Fisc consolidation is positive from Budget: Citigroup

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Head Research at Citigroup Ratnesh Kumar says the continuation of fiscal consolidation and the numbers are the positives that emerged from the Budget.

Kumar feels that the growth assumptions need to be more conservative. He comments that the basic story for India is growth and what is needed from time to time is to calibrate the various things that drive growth, be it supply of capital, of labour, of physical infrastructure and capacities, so that there is enough to grow without having inflationary problems from time to time.
Kumar adds that the best exposure to growth is basically equities.

Excerpts from CNBC-TV18's exclusive interview with Ratnesh Kumar:

Q: While most people think that we are okay on growth, there were hidden messages in the Budget speech and in the numbers that seem to indicate that perhaps the Finance Minister is more of a bear than any of us; he sees revenue targets increasing only by 17% which were up 28% last year, he says corporate tax, which was 41% higher last year will increase only 15%?

Kumar: Continuation of fiscal consolidation in this budget and the numbers are the positives to have come out of the Budget. So there is no doubt that helped by growth itself, the fiscal consolidation continues to go ahead.

As far as the Budgeting exercise, surely the growth assumptions need to be more conservative but I think the 3.3% fiscal deficit target which is there for next year does assume fairly reasonable tax growth assumptions. One must also remember that the strong growth we have had this year also creates a higher base, so 18 or 19% growth assumption in tax revenues is quite healthy numbers and I wouldn't say they would be overly conservative. 

Q: Mr. Narayan Ramchandran was saying that double-digit growth is great, even low double digit growth is something one has to learn to live with. The concern here perhaps is that today fixed deposit possibly gives you 10% fairly risk free returns so do you see money moving away from equity into debt or at least money into the side line not coming back into the markets? Can you give us a take on that?

Kumar: I would agree with that. I think the basic story for India is growth and as an economy, as a country, we do not have much of a choice except to perceive growth. What we do indeed need to do from time to time is to calibrate the various things which drive growth be it supply of capital, supply of labour, supply of physical infrastructure and capacities, so as we have enough to grow without having these inflationary problems from time to time and the best exposure to growth is basically equities.

I think in India right now if you see the total financial saving, less than 5% go into equities, so these short-term impacts on sentiments, I do not think will change the long-term trend of that number actually increasing over next five-ten years almost in a secular way.

Q: Valuations are down quite considerably-- 2,000 points on the Sensex, down about 12% from highs. So valuations are clearly down but the global sentiment is certainly much more nervous than it was a month or two months ago. How do you see it affecting flows?

Kumar: Over the last three years what we have seen is that FII flows into India have developed quite strong correlation to global risk appetite indicators, so if any of these events or these factors change that global risk appetite can certainly especially for the short-term impact the foreign flows and as the structure of the market is today the size of the foreign institutional money in the Indian market is still 3x, the side of the domestic money.

So definitely, when you have this changes to risk appetite, it can have short-term impacts on the market but purely from the valuation point of view, I like to follow a model of valuation, which builds in not just growth but high ROEs that Indian companies make because of their efficiencies and good managements. My models throw-up a fair valuation of around 13,300 for December 2007 and the target, which I have set for the year is 10-20% premium to that simply because the growth momentum is strong and we have good earnings upgrade momentum also with us.

Q: When you make the calculations, what rate of interest do you assume or do you think that Indian rates of interest do not affect the kind of companies you are taking about?

Kumar: Absolutely the rate of interest affects; in the fundamental valuation model, for any company the two important determinants are earnings and rate of interest. Definitely, the rate of interest and both earnings growth are part of that.            

Q: And you don't see that going out of whack, with inflation at these levels?

Kumar: My sense is that the entire sentiment on inflation and interest rates in India in the next 3-6 months can go through an about-turn simply because of the base effect and also because of some of the measures which have been taken over the last 2-3 months, including those in the Budget on inflation.

Both those factors put together will get the inflation numbers down and one of the other factors causing inflation is the pace of credit growth, which we have seen almost 35% growth in credit over the last 3 years and that is also going to come down in the range of 20-25%.

Both of these put together will put the inflation and interest rate picture quite substantially different in 3-6 months time.

Q: Most analysts felt that if 2006 was the year for largecap returns, 2007 maybe in favour of midcap, now 3 months down the line would you think that would be true or at this point in time its risky to get into midcaps when things are so uncertain?

Kumar: In 2006, our preference was largecap and only largecaps. When the year began there was a substantial amount of underperformance of midcaps at that time and the valuation differentials between the largecaps and midcaps were quite different because of the outperformance of largecaps.

So yes, indeed this year we have become much more constructive on the midcap space than in 2006. So I won't say at this point in time, I would be very much more in preference of midcaps than what I was at the beginning of the year. But fundamentally as an investment strategy in the Indian market considering that we are in the fourth year of almost secular bull market, I think the investment strategy has to be more of risk aversion and hence overall portfolio dominance has to be from the largecaps, definitely one can have more of the midcaps this year than last year.

Q: What strategy would you use? Are there certain sectors that will give you less risk than the rest?

Kumar: What I look at this point in time in the market, since the last few quarters is essentially areas, which have visible growth and hence lowest possibility of earnings disappointment.

Those areas are essentially IT services, telecommunication, largecap capital goods, consumers, media and cement till recently there is some policy uncertainty. But these are the areas which fundamentally look good to us from a one year perspective.