RBI steps to delay banks' NPA recovery process: BofA ML

The recent steps announced by the Reserve Bank of India (RBI) to curb rupee’s fall are temporary in nature and the central bank may withdraw these measures once the Indian currency stabilizes, says Jyotivardhan Jaipuria, Head of Research, BofA Merrill Lynch. Given the way rupee has appreciated, he doesn’t see bright prospects of interest rate cuts for few months.

In an interview to CNBC-TV18, he said asset quality remains a major concern for public sector banks and RBI’s actions may push back banks' NPA recovery by a few months. In a bid to rescue the falling rupee, the RBI on Tuesday raised the Marginal Standing Facility (MSF) rate and Bank Rate each by 200 basis points to 10.25 percent, which will make it unattractive for banks to borrow rupee at cheap rates and prevent them to short the US dollar. (Read More)

He further adds that the market is now trading at a top end of a range, but disappointing first quarter earnings will lead to a correction. He sees India Inc’s earnings growing 7-8 percent in FY14. According to Jaipuria, slowdown in China is the biggest risk for EM investors now.

Below is the verbatim transcript of his interview to CNBC-TV18

Q: You have turned a bit cautious in the near term. Is it because of the hardening signal from the Reserve Bank of India (RBI) or do you think market should ease off after the recent pullback?

A: This was our view even before the RBI moves had come in. Basically, my thing is market for the whole year is range bound - that’s what we have been reiterating right through the beginning of this year.

As we move to the top end of the range, you need earnings and you need the economy to start supporting that sort of level at the index. Our view is over the next four-five weeks earnings will disappoint again. In terms of economic growth also we will see numbers not being very strong and to that extent we will keep getting this pullback to the lower end of the range as we get these numbers.

The move up will be led by better policy action and hope. So for rate cut to some extent has been postponed, for the next two months the hopes of rate cut are going to be muted.

Q: Will you need to recalibrate your stand even further because of RBI’s decision or do you think what you are talking the 19,000 target for the market adequately reflects the changes that happened yesterday?

A: That in some sense reflects the changes that happened yesterday because it is more like a pace. That probably brings in one more element, why the market should correct. What is to remember is that yesterday’s measures are temporary so we have to hope that it works, the rupee stabilises and they are able to pullback these measures very quickly.

I don’t think they are looking at this as like a long term thing. They are looking at it as a short term thing to get the rupee to stabilise. Once we see a stabilisation of the rupee, I think the RBI will quickly pullback these measures.

 Q: I was just reading your fund management survey which talked about how emerging markets are being seen as the single biggest risk to financial markets now. Would you say at this point India has probably taken a step back versus even those peers or are they all just being looked at as one lump and that whole lump is an avoid right now?

A: India is probably being placed very well amongst the emerging market pack. That’s one of the reasons why we have had this huge amount of FII flow over the course of this year, inspite of lot of the growth problems that India has been facing.

At the moment, for emerging market investors the biggest risk factor is China. China is slowing and may get into problems, which are bigger than what is general consensus view today. That’s the reason India has been getting benefits that people don’t want to invest in China.  As you don’t want to put money in China one ends up getting negative on some of the other Brazil, Russia, India and China (BRIC) markets like Russia and Brazil.

India is a commodity importer and for most people because China is not going to do well, the super cycle in commodities is over. So, India actually is getting the benefit of lot of the other emerging markets having problems, which are bigger than probably India.

Q: Our own macro is not improving and neither are earnings. The last IIP numbers were quite awful. Do you think the time horizon that people were looking at earlier for a rapid improvement or a clear and discernible improvement is getting stretched out?

A: People are being too optimistic on earnings and economy and we generally have this that the economy will turn around in six months. Personally, I have been very bearish. For the last three years, our theme has been both earnings and economy will see downgrades and number will be way weaker than what the street was expecting.

So, we continue to have that. If you look in that light, I think Indian markets have done reasonably well because we have held on to these PE levels of around 13-14 inspite of growth being such a disappointment.

Even for this year, our view when we started the year was that earnings will grow probably 7-8 percent. Consensus was sitting at 17 percent earnings growth. We have seen that come down to 12 percent. I think there is more to go. By the time we finish this result season, we probably will have consensus numbers close to single digits.

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Q: Did you make any major recalibration in your approach towards banking stocks individual or generally as a sector after RBI’s communication?

A: Like we had put out in that report that given what RBI did on Monday night, banks would be weak and would really not perform sometimes. That probably in some sense would be opportunity to get into some of the big banks, but this whole private sector bank versus public sector bank debate and these moves probably hurts public sector more than the private sector.

So, you tend to again see that polarisation where you move to the really high quality banks rather than nimble around into something else, which has much lower valuations.

Q: You brought down your FY14 and FY15 gross domestic product (GDP) estimates yesterday. How does that fit in with what your earnings estimates are? For FY14 and FY15 how poor do you think earnings quality and earnings performance is going to look?

A: My view has been that we will probably see something like 7-8 percent earnings growth FY14. That 7-8 percent is also linked by a few big companies doing fairly okay. So, there is no real change to that view. In fact, there was some hope which lot of the economists had because we will have rate cuts and it would lead to some recovery in the second half.

Now that the rate cuts are getting pushed back and probably the earliest rate cut you will have is into the mid or last quarter of this year, everybody is going to tone down their GDP estimates. So, we have to hope that the rupee supports us, the rupee tends to appreciate and stabilise a bit given all these measures and RBI can move very quickly.

Q: What do you hear from your global clients? Are they still content to be running highly concentrated portfolios in a market like India where again the focus is on quality and their owning expensive blue chips like Hindustan Lever, ITC, HDFC, some of the frontline IT names or is there any willingness to look outside this very concentrated portfolio?

A: I think people do want to move into some thing which is under owned but nobody can see really the trigger or the need to move so early. So, I think at the moment everybody is content to keep holding on to the high quality stocks. Everyone thinks that the big money will not be made in these stocks.

The big money will be made in stocks which are under owned and have done very badly. Over the next four-five or six months you don’t really see that big move up happening in these other stocks. The newsflow and the earnings would be poor so people are still sticking to these high quality names.

Q: Would you be making a big switch out of banking though and tactically, what would you increase exposure to if you were to do that?

A: I think it is more of a tactical trade. So, my view would be once we get these pullbacks in the banks at least some of the big private sector banks is where we would be increasing our weight rather than cutting weight.

We have had these measures, it is going to hurt the banking stocks. However, beyond a point, if you get that 5-7 percent correction in some of the big private sector banks, we would really want to go back into those and buy them.

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Q: The concern also is that an asset quality trough could have been pushed back much further. Would you agree with that and what happens then to some of these companies which have deep asset quality concerns around them?

A: The reason why public sector banks have done so badly even though they look so cheap is that people are just worried about the asset quality. Hope is to see a turn in the economy, which will signal that probably the worst of the asset quality is behind us.

Probably what the RBI move has done is lot of people think any recovery in the economy is pushed back by at least a quarter till these measures are reversed and then we can see some hopes of rate cut. So, people getting into the un-crowded public sector space have probably got delayed a lot.

Within the private sector also, people will tend to stick to the high quality names and avoid some names where they were hoping that they would get a turnaround coming because of an improvement in the economy. So, I would think that an asset quality improvement has probably got pushed back by a few months. Hopefully, just a few months and then we can see that scenario reversing back.

Q: What are you telling your clients to do on IT? Are you asking them to book profits after the recent run?

A: The rupee depreciation has helped IT clearly. The one big overhang for everybody has been the immigration bill and nature in shape of that because that’s like some zero sum case which you don’t really know which way it will swing. In case the worst of the immigration bill comes through then the whole impact on the IT companies is quite significant.

So, it has been a sector which people have liked more because of lack of choice, but our thinking has been for buying the rupee. The pharma sector is much safer and stronger play than the IT packs.

Q: What do you hear from your global peers right now in terms of the general allocation towards emerging market funds per se? What emerging market funds are doing between their holdings is a different question, but what is happening with flow towards global emerging markets (GEM) in general?

A: This whole year has been a year where people have moved their money in some sense away from emerging market into the developed markets. Obviously, Japan and US has been the places where the money has been going. So that’s been clearly a trend where people are now saying, emerging markets were suppose to be the growth story but due to variety of reasons, growth in most emerging markets are disappointing and downgraded. To that extent, through the year we have seen money in equities move away from emerging markets and going to the developed markets.

Q: You have tracked politics and the impact on markets over the last many years. What’s your sense of how the market is going to approach these upcoming elections? Is there a sense that any great reform is probably not coming through, there are more populist measures like the Food Security Bill or do you think as many market people do, there is going to be a big burst in terms of reform announcements or at least plans?

A: I think we have to accept that we are so close now to the general elections. We have these big set of elections in November that we will have some of these populist measures going through. Along with the populist measures as long as we get some economic measures which comes through then I think market will be okay about it.

Quite often the more there is a crisis in the economy the easier it gets to push some of these measures. Like in some sense I think that we got this big burst of FDI announcements was probably triggered by the fact that the rupee started depreciating and the rupee wobbled so much.

So, I always feel that if we get a crisis, it just makes it easier for people to push through reforms because there are lots of people in the government who want reforms to be done. There is another set which opposes this and in a crisis it just gets easier for the pro-reform people to push through reforms. The hope is that government will use this crisis to push through these economic measures, which had got held up and at the same time I am sure some of these populist measures will keep coming.