Jan 11, 2017 03:37 PM IST | Source: CNBC-TV18

Gains from expanding tax base will come in: Leo Puri

While 2016 has been a year of uncertainties, 2017 will bring realignment to the world. Even with foreign investors withdrawing from India, domestic investors have not dried up yet, said Leo Puri, MD of UTI Asset Management.

The demonetisation pain is likely to last till the end of current financial year, believes Leo Puri, MD of UTI Asset Management. The pain has already started easing with improvement in note printing.

Speaking to CNBC-TV18’s Latha Venkatesh, Puri said demonetisation will be very good for the market in medium term. “Benefits of this (demonetisation) in terms of expansion base is very real and very likely,” he said. 

While 2016 has been a year of uncertainties, 2017 will bring realignment to the world. Even with foreign investors withdrawing from India, domestic investors have not dried up yet.

Puri expects analysts to once again turn overweight on India by middle of next year.

Below is the verbatim transcript of Leo Puri’s interview to Latha Venkatesh on CNBC-TV18.

Q: Before I ask you the trends for 2017, the big event that we are sitting in is the demonetisation. What is your understanding of this process; is the pain going to last for this quarter, would it last for two quarters that is the first part of 2017 or could it be a little longer?

A: I think the pain is likely to last until the end of the financial year. I personally don’t expect it to persist much beyond that. I was happy to see that we have started to print notes offshore as well, so, more cash will come into the system. So, I don’t anticipate beyond March there will be much pain.

Q: Could there be knock on effects, do you see FY17-FY18 as a period where there could be some shadows probably because of the real estate sector or because of some permanent dislocation in the informal sector?

A: It depends on the larger view you take of demonetisation and how you view the overall picture.

Q: How have you viewed it?

A: I think there is one piece which is certain to me that the benefit of this in terms of expansion of the tax base is very real, very likely and I think is empirically sound. The second element of this is the leap of faith. You have to believe that the taxes that are going to be raised are going to be better used which means we are going to have a government that is actually committed to good governance.

There is an economic theory, one of the concerns that many people including people offshore have had, is that today we have functioning economy where our entrepreneurs are able to make things worth. Some part of that is in the shadow economy but it doesn’t matter because the system, the supply chains and so on are functioning. We have absolutely put a stop to that now.

The leap of faith is when we restart that engine and you actually have a broader tax base, will you have a responsible government spending process where infrastructure, education, healthcare, the social security net, broadening of the formal sector, will that come into being or will we have another wasted opportunity.

I happen to be ready to take that leap of faith and say that we are at a point where this government, mid-term, is indeed committed to taking forward economic transformation, good governance, therefore the benefits are going to flow to us. That I think is a central divide here between the sceptics who fundamentally don’t see that anything is going to change and that this is just a one of intervention and an ill thought through, poorly executed intervention.

Others who say no this is part of a broader plan, you have had Jan Dhan, you have had goods and services tax (GST), you have had Aadhaar based UID, you are now going to get digitisation of land records, you have a broad movement towards expanding India’s tax base and formal sector and a government that is committed to better governance and reform. So, isn't that the best way to take us to being a middle income country and if you take that leap of faith then this is surely a good thing that is happening, very good for the markets over the medium term.

Q: You are beginning to convince me but the market out there is still deeply divided between bulls and bears, between skeptics and optimists. Let us just pause and speak about the markets. We have seen in the past eight weeks, the markets shed off goodish bit partly because of Trump and demonetisation hit us on the same day. Do you think we have much more to lose before the markets are able to pull themselves up?

A: The markets - of course we talk of volatility and uncertainty and I think that 2016 actually has been a year where for better or worse some of these uncertainties appear now to have been resolved. If you look at Brexit and Trump, they are answering questions as much as asking them.

They are answering the questions about is the world seeking a shift, a new paradigm, is it seeking to re-establish rules of global trades, globalisation, and you may not like the answers we are getting but we are getting answers and this is the problem – be careful what you wish for. Markets were wishing for certainty, we got certainty, it wasn’t necessarily the certainty everyone expected.

However, you can’t argue any longer that we don’t have a better sense of where we are going. We are going in 2017 to a world where there is going to be realignment. Some of that realignment is geopolitical which is represented by the Trump presidency; we are seeing signs of that in East Asia, in the Middle East and with Russia. Some of that is economic which is the view on Fed interest rates and the impact that has already had on the dollar and by the way has spurred a tremendous rally in the US market. So, we are essentially seeing a very bullish phase in the US market as we speak.

Q: But that has also been a short emerging markets (EM) trade. The long developed market (DM) or the long US trade has also meant a short EM trade. Would you believe that there will be more to come as president Trump is sworn in on January 20?

A: I think that is a temporary rebalancing. It had to happen at some point. I actually think it is a good thing that it has happened earlier rather than later because I think the rebalancing is to India’s advantage. What has happened at this point is, you have seen the dollar strengthening and to that extent you have seen a general pullback from emerging markets rebalancing. India is still at more or less neutral weight if you like within EMs. EMs have seen flows out; no one has gone underweight India just yet. They are either staying neutral to modestly overweight.

Q: But we have underperformed.

A: In-line with other emerging markets we have seen that rebalancing which to my mind was inevitable. However, there are two silver linings if you like to this episode. One is that even as this has occurred, we have seen a stronger commitment to domestic economic reform and in a way I think the fact that we are seeing continued uncertainty in the west, further strengthens our own resolve and our own focus on the need to get our own house in order and the central bank and the ministry of finance I think are both acutely aware of that and you hear that in their statements.

So, I think it is a good thing that the world is keeping some pressure on us because we tend to operate better when we are under pressure. To that extent, flows in our domestic markets have not dried up. They have certainly tapered off somewhat but you are still seeing steady flows coming in through our DIIs, mutual funds and so on.

The second is, if you hear the commentary on India, even as flows have receded from global investors, the commentary has remained very positive. Some hesitation because of demonetisation where people are little bemused trying to form a point of view, but broadly very positive commentary.

So, I absolutely anticipate, as faith and conviction builds around our economic reforms, as people sense that we are going to use the Budget that is promised to use the benefits of demonetisation, you will see come middle of next year India back in favour and back to overweight in most portfolios. So, I actually think 2017 will be a year of more certainty and more stability for our markets than 2016.

Q: We are at closer to 3.5 percent inflation as of the last number we have, the November number. There are some people who believe that to kick-start the economy a series of rate cuts from the RBI is what the doctor orders. How much would you pencil in?

A: I would hope we would see fiscal rather than monetary action. The time has changed for us to focus on monetary action. That for reasons of global imbalance is a little dangerous right now. I do believe we can take a view that our fisc will be in better shape in 2017-18 and that gives us room for fiscal expansion. I fully expect that, the signalling suggests that. So, it is time to think of fiscal, not monetary policy, I would leave well alone on monetary policy at this point.

Q: Is there material for a fiscal push?

A: Yes, there is a bit of a myth about this return of old notes because first was just a miscalculation. The numbers include new notes and old notes.

Q: The governor also said that legally he has to keep the liability open.

A: Yes, and I agree. I don't think there was going to be this bonanza from the de-notification if you like. I think that and I think Vishal Thorat and others have rightly pointed out and I tend to agree with the more conservative view on de-notification. There is no bonanza there. But the improvement in governance from money now having come into the formal banking system is very real. People are underestimating how difficult it is going to be to recreate flows of black economy. This money is now monetable and trackable, you are not going to be able to take it out. I do believe there will continue to be limits on cash withdrawal and pressure on digitisation. You will therefore see much more accountability and therefore participation in the tax base of this country expand.

Q: Budget is on us in about 32 days or 35 days. We are still getting idiosyncratic voices on taxes. There is the Prime Minister saying at the Sebi meeting that people have to pay more if they make more money from markets and we have the Finance Minister on record saying that the stage is set for perhaps lower corporate taxes, what are your own expectations?

A: Finance Minister clarified that what the Prime Minister did not mean was that long term capital gains tax. Let me take this opportunity to immediately underscore that point because that is a critical point. It would obviously not be the right time in our view, in my view personally to remove the long term capital gains tax and I am glad that the FM has clarified that that is not what is in mind.

There are a number of other loopholes that the government might possibly have in mind. There are issues related to dividend stripping, there are issues related to bonus stripping, these are loopholes that the capital markets use to legally avoid tax today. I think some of those could be closed. Personally I don't think that is such a bad idea. I think those are loopholes and they should be closed. However the broad structure that we provide today, the incentives that exists in terms of taking risk with long term capital, I think those need to remain intact for some time to come and I don't expect those to be impacted.

On the issue of lowering in some way direct tax - both corporate and maybe income tax perhaps by raising thresholds, there fairly seems to be a strong expectation and to some extent that would provide a stimulus to take into account the temporary depression created through demonetisation. Some form of stimulus is necessary I think. You can't have hollowing out of demand followed by complete lack of stimulus.

Q: How would you rather that stimulus come? Through lower taxes and therefore boost for consumption or would you rather that they take more money and spend it on probably railways or roadways?

In the short term we do need a boost to consumption. It would be risky and it would further feed the pessimism of the sceptics if you did absolutely nothing in terms of demand stimulus.

So, I do think there is room for demand stimulus. I also think if you can take a view and no doubt the government will be crunching its numbers on this that indeed the tax base will expand and that indeed GST will be successfully rolled out at least in September if not before, that you do have more fiscal room. If you then believe you have good governance that is the leap of faith because we have not been used to lot of good governance in the last decade or two. However if you believe we will have good governance and the spending stimulus that you mentioned, the supply side stimulus could follow in the second half of the year as well and that would be something I believe will be a bonus for the markets.

Q: How do you see FY18 for the banks, will it be the end of the tunnel at all?

A: I think there are two things which could be helpful to the banks if we get this right; one is that this is the push for further financial inclusion and participation and the banks are the first major beneficiary of that. I hope ultimately capital markets too will be, but the first beneficiary is the banking system. Again if you ignore the temporary hiccups around extraction of liquidity through cash reserve ratio (CRR) and so on which happen.

In the next 3-6 months we will see and get sense of the stabilisation of current account and savings account (CASA) in the banks and that is a good thing. You will also see in possibly 6-12 months maybe not in 0-6 months some room for the treasury gains that some people have written about which would at least be a financial optical assistance for the banks and their balance sheets it will help strengthen that and to some extent again mathematically because their denominators sort of growing, the numerator on their non-performing asset (NPA) improves, which gives the government a bit of breathing room. But I will hope that the government will view in its next Budget an opportunity to complete the recapitalisation of banks.

We have been a little hesitant in following through. I think they deserve now a proper vote of confidence and they need a vote of confidence – so public sector banks need that vote of confidence if they are to actually survive. I would expect that to happen this year. The second is again there appears to be some confusion around where we are headed with asset restructuring. We had a tremendous push in 2015-16. Again we thought we were in a paradigm shift. We have the insolvency act and that seems to have got the focus a little bit. Again I would hope for 2017 that we will come back to this.

Q: How do you see the banking sector evolve?

A: Another element which has been defocused for now was the process of the evolutionary privatisation of the public sector banks. We had a process that was started the Gyan Sangam and so on which was evolving, ways of thinking about gradual improvements in governance, relative levels of independence using consolidation and restructuring to essentially separate perhaps the national champions from the rest that could be privatise in effect through both governance and shareholding changes and I think that role the Bank Board Bureau was constituted and we must be careful not to abandon all these as again at least from the public eyes some of these look a little off right now. I hope that is not the case, because those were very good initiatives and therein lies the answer to the question what are you going to do with – it is not just about pumping in capital more, good money after bad. It is about using this as an opportunity to catalyst the creation of new healthy institution through these changes.

And here I remain cautiously optimistic if we are going to push for economic transformation – if that is our new found energy and conviction that we are displaying and 2017 is the year in which we will have a government committed to revolutionary transformation of our economy then I really hope that this issue will once again be taken up vigorously.

Q: Once before many years ago when you were in the heart of banking the government has used recap bonds to recapitalise the banks. Would you still advise if you are otherwise financially constraint somehow recapitalise with these recapitalisation bonds?

A: They are a temporary solution. They don’t offer as much long term confidence to the markets. If you are dealing with a crisis recap bonds are excellent because they are the finger in the dike. If you are dealing with a signal that says we are serious about the reform of the efficiency of our banking system and its ability to allocate capital properly for the future then recap bonds are not going to be the end of it, then you do need to go back to the agenda that was laid out through the creation of Bank Board Bureau, the bank holding committee those are very good things.

Q: Let me now come to the sector that you are now presiding the mutual fund sector. How do you see that evolving, do you see more sophistication in 2017? Do you see more consolidation in process?

A: Again I hope that one of the affects of demonetisation will be to deepen financial participation the banking system and therefore eventually the savings markets and therefore ultimately the capital market both debt and equity, because this money will seek out higher yield. It is up to us to position our products appropriately as a substitute for either fixed deposit or savings account and to start capturing that and we are giving a lot of thought to that. We do believe that this will be a material expansion of the base of customers who come into the mutual fund sector.

Q: You can show the way because UTI Mutual Fund really is the pioneer of mutual fund itself and still has the widest distribution.

A: Yes, and we are very committed to that. So, we are very committed to enrolling new distributors as well as opening up new locations as well as using digital technology very effectively through both mobile and the website that we revamped. So, all of this is going to happen. It is up to us. It is an opportunity that is there for us to take and things like e-KYC and certain operational issue which are getting resolved which could make a very big difference if we get that right too. We are quite positive about that. So, this is good news for capital markets.

Not all of this money will come into equities immediately. The industry includes debt products. In fact the best performing products for 2016 have been debt products. Equities have been more or less flat for most people when they look at their portfolio at the end of this month, would be a little disappointed a bit perhaps that this year has not been an year when equities have performed well but those who had a balanced portfolio will see returns of 13-14 percent in some cases and perhaps feel a little more cheered up and to us we are somewhat agnostic.

We are happy that flows come into capital markets because buying bonds fuels economic growth as much as buying equities and those are judgements based on economic cycles and risk appetite and that we shouldn't be concerned. I do think though next year again start to see equity returns pick up and as you know equity returns over a 20 year period had been 13 percent or so.

Q: We have really made money in bonds, what will 2017 be?

A: I think 2017 may not have as much opportunity as I said certainly in the first half for rate cuts. So, accrual products will continue to do well. I do anticipate that you will see earnings recovery very strongly from the middle of the year onwards as the effects of demonetisation ware off and the demand stimulus we talked about earlier kick in. So, I do think you will see the markets start to price that in and this could happen as early as March or April and if we have a good Budget it may happen even sooner because we are still a fairly emotional market in that sense.

I do anticipate once again some reallocation towards equities next year domestically.
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