Indian equities' long-term fundamentals intact: ICICI Pru

Lakshmikant Reddy of ICICI Prudential believes the FOMC meet will not have any impact on the long-term fundamentals of the Indian equities. The Federal Open Market Committee (FOMC) is scheduled to meet on Tuesday.

According to him, the reason why capital flows have been coming to countries like India is the significant growth potential that exists between it and the developed world. He feels that as long as India’s growth rates and potential remains high relative to US or Europe etc, the long-term capital flows would come in. However, he sees short periods of reversal in capital flows. Also read: See little impact of FOMC meet; buy JSW Steel: Experts Below is the verbatim transcript of his interview to CNBC-TV18 Q: How are you guys dealing with the way the dollar-rupee is moving and what kind of impact do you think it has on balance sheet of so many of these companies? A: If you see quite a bit of large companies have huge amount of forex debt and where the companies have actually taken forex debt to make acquisitions abroad to that extent they have a dollar exposure on the P&L. Any impact that you would see in the short-term is purely the translation or mark-to-market. There are companies, whose operations are going to be impacted by the currency. That is where one has to look at it. However, if you look at the aggregate for the market as a whole we have companies which are in the pharmaceutical and IT, which are going to benefit from the currency depreciation. We have certain companies in the metals and resources area, where even if they do not export their pricing is dollar dependent they stand to benefit. So, on balance there will be some gain on the P&L, but some hit on the balance sheet. It is not such a material thing from a purely accounting perspective. From an economic perspective the depreciation of the currency is certainly growth negative. All the expectations that one had about inflation coming off, interest rates coming down, therefore fuelling a new growth cycle, those have to be tempered a little bit if the currency weakens very strongly. Q: What would your view be then on the Indian equity markets, especially in the backdrop of a weak INR as well as the Federal Open Market Committee (FOMC) policy which starts today? A: Absent even weak INR that has happened in the last one week-10 days or FOMC our view on the equity market has been that it is going to remain like this for sometime. On one hand you have expectations of interest rate reversal as well as the ample global liquidity has been supporting the market at the lower end. The very modest corporate earnings growth that we have seen last year, about 7 percent or so in FY13 and in FY14, we believe corporate earnings growth can at best be at high single digit or low double digit. So, we were of the view that till there is convincing evidence that the economic growth is going to come back in a materially higher manner than what it was last year the market is going to be in this trading range. On top of this obviously these two particular concerns, one about weakness in currency at the margin a delay if one had any expectations with any immediate revival would be a negative development and as far as the FOMC thing is concerned I do not have a specific view on what the US Fed would do. However,  our own belief has been that the reason why capital flows have been coming to countries like India has been the significant growth potential that exists between countries like ours and the developed world. As long as our growth rates and our growth potential remains high relative to US or Europe etc. the long-term capital flows would come in, intervening there could be periods of reversal in capital flows. But, whatever FOMC does that should not change our long-term fundamental opinion on the Indian equities. Q: If the capital flows are going to continue what is your view that the market will be range bound predicated on? Is it because it will be hindered by no great earnings growth or no great macroeconomic growth? What are your biggest concerns now? A: When I say capital flows will continue I mean it will continue in the long run. As we have seen in the last fortnight we could have a small reversal in capital flows. That is pretty much a possibility in any market. Those periods would happen, but in the long run we are of the opinion that as long as the growth potential between countries like ours and the developed countries remain sufficiently large, the capital flow would sustain.  According to me the biggest concern has been very tepid corporate earnings growth. Last year it was 7 percent on a full year basis and in the fourth quarter it was practically close to zero. As investors you make money in one of the two ways, 1) The market valuation goes up. Today already market valuation is close to average, if not slightly higher than the last 5-7 years average. 2) The earnings rollover happen. Today if the earnings growth is so poor it is very difficult for us to see in the short-term equities outperforming fixed income returns. The biggest concern is that economic growth should come back. That should lead to corporate earnings growth getting back into double digit range, which it was for a long period in time. Q: How would you be placed on the banking space on the basis that the RBI did not move in June and that transmission of rates has anyway been so dismal and the other point being that growth is now seeing some amount of sluggishness, so hence asset quality could possibly be affected into FY14, would you concur and what would your call be on the banking space as a whole? A: I agree with you that growth remaining weak, particularly banks which are heavy on the corporate capex or infra capex lending space would have asset quality concerns that will sustain throughout FY14. That is pretty much a possibility and that is more like a base case. As regards our view on the banking sector there are pockets in banking, particularly, people who are in the retail lending space and mortgages, which are doing very well. Therefore that will continue to do well because the penetration rates in those particular product categories is a tremendous scope to increase. That is where even the market has given thumbs up. If one look at the valuation differential between banks that are focused on this segment versus the banks that are focused on infra, corporate lending etc. Particularly the corporate project lending, not so much the working capital lending and that will continue. Q: What was your takeaway from the RBI policy yesterday and how worried would you now be about the macros, especially trade deficit and also with regards to inflation because of the impact of the rupee depreciation going forward? A: As regards the central bank's policy statements as of yesterday it was broadly on the expected lines. One has clearly seen the impact of the policy in the bond and the equity market. It was not really something that came as a big surprise. It is only a matter of time before central bank would cut again. If not now they would probably in the next policy or the policy after. Overall, I think the broad direction is that the interest rates would trend lower as we go into the future. Our view is that it is entirely possible that the capital flows reverse significantly and currency in the short-term may become even weaker than what it is. However, the fundamental drivers of the currency which is your growth differential as well as your inflation differential with trading partners, probably on that front we are close to the bottom. Things can only improve from here. Fundamental drivers for the currency could not be improved from here. It is entirely possible that in short-term the currency may overshoot, but over the medium to longer term probably the worst is behind us from the fundamental perspective. Our view is that what was going to happen anyway, which is interest rates falling and stimulating the cycle is only delayed by maybe a quarter or two, but certainly that would happen is what our expectation is at this point in time.