FIIs will return, see Sensex at 23000 by year-end: Ambit

The US' stronger-than-expected non-farm payroll in June has made the emerging market (EM) bond outflow inevitable believes Saurabh Mukherjea of Ambit Capital. Mukherjea says the foreign institutional investors (FIIs) will pull out more money from the debt and equity market in the coming months but will have to return to India eventually.

In an interview to CNBC-TV18, Mukherjea says this negativity, however, isn't India-specific as a frozen exchange rate, as is in the case of China, is a bigger crisis.

However, Mukherjea says FIIs are positive on the Indian equity market. He also adds that he maintains his 2013-end target for the Sensex of 23000 and says global events will play a major role in achieving this target.

"The two factors-resumption of FII equity inflows into India and a further exacerbation of the China problem leading to commodities cracking, are two main layers of hope. I do not think that much will be forthcoming from our own politicians. So, we really are looking to global events to deliver our year-end target of 23000," says Mukherjea.

Below is the edited transcript of Mukherjea’s interview to CNBC-TV18.

Q: What have you made of the news flow through Friday and what emerging markets (EM) have taken away from it in terms of it implying less and less money?

A: As soon as the US jobs data came out on Friday it was clear that there would be further bond outflows from EMs as a whole and it was but inevitable that we would see further pressure on the rupee.

It is happening around the world, not just India, the bond outflows that is and in countries where they are keeping the exchange rate frozen, for example China. If one is keeping the exchange rate frozen, then the crisis is even worse. This is because if one keeps the exchange rate frozen, then the hot money outflows are even bigger and the money outflows in China are such that it is pushing the banking system towards a crisis.

Hence, I expect further pressure on the rupee. It is inevitable. I think we will see further bond outflows in the coming month. There is around USD 25 billion of debt that Foreign Institutional Investors (FII) own and I think we will see a lot of that flow out over the next couple of months.

However, I remain positive on equities. I met around 30 of our clients last week at our conference in London and the mood about Indian equities is fairly constructive in spite of the concerns around the currency.

Q: What did you hear about the kind of outflows that have happened from EM equities including Indian equities over the last one month? That is a departure from the trend that we saw for the last many months. Did you get the sense that Exchange-Traded Fund (ETF) led flows might cause some pain in the short-term?

A: The bulk of the FII equity outflows such as they are have been ETF flows. I really have not seen too many of the hedge investors pull a lot of money out of India. The ETF outflows out of India have taken place. They have to reckon with not just the fall in the Nifty, but also the slide in the currency and I expect that to continue in the near-term. If the rupee slides, the ETFs have to pull money out.

I have spoken to the investors that are 'long only' at length. We are still receiving incoming orders from them and the view of the seasoned FII equity investor remains that if one wants to make money in India one has to come into India against the background of some sort of burning platform. If one comes into India, when everything is looking picture perfect, one really will not be able to make that much money in the market.

Hence, for the savvy investor out this sort of concern on the currency is really the time that they are taking to gradually accumulate large positions in stocks of their liking. Clearly, stressed sectors such as power, infrastructure are not going to see too much of that inflow. I think even private sector banks are slowly beginning to cause a lot of worry to foreign investors. But for the savvy long-term investor, this is more of an opportunity, than what they are seeing pretty much anywhere else in the world.

Take any other large EM, they have got far more to worry about over there, especially the commodity linked plays or indeed China. India is emerging as one of the more stable emerging market place in a very difficult global climate.

Q: You were talking about how long only funds are still not throwing in the towel. But do you think it is a matter of time before their end investors start asking some questions, because in the last six years in dollar terms no EM investor in India certainly would have made any money. How soon is it before this whole asset class starts to lose it sheen with global investors?

A: Sitting in India all of us do worry about exactly that that are FIIs unduly optimistic on India. But when you look at it from their perspective and especially when I go abroad for these meetings, it is easy to see why they continue having faith in our country. The choices for them are not particularly attractive.

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Bonds globally are not the place to be, given what the Fed is saying and there is the added concern that if the Chinese government starts selling US government bonds, to finance the recapitalisation of their banking system, then obviously the hammering for bonds will be even more. So, bonds are not the place to be.

Globally bond funds saw their heaviest month of outflows in June. So, we are seeing a massive outflow from what is a big asset class. Where does one put that money? US equities have already seen very heavy inflows over the last year.

Within EMs, Russia and Brazil are commodity plays. They are under pressure as the Chinese economy slows down to its lowest growth rate in close to 20 years. China itself is going through a crisis of sorts.

That really does not leave one with too many other EMs to focus on barring India. And  that is why I think the focus on India stays strong and that is why in our London conference last week we saw close to 200 meetings between FIIs and small and midcap Indian companies. I am not even talking about frontline Nifty stocks, these are small and midcap Indian companies and we have seen unprecedented levels of investor interest in meeting them.

Sitting in India it is very easy to worry, but when one goes abroad and looks at the world from the perspective of a global investor, there really are not too many choices out there for global investors. In terms of returns the Chinese market has returned one third of what the Indian market has delivered over the last 10 years or so. So, the question of long-term equity market returns, our country does not acutely look as bad as it looks to us locally. So yes, it is worrisome, but in a difficult global climate our country does stand out at the one place where broadly there is some sanity to the economics of the country.

Q: You are reiterating your year-end Sensex target of 23000 on Sensex. Are you confident the market is going to scale back to that level in the next six months or is this a financial year target?

A: We have maintained it as a calendar year-end target and we will stick to that. There are a couple of dynamics which we are not yet factoring in which will play out in India's favour as the year ends. We have seen heavy outflows from bonds. We have actually seen Global Emerging Markets (GEM) equity funds see net outflows pretty much year-to-date (YTD).

As we go toward the year-end we will see a resumption of inflows towards some of the stronger EMs, markets such as Indonesia, Philippines, India, Mexico and that should be a level of support for the Indian market.

The second factor which we need to reckon with is commodity prices. Given the scale of the crisis in China and every indication is that the crisis in China will worsen commodities will crack quite comprehensively as we go towards the year-end, so leaving aside the 20-year super cycle in commodities which a number of commodity experts believe is now over, leaving that aside, the extent to what is happening in China should exert downward pressure on commodity prices which should give us some relief on the inflation front.

So, whilst the Reserve Bank of India's (RBI) hand on interest rates is being stayed by the level of pressure on the rupee, if commodities ease off further, that should once again give RBI some room to cut.

Those two factors-resumption of FII equity inflows into India and a further exacerbation of the China problem leading to commodities cracking, are two main layers of hope. I do not think that much will be forthcoming from our own politicians. Election pre-occupations will probably takeover their minds pretty soon. So, we really are looking to global events to deliver our year-end target of 23000.