Need major policy action for growth to pick up: Religare MF

Ahead of RBI's monetary policy review, the market rallied forward with hopes of a rate cut. In an interview with CNBC-TV18, Vetri Subramaniam, Chief Investment Officer of Religare Mutual Fund said that the valuations are 15-16% cheaper than trailing 12 month average multiples.

According to Subramaniam, the economy has entered a period of consolidation and a lot of policy action is required to bring the economy back on track. Below is the edited transcript of the interview on CNBC-TV18. Also watch the accompanying videos. Q: What do you think, is there a lot of upside potential to this market or is the fundamental underpinning still weak?
A: If you look at the fundamentals from two perspectives; one in terms of valuations and second in terms of the growth environment, then the way to look at this is the valuations are quite comfortable. We are almost 15-16% cheaper than trailing 12 month average PEs and we are looking at fairly long-term PEs when we are looking at these numbers.
From valuation perspective, we are pretty much in the comfort zone. There is nothing to be scared about. However, on the other front as far as the macro economic environment is concerned, there are still significant challenges both in terms of growth in the local market. The global environment continues to be remains quite challenging and the European problems despite news about Greece over the weekend still do not show any signs of going away.
You got to look at it in the context that valuations are supportive but, there are macroeconomic challenges and therefore, while we would be constructive in our approach towards equity, you have to keep in mind the fact that this window of a tough economic environment may last a bit longer and we do not see any easy way out of this anytime soon. Q: How much of a trigger can the Reserve Bank of India (RBI) provide? Do you think it could provide a game changer for equity markets or the fundamental problems are not quite resolved one way or the other with the kind of moves that are expected today?
A: I would go with the latter case. I think the RBI will do what it can and they are under intense pressure to deliver on a rate cut. So they will show some leeway there. There is sign that growth has moderated which is what they wanted. There is evidence that core inflation has also moderated though, consumer inflation still continues to be quite uncomfortably high.
I think there is a possibility that they will deliver on a rate cut and its not that it will not help, there is clear evidence that a lot of the small and medium companies in particular have been facing severe difficulties in terms of cost of credit and access to credit. It will help them at the margin, but whether this by itself can turn around an economy in which the investment cycle has completely stalled due to policy and implementation issues is a very big ask.
Therefore, I would not overplay the kind of impact that any RBI action today might have. It is also important to remember now that we are no longer in the kind of dynamics that we were in 2010 and 2011. During this period the entire debate about monetary policy centered around essentially the growth inflation trade-off.
But it is no longer a two legged stool because we have now got a third dimension added, which is the stability of the Indian rupee. Hence, RBI has to view it now as a three-legged stool and that doesn't make policy making very easy right now. Q: What looks easier to explain or justify for the second half that we remain range bound like this and we get the odd on again-off again kind of rally or do you believe as some people point out that this is the beginning of a base building exercise for the market, this is the real McCoy?
A: I suspect it will surprise you in terms of when the real McCoy comes around but the window of opportunity is wide and long. There are no easy solutions or hard work. There is a lot of heavy policy action that is required to set this economy back on track again and the micro environment in terms of companies and their own actions as well suggest that the economy has entered a period of consolidation.
If you look at some of our very large companies with significant debt overloads, the news that we get from them is not news about new project investments. It is news about trying to get rid of some of the excess capacities that they had created to try and get their balance sheet back into shape again.
I do not think it's as simple as saying that just a policy action or just a macro environment by itself or the monetary policy can suddenly trigger a turnaround. There is also the action of the individual constituents of the economy, which are these companies that are now starting to change course.
Look at the number of companies who are now talking of essentially getting rid of some of the large investments that they have made and trying to shrink their balance sheet size. That tells you that this economy and this momentum is not in that phase where everybody is gung-ho about investing for growth. Everybody is just trying to get their own house in order and that's what the economy is doing as well. There are no easy solutions or shortcuts over there.
_PAGEBREAK_ Q: While one can construct scenarios based on central bank action of some trading rallies, when is the earliest you can see some kind of fundamental tailwind to this market before which the market can start bottoming out?
A: To my mind the most critical factor is going to be the health of the investment cycle and to what extent we can get investments chugging along again. Investments in India do two things; one it is a driver of growth in itself but, more importantly it also reduces the supply side bottlenecks which come back to haunt the economy every time growth tries to accelerate. We then see inflation going up as well.
If there is one magic bullet or one magic pill for the Indian economy, that's infrastructure. But that is not rocket science and we have known this for a long time now. Therefore, if I was to put my finger on one single element, it would be the investment cycle.
Subsequently, I would also say the other significant element that we need to see action on is the fiscal deficit because the fiscal deficit has become a monster. The government's borrowing programme this year is most probably 5 times as large as it was 5 years ago. That is completely unsustainable.
We need to see action in terms of controlling the fiscal deficit. I would also add that on the fiscal deficit, one of the advantages that India has compared to a lot of other economies is that we do not need to slash our subsidy bill by 50-70% to get the economy back on track. All we need to do is gradually allow it to plateau, maybe with a marginal decline if possible to release the pressure on interest rates in the short-term.
But, even if we can get it to plateau over a three-five year period, as a percentage of GDP that would be a significant addressing of the fiscal deficit issue. The decisions that we have to make even on the fiscal deficit are not as challenging as it has been made out to be. We just need a little bit of long range thinking, in terms of controlling the deficit as a percentage of GDP, subsidies as a percentage of GDP and we can solve the problem over time.
This is exactly what happened in the late 90s. It's not that we brought the deficit build down dramatically in absolute terms. It's just that because the economy kept growing in percentage terms, the size of the problem reduced. Q: What is your call on the market per se given the fundamental underpinnings that you described? Can you justify significant upsides over the next couple of quarters or do you think it will continue to grind?
A: My suspicion is that it will continue to grind. But every now and then, when we catch a bit of good news which could be local or global, which could be policy action then the market could try and challenge their average level of valuations, which are still 10-12% higher than where we are.
But I still think it is more trading range market in the foreseeable 6-12 months. I do not think we are in that environment where you can see anything more sustainable than that.
The trick, at this point of time, is more to focus on stock picking because a lot of the macro challenges and bad news is already reflected in the market valuations. Our strategy is more to focus on those companies that we think are well placed to survive these tough times and will be in a position to benefit as and when the external growth environment starts to improve.
Right now, the challenge is not so much in terms of finding companies that can grow and a lot companies have troubled growth outlook at this point of time. The challenge is more to make sure that the company balance sheets are strong enough and the fundamentals of the business and return on capital is strong enough to take them through these troubled times.
We don't know whether it will be six months of a slow growth phase or another 12 months or another 18 months or another 2 years. What is more important is to get stock selection right at this point and that's the way we are addressing this market.  Q: While the market is trading at lower than average valuations, it's not quite hit bear market trough valuations. This is what is keeping away a lot of people that whether we will think to those kinds of valuation lows once before the market bottoms out. Do you see the risk of that?
A: There is certainly a degree of tail risk because we haven't executed very well as an economy over the last two years. The longer the situation persists that tail risk will only continue to go up. But at some point, it will come together in a very messy situation.
Certainly, that tail risk exists as this market has not gone to the kind of trough levels or valuations that we have seen early 2000 or even maybe about three years ago. We are not anywhere near those trough valuation. Is it a time to go all into the market because it reached two standard deviations cheaper than normal? It hasn't reached that level but is it at a level where you should be more constructive rather than negative?
I think it is certainly that kind of a level. But it has not reached the absolute trough valuation levels that we have seen in the past and there is some degree of tail risk.  Q: How do you approach a sector like infrastructure? Is the worst behind or is this just a trading rally playing out?
A: I think you got to look at it at a stock level in terms of how well placed these companies are in terms of their balance sheet strength. Unfortunately, in the infrastructure sector, what we see is that a lot of companies have market value implied debt equity ratios of 4:1-5:1-6:1.
To me, that still is a bit of a concern because what that suggests is that the principle of these companies is under threat and we are seeing these companies now gradually start to respond. They are talking about divesting some of their businesses; they are talking about getting rid of some of their assets.
So that is a good step forward but I still think you need to be selective in terms of which companies you are willing to expose to because there are lot of minefields out there. The minefields are in the balance sheet and minefields in the balance sheet can be terminal as far as the health of that company is concerned. So you need to be still very selective. 
_PAGEBREAK_ Q: Had the market digested any great benefits that have come in from the cool off in commodity prices because that is the one everyone holding on to for the second half that this is the end of crude and that is going to be the best news for India?
A: I do not know where this belief comes from that crude is the only problem that India has. I wish it was so simple. If you look at 15-20 years of market history, there is absolutely no indication or conclusion that you can draw that the Indian market's performance in anyway inversely correlated to the way oil prices move.
I do not think this belief is all around the place. We haven't seen it in the data, and therefore, that's not our operating premise. In general, however, the cool off in commodity price is not just oil, but also oil derivatives and metals, which is good news. There is pressure on manufacturers in terms of margins but their ability to hold on to some of these margin gains is perhaps a little bit under threat.
We are in a market environment now where it has become a battle for market share. Therefore, the pressure on margins will come more just from competitors' battle for market share rather than by companies being able to gain some advantage because of raw material prices coming down.
I think the battle, in terms of corporate margin, still continues.
It will be a challenging environment but, to the extent that commodity prices in general have come down, it will release some of the pressure that we see on inflation numbers. It will have a little bit of positive impact on the government as well if crude oil prices go down. But I would not overplay this impact because history tells you it is not being a bet in that direction. Q: When do you expect growth to trough out and start improving? How long is this process of restarting an investment cycle? Is it just a switch on-switch off given sentiment or once the momentum is lost, it takes a while or a few quarters for it to be restarted?
A: I think it will take more than a few quarters to get restarted because you need to see two things happen and in terms of the investment cycle, I think it's a question of approach. The CMI publishes some data in terms of the value of stalled projects which are stalled at various levels. These could be completed projects or these could be project announcements that haven't taken off.
When we talk about the investment cycle, I think the easy picking or the low hanging fruit is over there. All we need is somebody to look at these USD 100 billion or now, it's up to USD 120 billion worth of projects which are stalled for various reasons. Look at how we can fast track those projects because what that does and what that involves is that a lot of companies which have already committed money to these project, have got these projects at fairly advance stages of development.
Those companies do not have the risk appetite to go out and start new projects when their existing investments have suddenly come under so much threat. What you need to do is look at these USD 120-140 billion worth of investments, which are stalled for various reasons.
If you can just get that going, then the virtuous cycle will start to kick in far more easily and efficiently because as companies find their balance sheet strength reducing, they will automatically start thinking about growth related investments.
So forget a big bang about FDI in retail, FDI in insurance. Nice to talk about, we will get few headlines in the Financial Times and in the Wall Street Journal but does it make a difference in terms of trying to get this economy sustainable rate of growth up? I do not think so.
Will it do much to get the confidence of entrepreneurs up, which is a key element in getting growth rates up. I do not think so. If you can target that USD 120-140 billion of stalled investments, I think it will do far more good to this economy than any big bang announcements that any finance minister or any Prime Minister were to make.