Nifty may slip to 4800; bet on fixed income: Ridham Desai

This is a relief rally and those who missed the bus earlier can look to sell now, says Ridham Desai, MD, Morgan Stanley. Desai is focusing on a bear case scenario and foresees the Nifty sliding all the way to 4800 by year-end. Speaking exclusively to CNBC-TV8 as a guest editor, he said that the market situation now is similar to 2001 scenario and post recent moves it has not remained cheap.

He believes early elections could be a great trigger for the market, so for those looking to play equities from a six-12 months view, fixed income products offer better opportunity. "Betting on equities is advised only to those market participants who hold a three-five years view," he said. Banking sector is a complete no-no for Desai. As of now, he feels Indian banks need recapitalisation of USD 20-30 billion and de-rating of those companies may not be over yet. According to him, anecdotal evidence suggests that interest rates are likely to remain high for a long period of time and rupee's movement going ahead will be driven by what the US Federal Reserve does. Further, a rally in crude oil and gold prices is a bad sign for the Indian economy, since these two components are the largest contributors to already huge current account deficit (CAD), he cautioned. Below is the edited transcript of Ridham Desai's interview with CNBC-TV18 Q: I was reading your report where you ask an important question how does one know whether the market has troughed out, did you find an answer to that? A: Valuations and sentiment will lead the fundamentals. So that is what we need to look at. How cheap the market gets and how sold off the market gets. So those are the two things to watch. Right now, the market does look like it will bounce around a bit. It has done a bit over the last couple of days and we continue this relief rally as I may put it. The valuations had not gotten there. The framework is different. Ordinarily you will look at the price to earnings (P/E) ratio, the price to book and then say, yes, we are there. In fact, the price to book middle of last week got to a level which portends a buy call on the market. But currently the ratio that we are looking at is very similar to 1998, which is the trailing earnings yield or trailing equity yield minus the short-term bond yield. In 1998, the Reserve Bank of India (RBI) was forced to hike rates and in response to the Asian financial crisis and we held short rates high for long. People may not remember this, but as long as three years, it wasn’t until 9/11 that we got an opportunity to cut rates when the Fed cut rates because the US yields were rising, we had to keep our yields high and then the markets multiples remained low for a prolonged period. The markets were in this trading range and multiples did not move because the equity yield was much lower than the bond yield. We are in a similar situation right now. The equity yield is 7 percent around that 14 times earnings so 7 percent, the bond yield is at 10 percent. There is a negative 3 percent gap. So either the bond yield goes down or the equity yield falls. If the equity yield has to fall 3 percent that is almost a 20-25 percent knock on equity share prices. We may not get that because markets will heal overtime but markets are not cheap. They were cheap prior to July 16, they suddenly turned expensive because the way we responded to the situation. Had we responded differently and this had happened, we would have gone and bought equities but not at this stage. Q: Do you think that there is that elbow room now for the Reserve Bank of India (RBI) to the lower rates, it will be seen as tactically giving up the fight on the rupee possibly, also you have to beat this perception of rising US yields as well and then a consumer price index (CPI) is not down. It is still at 9.7 percent, when do you see the yields coming off at all? A: Let us step back for a moment and think that the RBI reverses the rate hike that happened in the middle of July. What do you think will happen to the rupee? Q: I would expect an immediate sell-off at least. A: Exactly, the rupee will be under tremendous pressure. The bottomline is it is not our choice anymore. It is going to be driven by what the Fed does. So we will have to hope that by some stroke of luck, US data turns bad and the Fed has to retract its quantitative easing (QE) taper. Unless that happens, it is going to be very hard for us to automatically reduce rates. What we will have to do is lift savings because you see the problem here, the genesis of the issue is the current account deficit (CAD), which is the investment rate minus the savings rate. Now the investment rate has gone down but your savings has gone down even more. Let me just go back a little bit, the policy response that we generated post the 2008 crisis was to drop public savings and to boost growth. Now the Indian economy in post 2008 situation was not that bad. So we got a V-shaped recovery. However, for whatever reasons now we can keep debating those endlessly, we did not retract our fiscal stimulus. So public savings remained depressed for too long. That pushed in inflation. Once inflation came in, it became very hard to bring that down. So we are looking at public savings which by the way got taste of fiscal deficit because everybody looks at only the fiscal deficit. You have to look at aggregate public savings, which is the government’s deficit at the center, the state deficit and the public enterprises because we tend to push a lot of these things onto the public sector enterprises that has fallen in aggregate by a whopping 450 basis points (bps) since 2008. That is a huge drag. What is your current account deficit gone up by? A similar percentage. So where is the problem? The problem lies in the public savings. So you have to lift public savings which means that you have to go through a period of very stiff fiscal consolidation or you have to lift real rates so that household savings compensate the inability of the government to retract the fiscal by a similar amount. So if real rates have to remain high, nominal interest rates will remain high because inflation is not going to come down in a hurry. So that is our dilemma. We don’t have the option to cut rates, the rates will remain there until the US comes in. What has changed since May is that the world’s reserve currency has told us, it is no longer interested in funding our CAD period. Until then we were having a party because the world’s reserve currency was happily funding us because they had their own set of problems. Once they decided they don’t want to fund us, we have to fix our CAD.