Cautious on the IT sector: Morgan Stanley Investment Mgmt

Q: Would you say that investors would have sold off India after the Budget, but for the fact that there is a global liquidity issue?

A: We have already seen a correction. I would assume that some bit of nervousness is surely there. But I think a larger part of the nervousness will also come because of some of the fine prints in the Budget. We saw the retrospective change that has come. There is also lot of fine prints on the Mauritius Tax which hasn’t been spoken much about. But that could be huge dampener because almost 60-70% of the FII flows come through the Mauritius entities. The PE notes and a lot of the other, the index fund also comes from Mauritius.

It’s highly possible that the government is looking to plug these loopholes, in which case the Mauritius entities maybe questioned. This could be a huge dampener for the markets. We have seen in the past. This happened some seven-eight years back and government issued a clarificatory note that if you have a tax residency certificate from Mauritius, that’s good enough. Now that’s being questioned from this Budget onwards where they are saying that you have to really prove your genuineness from Mauritius. I think this is a huge issue which I really don’t want to think so far ahead. But post July, I think there are some serious issues because once the bill is passed, we will see the assessing officers becoming very active on this.

So, I think FIIs in general will be very cautious from here on. I know every securities firm has been having discussions with the tax consultant. There have been few conference calls with tax consultants because every FII is worried about this, but this could be a dampener. So, already we have had some macro issues post Budget. Some of these micro issues on the taxation side and the fact that government is also looking at retrospective changes to benefit their views isn’t going very well with FIIs in general.

Q: So, would you think that even if liquidity juice continues to come from global markets, from OECD countries, India may still underperform?

A: In the first two-three months, we have seen disproportionate benefit because a disproportionate share has come to India as oppose to the benchmark weight. I think incrementally if flows do come, we won’t see this disproportionate flow coming in. In fact I would say that lesser flows come in as oppose to the benchmark weight. People would be more cautious from here than they were before.

Q: You spoke about all the concerns and the risks that we could potentially be working with. Any targets on the Nifty or any sort of range that you think we could be working with?

A: I think it’s very tough to give targets. We are up maybe 12% for the year. We have corrected little bit from the high. But, at the ground level, you still see some positive momentum because there are enough companies where growth is still strong. Some of the domestic companies are showing good traction. So, it’s highly possible that because of the earnings momentum and also assuming that there is no re-rating of the market, you could see the market’s slightly higher, provided you don’t see any major crisis sort of a situation either on the tax side or globally.

I can still expect market to end maybe 5-10% higher by the end of the year. So, maybe a lot of it could be back ended. Since we have had a strong rally initially, we could see the market sort of settling here for a while. We will have the results coming up from next month. Markets may want to take cues from some of those results and figure out which sectors to buy, not to buy. Maybe from here on, it won’t be sector specific because we have seen some sectors do very well irrespective of whether the stock is good or bad. We could see some change there where post results we could see stock specific movements more stark than what it has been in the first three months.

Q: What would you prefer sectorally? What have you made of the banking sector? I am asking you because over the last two or three weeks we have got Moody’s downgrading couple of banks. The bank chairman routinely have come and pointed out that actually even their third quarter NPLs are lower than their second quarter NPLs and this is really a rating behind the curve. Even in private conversations, they point out that there is an NPL problem and it is being blown up more than they think. So, specifically your approach to that sector since it is over quarter of the market.

A: We have checked how financials have performed from 2003 every year. Surprisingly, interest rates have very rarely played any role on the way financials perform. So, 2003 to 2007, financials outperformed every year and we have had a rising cycle there. We have had 2008 and 2009 when actually financials underperformed where actually interest rates were being cut. The bigger theme there was NPA because post the Lehman crisis, everybody was worried on NPA. Then we had 2010 when financials outperformed substantially and 2011 they underperformed again. Again, the over riding theme there was NPA.

Given that we are a growing economy and if you assume that the GDP growth at 7%, the banking loan growth can grow somewhere in the range of 13-14-15%, you pick a number there. There is enough opportunity on the financial sector to grow. So, growth is not a problem.

I think NPAs are biggest scare. So, if we see resurfacing of NPA or some of these macro issues having an impact on corporate performance and that results in higher NPA then we could see financials again underperforming. So, I would be worried with banks who have not shown their NPAs as oppose to banks who have been upfront and have declared their NPAs. So, the negative surprise is higher for banks who have some of the NPAs, but for whatever reason they think that they are not NPA right now. I cannot really comment why same account is NPA with one bank and not with the other. So, I would be more wary of such banks. But I think if there isn’t too much of an NPA scare then financials should outperform.