Daily Voice | Investors should focus on banks with lower costs of funds, says this CIO

Yes, the banking regulator has sent a strong signal to lend cautiously directly or indirectly. It is therefore correct to assume some moderation in both unsecured lending (as players tighten their lending standards) as well as bank lending to NBFCs.

The credit exposure of banks to NBFCs stood at Rs 14.2-lakh crore (pre-HDFC merger number) in September 2023, a 26.3 percent YoY increase. The proportion of NBFC loans to banks’ total credit rose to 9.4 percent from 8.9 percent a year ago. (Source: Citi India Strategy Report, Oct 23) This will likely be slower post the change in risk weights by the RBI.

Having said that, the measures are unlikely to meaningfully impact margins, asset quality or capital adequacy levels for most banks or NBFCs.

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Is it a good time to be in the tech sector?

The Indian IT sector is certainly a multi-year opportunity; even though the demand for IT services has been sagging in the short term due to anxiety of customers in the developed world about the possibility of global growth slowdown. Customers are conserving resources as they move into an uncertain economic outlook.

The deal pipelines are healthy indicating willingness of customers to plan and spend on IT projects, although translating these into actual revenues has been slower due to the uncertainty. As confidence builds again about global growth, it is expected that demand will spring back sharply and make up for the lag thus caused. So, there is a shorter term uncertainty in the IT sector although the medium term looks attractive.

Do you think the interest rate cut, if it takes place in the next year, will not be as fast as market thinks?

Higher interest rates for longer is a global expectation for market participants and India is not any different. Central bankers across the globe, including India, want to be certain that inflationary pressures are firmly behind them. They are unlikely to cut rates in a hurry, lest inflation gallops back, making it even more difficult for them to control it.

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In its recent policy last month (October), RBI Governor Shaktikanta Das made it clear that the central bank’s inflation target is 4 percent and not 2 to 6 percent. According to the RBI estimates, inflation is expected to be average 4.5 percent in fiscal year 2025. In fact, the RBI expects inflation to fall below 4 percent to a range of 3.8-5.2 percent next fiscal, if monsoon remains normal and there are no further policy shocks. (Source: RBI)

According to the RBI, the overall inflation outlook, however, remains clouded by uncertainties from the fall in kharif sowing for key crops like pulses and oilseeds, low reservoir levels, and volatile global food and energy prices.

Earlier, the Federal Reserve held its key interest rate steady and signalled it would remain elevated for longer than expected.

RBI’s reaction function has been in sync with our view so far and the latest decision should continue to push out any expectation of accommodation to deep next fiscal.

Which are the key themes to bet on for 2024?

What has been pleasing to see about the current market rise is the breadth of sector participation. It is usually a sign of a strong market. Sectors such as capital goods, autos, domestic pharma, insurance, telecom and defence continue to be attractive themes for 2024.

Do you think the worst is over for the chemicals space? 

The market opportunity for Indian chemicals players, which have over the past 10-15 years developed competency in various areas beyond bulk chemicals, remains significant. The opportunity has been in part accelerated by global players’ which need to diversify and de-risk supply chains. Indian companies are now expanding their offerings toward the higher complexity end, backed by growing investments in R&D, which augurs well for long-term growth, unlike the past when their differentiation was largely cost-led.

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While the need to de-risk supply chains has gained momentum especially after the Covid-19 pandemic-related supply chain disruptions, large global buyers had already been evaluating the possibility for several years. The need to diversify supply chains was triggered in part by the disruption after the tightening of environmental regulations in China around 2016 and earlier around the Beijing Olympics (2008), which impacted chemical companies.

Indian companies’ focus on specialty chemicals has sharpened in recent years. India has reasonably good infrastructure in terms of land, power supply, port connectivity etc., which are only getting better. The presence of upstream supply (such as petrochemicals, benzene derivatives, chlorine and hydrogen) and a large technically qualified manpower pool also bode well for the sector. India’s legal system (based on English laws) is fairly well understood by global companies.

In fact, the Indian specialty chemicals industry is well placed to capture opportunities.

Do you expect the rally to start soon in the FMCG sector, which has been into consolidation mode?

Consumption opportunity in India remains attractive across categories, a combination of a penetration and premiumization-driven story backed by an upward mobility in income levels. FMCG consumption on a per-capita basis in India remains well below other developing nations in Asia – a metric that is likely to improve with a rise in GDP per capita.

Rising income levels in India would lead to an increase in the population of middle- class and high-income households. The consumption pattern of both these groups is (in comparison to the lower-income households) skewed towards branded products and organized channels and is therefore likely to result in an expanded addressable market for branded players.

India’s favourable socio-demographic trends such as a young population, urbanization, growing nuclear families and mobile / internet penetration are all likely to contribute to overall consumption growth. The changing consumer behaviour, with higher spending on specialized categories and increased personalization in general (more individual usage of products), could be an incremental growth driver.

You're known as a big fan of PSU space that has been in the upward journey...

Yes, the surprise is the follow-up. Last year was a great year. In fact, the PSU banks were the best performing sector and this was after a decade of underperformance. PSU banks used to be one of the under owned space in India.

In fact, the whole PSU basket if you see is not just banks, there are defence stocks, a lot of these infra-type players as well. They have given back 40-50 percent drawdowns and the market has ways of surprising. So, going with the trend, being humble, accepting what the market is telling you, is what I have learned. So, the trend is your friend until the end when it bends.

Some of the PSU banks are remarkably efficient, indicating that investors should focus on banks with lower costs of funds. Certain PSU banks still have room to grow, hinting at their potential for further gains. Larger footprints in smaller cities for PSU banks, robust sticky and granular retail deposits (62 percent of deposits for PSU banks are from individuals compared to 43 percent for private banks) and a favourable sentiment are positives. (Source: Citi India Strategy Report, October 2023)

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