India's micro environment challenging in robust macro:Uday Kotak

As long as global situation is not hostile and we have decent monsoon there are chances of an economic bounce-back in the second half of FY17, feels Uday Kotak, Executive VC and MD of Kotak Mahindra Bank.

Kotak says, globally, a lot of factors are playing out simultaneously like the China crisis, reverse impact of a hugely negative commodity cycle, implications on banking system from low commodity prices and excessive leverage that companies have worldwide.

He believes that global markets have reached a point where people have started questioning the political class on the efficacy of quantitative easing and fundamental reforms undertaken.

However, he says India is looking extremely robust from a macro point of view, adding "India's micro is challenging in a good macro. Tailwind of the macro must be used by micro to improve the situation."Below is the verbatim transcript of Uday Kotak's interview with Latha Venkatesh on CNBC-TV18.Q: IT is a very opportune time that we have got you. Before I get to the nitty-gritties of Indian banking which is throwing up a lot of questions, first up on the global markets itself, 2016 has been treacherous to say the least. Does it look like the markets have overpriced in your recession or are the overpricing in competence of central bankers?A: On a global situation, a few factors are working at the same time. First of all, the black box called China. Second is the reverse impact of a hugely negative commodity cycle on those companies and future investments by those companies. Third is the implications on the banking system coming out of the low commodity prices as well as excessive leverage which many of the corporates are having worldwide.Q: Is all this getting overpriced? It is true that the Chinese economic model is changing but does it merit this kind of a 25 percent meltdown in five weeks?A: The classic example is Japan. When Japan went to negative interest rates, one would have assumed that the yen would weaken in fact, the yen strengthened contrary to traditional economics and the Japanese market went down.I think we are reaching a situation where the markets are beginning to question the efficacy of quantitative easing and also the question to central banks that beyond the one medicine, which you used for all problems, what next and the second question is to the political class globally that where are the structural reforms needed to improve the fundamentals of economics.Q: To be fair, Dr Rajan has been raising this issue from kingdom come, that central bankers should not pose themselves as the only game in town. But nevertheless, I am asking you a question for an answer to which every investor is seeking. Should we price much more downsides to global markets?A: My strong belief is, in turbulent times go back to fundamentals. Therefore, ask the questions on the earnings of companies, sustainability of those earnings, fairness of the price earnings ratio, rather than being carried away by momentum. Go back and do your homework on fundamentals.Q: The Chinese central bank, over the weekend, actually put out a very clear statement for the first time, the governor spoke to the media and very clearly said that it is not our game to depreciate the yuan. And we are 600 billion surplus in terms of exports in a year without depreciating the yuan. Do you think therefore that the bottom has been hit, are we all overpricing a Chinese confusion?A: The question is outflows from China. The month of January, as I understand saw USD 100 billion outflow. So, this is a good confidence building measure, but the key to me is what is the individual Chinese feeling about his or her money in China. If he or she wants to take out the USD 50,000, that is not a good sign. So, we have to watch post this confidence building measure, whether this is for real. As I understand, on the ground in China, if an individual today, applies to his or her bank for a Rs 50,000 withdrawal, the banks are not allowing it in a hurry, though it is permitted under the guidelines. So, when this is done in normal course, I would believe the confidence which has been put out.Q: That is hopefully for the momentum at least, the worst is over, we will have to wait and see. But actually, that brings us to the question of the India investor. What is the sense? Do we go down with the globe or do you think we can outperform in 2016?A: I love to compare India to a situation which I call as a long-term, I think India is looking extremely robust from a macro point of view. Therefore, if you look at India macro, it has never been this good. 10 years ago, if you had asked me, what is the dream for India macro, we are there. But, the problem is micro and India's micro is more challenging in a good macro. The tailwind of macro must be used by micro to improve the situation. And the current pain is coming out of micro.Q: I will have more questions on those micros especially because your sector, the banking sector, is bearing the brunt of bad micros. But before that, let me come to your conference itself. Your conference theme was chasing growth last year, it remains chasing growth. Is it becoming a mirage or are you seeing any tangible difference between last year and now?A: You have to answer that question I will ask. India is going to show 7.6 percent growth, so growth is up. The question is what is our confidence that those numbers are something which we have conviction, are the levels of growth India has. If it has, then the growth is better than last year, so why are we complaining?Q: Macro numbers we all know. But you handle a lot of micros yourself. Between last year and now, are your borrowers asking for more working capital? Are you funding more projects? Are your retail clients asking for more money? You would know better. Are you seeing growth?A: The urban consumer is in very good shape and continues to be comfortable. The challenge if at all is we have had two bad monsoons. So, that is putting pressure on rural India, I think the Budget hopefully will address it aggressively. And as far as the corporate sector business model in India is concerned, it is fundamentally broken.And what I mean by broken is that between 2005 and 2010, corporate India went in for what I call as arbitrage. Arbitrage on resources whether it is coal, telecom, infrastructure, real estate, get resources cheap and arbitrage out the price. That model is gone. You now have a transparent mechanism, an auction mechanism where you are not going to make money on arbitrage, you are going to make money on productivity and efficiency. And corporate India is still not coming to terms with this new world.Q: Is it not coming to terms at all? Are you seeing some of the top 10 leveraged groups? Are you seeing some better behaviour in terms of deleveraging, selling off shares, selling off assets?A: When everyone is in one direction, valuations dramatically correct. That is the challenge we are beginning to face. If the valuations go down to that level, it has a challenge on the valuations of the debt. So, you are in a little bit of a cycle. As I say, debt can be virtuous or vicious. At the moment, you are seeing the viciousness of that.Q: You don’t think the worst has played out yet? You are yet to see the green shoots in corporate India?A: My view is what we are currently seeing is still a reflection of historical stock problem. The flow problem is not there so you are not seeing dramatic creation of new bad or stressed loans in the system. This is still a reality of the past we are just recognising it now.Q: Let me then come to that itself, the banking sector, the big news really is each bank outdoing the other in terms of recognising the dirt. What is the sense, we saw Bank of Baroda come out and say very boldly that they are done with cleaning. Do you think we have at least got our hands around the problem?A: We are moving in the right direction. This is the first time we are beginning to see the baggage of the past at least getting washed. We need to see this happen consistently over the next four to six quarters where we come to a situation where we can say that we have no baggage.When we reach that situation, whether it is the banking system or the banks or the policy makers ,we should then avoid any further pretence and not have any baggage genuinely.Q: Is the worst known or can there be known, unknowns?A: You are in market, you are in volatility, you are in a fast moving global world. My personal view is that we are moving in the direction towards bottoming out and we will see it sooner rather than later.Q: You don’t think it has bottomed out in the sense not just India but other countries, the European countries have also put up minimum import prices or some kind of barriers against steel dumping. Well crude also saw USD 25per barrel, does it get worst, are we bottomed or still bottoming?A: Let me move to fundamentals because making judgments without fundamentals is always dangerous. Our equity research believes Nifty earnings for March 2017 to be around Rs 470 a share and their fundamental view which I share is the fundamental value of the market is somewhere around 14-14.5 times Rs 470 which gives you a fundamental floor in a sense of around 6,600 to around 6,800 Nifty.Now, markets can move on either side of this fundamental value. However, for the first time we are seeing our markets now begin to look at valuations which are significantly more fundamental rather than momentum. Now, can 6,800 reflect the 7,200? Yes. Can 6,800 be 6,500? Yes. However, broadly we feel we are coming to some sort of a range on fundamental value in the market place.Q: Just to scratch that point one bit more, do you see earnings growth, does your research team and you share the confidence that FY17 there will be that kind of double digit earnings growth?A: We believe so. We believe that earnings will pick up particularly in the second half of FY17._PAGEBREAK_Q: The Budget is on us and you said that growth is still something you are waiting for. Would you place a lot of bets on the Budget, what would you want the Budget to give you?A: I would like the Budget to be a solid statement of structural change in Indian economic and policy thinking with substantively making sure that we are having fiscal deficit below 3.9, hopefully closer to 3.5 but 3.5-3.7 is the kind of range I feel we should try and be in because never in our history have we had this advantage of such low oil prices and the tax benefits into the fisc as we are now seeing against that yes, there is the settlement payments, there is the payment on one rank one pension (OROP) and probably capitalisation of banks which is also there as a part of the Budget making exercise. So, it is a balanced situation which we need to come to but sub 3.9 and ideally 3.5 or at the most marginally higher.Q: You are practically the only person I have spoken to in India Inc who believes that fiscal discipline is important. A lot of people are betting that the budget is going to do this big thing for investment. You don't think it needs to do that, will investment pick up without a big push from the Budget?A: In addition of the central deficit we have to also watch out for the state deficits and here we are going to see a significant movement of DISCOM debts on to the state budgets and state deficits. Therefore the rating agencies and the global communities and the Indian community must watch for consolidated deficits and they need to be contained as well. So, in such volatile global times good fiscal behaviour is extremely important.Q: You watch the debt markets very closely, will they stomach anything more than 3.6 percent?A: That is clearly the issue and we are underestimate that if we have debt markets which are free to operate the impact of every 0.1 percent on the pricing of debt markets and the same is going to be an issue for state development loans which are already seeing the pressure on yields coming out of excess supply.Q: Let me move to the banking sector itself. What is your honest sense about public sector banks. We have got these 21 new licenses coming in and people like you are restless to grow. Finally do you think public sector banks, very shortly, will occupy maybe less than half the banking space?A: I am enthused by the Finance Minister's statement over the weekend at the Make in India program that there will be significant steps towards transformation of state owned banks. State owned banks are an extremely important part of the Indian economy and at such a large percent of India's saving and advances it is important for us to make sure that we have a well thought out game plan for their future.Having said that one of the important aspects is when we as a system from a policy point of view in a sector which is highly leveraged at an average of 10:1 when we decide that we would like to have move entry of competition we have to be more careful. India has never had mortality in the banking system. It has always found ways and thanks to the RBI for ensuring that banks get merged by there has been no issue of exit from the system. In that context how well prepared are we with more open entry for the exit aspect of a competitive system.Q: Now you are an incumbent, so it is to your advantage if there isn't too many entrants.A: I am open for entrants, certainly. Competition will get the best in us but to what extent is the system ready for exits.Q: So, you are actually arguing against on tap licenses?A: I am not, I am not arguing for or against. I am saying for each of the decisions we take there are positives and there are outcomes of those decisions. The system must think about both as we move forward.Q: So you are asking both the fiscal system, the government and the regulator to think whether we can face the consequences as a society if a bank failed?A: I am just saying that free competitive entry has to have an outcome which is free competitive exit.Q: The Financial Sector Legislative Reforms Commission (FSLRC) has recommended an institution which will take charge of failing banks, but we haven't yet seen it on the horizon just yet, but yes, for a poor country without too much of a safety net failing banks will be a huge society problem.A: I am not saying there will be failing banks. I am saying the philosophic aspect when we are thinking about 3-5 years ahead we need to have a framework in place for both. I am certainly open to more competitive entry but the system must make sure that we have mechanisms in place for a competitive exit.Q: Do you think that banks in secular sense over the next 3-5 years are definitely going to see a reduction of margins? Have you to work in wafer-thin margins simply because of the digital challenge, I mean more payment banks?A: Let there be greater competition. I think margins need to shrink as the size of the pot grows. And we see a significant growth in the pot, even if it is at lower margins. And this is where our training in addition to banking, in capital markets and other businesses where we have learned to deal with lower margins every year, for decades together, will be something which we keep as our philosophy.Q: Let us see how the digital challenge pans out. Are you planning to probably take over a payment bank, merge with a payment bank?A: We already are taking a 20 percent stake in Bharti Payments Bank. So, we are with them in that and we are very excited about it because it will give us an insight into how the whole payment mechanism works. Q: Are you in touch, in the sense, are you working together on that bank? Or are you just a financial partner?A: No, we are certainly very much involved in the whole process and we are very excited because it enables us to learn how to deal with a large number of people who would not be the customers of our bank in our current business model.Q: So, when the launch would be, anytime now? A: We will certainly come back to you when Airtel Payments Bank is ready to roll.Q: It is a 2016 launch?A: We hope so.Q: That would be a matter of grave interest. Let me come to another aspect of banking which is practically getting everyone's goat. The fact that in spite of such a large amount of bad loans, Indian banks have not really gone after errant promoters. I mean, it cannot be the case that everyone has failed, only because of the economic cycle. Why is it that no one is behind bars? Why is it that no one has lost their house?A: You have got to divide the question of stress into two categories. One is stress happening out of a normal business cycle or government policy over time. The second is where there has been a significant diversion or misuse of funds by borrowers from the banking system. The second category needs to be dealt with, because finally, if public sector banks or private sector banks, the broader agenda is to provide credit to society. And if bulk of the bad credit comes from the big guys because of misuse, the tax payers' money is at stake. And it does need tough questions and good answers.Q: But are bankers at least moving in the direction of bringing culprits to book?A: I think it is not only the bankers. It has to be the bankers, the government, the various investigative agencies to be working on this together, or independently to find out where the system has been misused.Q: Are you seeing things in that direction? A: Media should be asking those questions.Q: I am asking you.A: It is something which, it is very difficult for one small banker in the system to be able to give you an answer which is a significant question at the broader economy and policy level.Q: Is it something that is wrong with the legal system? Is it that there is too much of political lending and that is why this is not coming out? Why is it that we are not able to... (Interrupted)A: I will just mention one thing. At Kotak Mahindra Bank, we are pretty clear that if there is misuse of bank fund by any borrower which is not in line with what the money was given for, we will do everything within our power, to recovery that money and use all the instruments we have within the legal system.Q: Let me get back to the stock market investor and the foreign investor. In your various conversations, ahead of your conference and even in you routine business, what is the sense you are getting? Will India stand out as a better place and outperformer in 2016?A: India is getting and will get a larger share of the pie from a shrinking emerging markets pie.