names.

Latha: On your interest rate sensitivies you have more the housing finance companies. Is there not a trading call in the public sector banks (PSBs). They would be the beneficiaries of the exact two trends that you are talking about. A 100 bps fall in bond yields would be a mark to market gain which can take care of provisioning and at least bring near term profit. Steel, one of their worst sectors if that pays back a little you don't have any positive view on any public sector undertaking (PSU) bank?

A: There are a couple that we like but generally as a basket. We do think that they are basket case. We don't like them. The market is anchored. We were just discussing this just today in our morning meeting that the challenge is that people are anchored to what happened in the last cycle. In the last cycle, the PSU banks had a much larger proportion or ownership of bonds as part of their balance sheet than they do now. So, one the Statutory Liquidity Ratio (SLR) rates were higher and they also had excess SLR if you recall.

Secondly, the pension accounting standards were not as stringent as they are now. So, as the rates fall their pension liabilities and in 10-year they have accumulated lots of wage hikes, they have accumulated lots of retired employees. So, right now at the margin low rates may be hurting them because the losses on the pension side will offset the gains on the bond side.

So, they could see one or two quarters where they book excessive profits to shore up their balance sheets but I don't think that is a reason to turn positive. In fact in a general case what is starting to now look even more challenging is a resolution of the bad loans problem.

Latha: What is the view on the Nifty itself. Do you think 12 months from now or even within 2016 itself we will cross 9,100? What are the gains from the heavies?

A: That is much tougher to call because there is lots of things happening globally as well. So, while there are good things happening in India at least from the market perspective, we have to be cognisant that a lot of monetary policy experiments globally are now being withdrawn or at least can be withdrawn. So, we are seeing the Bank of Japan (BoJ) move to a very different mechanism. We are possibly going to see tapering by the European Central Bank (ECB). There is ground being created for a hike by the US Fed. We are not still sure about how the market will react to some of that. So, very hard to say when that 9,000-9,100 gets done but yes, if you are looking out 12 months because I do think that right now the Indian economy is also not very hot. It is pretty slow.

I expect by December to start seeing more robust and more widespread signs of pick up and as that happens, confidence in earnings per share (EPS) numbers will resume and we should see much higher Nifty in 12 months from now. But till that evidence emerges, we are still seeing very weak cement demand growth, very weak power demand growth and so on and so forth. So, there are pockets which are strong but it is not a very widespread pick up yet, but hopefully in the next three months we will see that and once that happens then Nifty will start showing that up in the markets as well.

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