Demonetisation: After pain subsides, see tax-to-GDP ratio rising to 20%: Ambit

Speaking to CNBC-TV18 Ashok Wadhwa, Group CEO of Ambit, said that demonetisation has reduced the consumption engine which was propelling the Indian economy.“Very clearly, we were operating with an investment cycle which is not yet fully picking up.” Since private sector investors aren’t investing, the burden of capex will fall on the government and corporate earnings are going to be disappointing, he warned. “The market is reflecting that dilution in corporate earnings,” he said.Post the phase of uncertainty from the demonetisation effect, he believes money will come back into banks and financial intermediation will be a reality. He also expects the cost of capital to drop. And finally, tax-to-GDP ratio will possibly move up to 20 percent.The Budget will likely focus on planned government expenditure, he said.Below is the verbatim transcript of Ashok Wadhwa’s interview to Prashant Nair & Ekta Batra on CNBC-TV18.Prashant: How are we placed in terms of the economy and stock market levels at an aggregate level? Are things starting to get better or it is just start of the year kind of cheer where everyone waves in says well this year can’t be worse than the last year? Is it possible that we are yet to see the bottom both in economywise and marketwise?A: Let us start with the economy first. Clearly we are still suffering from the aftershock of the demonetisation policy and anybody who thought that such an important and transformational change can happen without some element of pain and perhaps sustained pain wasn’t bargaining right at all.What we are going through now is a natural outcome of a transformational policy perhaps the most transformational since independence in India. What that has done is it has reduced the fire power of one engine, the consumption engine that was propelling the Indian economy at this point of time.The effect of this important policy change is not just a two-month change or a three-month change on demand. We still have to see how sustained the kind of dilution in demand is. Very clearly, we were already operating with the investment cycle not yet fully picking up, people still not in a mood to make CAPEX, people still not in a mood to increase capacity. With that backdrop, as I said the one engine that was firing has a diluted effect, which obviously means that the economy is suffering from that shock shall continue suffering from that shock for a period of time.It is anybody’s guess whether that dilution will continue to operate for a three-month period, six-month period. Our analysts believe that it could be as much as 15-month to 18-month period. However, one thing is certain that the investment cycle is not coming back. Private sector investment is still not being conceived or considered, which effectively means that a lot of burden for a capital expenditure will fall on the government and we will have to see what the Budget does. With that background clearly, corporate earnings are going to be diluted and disappointing. Therefore, if you reflect that on the market at this point of time, perhaps the market is correctly reflecting that dilution in corporate earnings.My own view is that we don’t necessarily have to be pessimistic on the markets at this point of time but we have to be certainly cautious. If somebody was to ask me and say has the market bottomed out? I would certainly say that there is going to be one or two other opportunities perhaps soon when you will see further dips in the market.However, nobody is going to be able to time the market perfectly. Therefore, if people said, is this is a good environment to start considering buying and getting back to the market? I would say it is the start of a good environment and perhaps some of the early buying of 2017 reflects that any which way.Ekta: It sounds as though you are much more cautious than optimistic because in one of your previous interviews you did mention that you are cautiously optimistic. However, now is the caution overweighing the optimism for 2017 is that how we should read it?A: I would say that clearly now and perhaps for Q1, perhaps for the first of 2017 we continue to be cautious. Having said that, I remain optimistic both on the market and on the Indian economy in the medium-term to long-term. The positive impact of what the Prime Minister and the government has done over a medium-term to long-term cannot be underestimated at all. Once we go through this painful period, there is every reason to be significantly optimistic.What that turning point is, whether that turning point will be at the end of Q1 of 2017 or the first half of 2017 calendar year one still does not know what the right timing could be.Prashant: I just want to understand from you what is, when we say that it is the positive impact over a medium-term to long-term will be felt what is that period we are looking in by when the effects will start to show and what exactly are those benefits that we will see?A: In a lighter way to begin with Asia money poll results have come out recently and as you may have seen Ambit has been voted as the most independent broker second time in a row and we have also been voted as the most improved broker fourth year in a row. Therefore, the point I am trying to emphasise is that Saurabh Mukherjea and the research team are fully entitled to and have a right to have their view and as an organisation we certainly give them complete liberty and freedom to state what they believe is the right outcome based on the work that they do.On a more serious note honestly, nobody can define how long the painful period will continue. The government machinery has been talking about it being a three months period, many market participants talk about it being a 6 to 9 month period, I know that my research team talks about being it being up to a 12 month periods.Honestly, when you look at a long-term a five or ten year horizon, it is irrelevant whether it is a three-month period or a six-month period or a nine-month period. I think there is consensus on the fact that through this painful period there will be dilution in corporate earnings, there will be a negative impact on gross domestic product (GDP).Prashant: So, let us assume it is 12-months or maybe 15-months the painful period, the question is post that period what are the changes for the better that we will see because of what has been done?A: If you look at the two important statistics 24 lakhs people in this country report an income of USD 15,000 and 12,000 people in this country report an income of USD 1,50,000. I mean something significant needed to be happening. The reset that the Prime Minister has pressed is to attack that part of our economy that is earning income but not reporting income.My own view is that there are some significant positive outcomes once this whole sustained attack start showing positive results. One, clearly, there will be a significant amount of money that will go into the banking system and therefore financial intermediation becomes a very important positive growth phase from there onwards.Second, once banks gets a significantly larger supply of money coming through it, we have reasons to believe that long-term interest rates will drop. Cost of capital in this country will drop. We have to be competitive on our cost of capital if Made in India has to be a serious and a successful dream for us.Third, our tax to gross domestic product (GDP) ratios is appalling at 11-12 percent. It needs to move to 20 percent and I would like to believe that the reset that the Prime Minster has set will help us achieve that over a longish period of time. Once we get to those numbers, we are in a significantly better position and we are in a significantly better monetary position I would like to believe.Ekta: What exactly is your expectation from the Budget this time around because there is an underlying fear in the market that maybe, it could be a little more populist in nature simply to assuage a little bit of pain that we have seen post demonetisation. Your sense in terms of what the Prime Minister announced on December 31, and if you could extrapolate it to the Budget?A: Perhaps, some of the more populist measures have already been announced by the Prime Minster. Having said that, if there are some more populist measures in the Budget, I do not think it is to be disappointed with or to be frowned upon. The government has taken upon its agenda that it wishes to build a country and an economy that is a little more egalitarian that we have seen so far.Having said that, I continue to be positively inclined towards what I think will be the contents in this Budget. There will be a lot of focus and attention on planned government expenditure on infrastructure and in terms of capital expenditure (Capex). Government recognises that at this point of time, private sector is not inclined to making investments. Therefore, government will ensure that it creates that adequate balance that it needs to create at this point of time. So, there will be a lot of planned expenditure in the infrastructure and perhaps capital expenditure over the sorts.I also see a rationalisation of tax rates. I recognise that thus far, reduction in tax rates, both in 1997-1998 and once or twice after that, have not resulted in commensurate increase in tax collections. But if one is to look at that way government is trying to formulate its strategy on attacking black money, one can safely believe that there will be an increase in threshold for the lower class, for the minimum tax payable, there will also perhaps be a simplification on tax brackets for individuals, perhaps maximum marginal tax rate of 30 percent instead of 35-36 percent effective rate today. One can hope for some reduction in corporate tax.Government will have to play a balancing game between not disturbing fiscal prudence and providing tax concessions. But recognising that both demonetisation and goods and service tax (GST) after that is hopefully going to result in due course with significantly larger collection in taxes government could perhaps pre-pone some of the tax concessions and start the process with the Budget this year. So overall, there will be decent and good news in the Budget even if there are some populist measures.Prashant: How do you see these drops in interest rates that we are seeing purely from a banking investor point of view? Some people are concerned that the onus of trying to restart lending once again being put back on the shoulders of banks, especially public sector banks. Questions like whether the sharp rate cuts that we have seen in a very low credit demand environment reflect that or is it purely a function of the marginal cost of funds based lending rate (MCLR) formula in those things. Any thoughts there?A: I would say it is a combination. Clearly, government is concerned about credit uptake and wishes to provide positive incentive for people to go out, borrow and start the investment cycle again. To that extent, the public sector banks are facing a little extra burden. Having said that, we do know that public sector banks are flushed with liquidity at this point of time and  what the government is trying to say is try and pass on some of the benefit of that excess liquidity that you will continue to receive on to the borrower and kick-start the investment cycle or the positive sentiment.I would worry about the non-banking finance companies (NBFCs) more than the banking sector because the NBFCs will have to compete, particularly those that lend to the small and medium enterprises (SME) and also the housing sector. They will have to compete with the banks and therefore, they will be under pressure to reduce their lending rates to be competitive and yet, they do not have exactly the same flows that the banks have on the liabilities side. So there will be a bit of a mismatch in that sense for the NBFC sector and I would worry a little about them at this stage.Ekta: I wanted your thoughts with regards to the Central Board of Direct Taxation (CBDT) clarification that came in on foreign institutional investors (FIIs) and indirect taxation on December 21. Your sense in terms of whether that is going to impact FII flows to a larger extent that once they come back from holidays, they start looking at it more closely, they realise that there could be an element of double taxation and hence, there could be some amount of pulling out of money from FIIs. Are you sensing that? Are you cautious about it?A: First and foremost, I have a little sympathy for Arun Jaitley, our Finance Minister, at this point of time. Vodafone has created such a negative perception and such negative illusions that almost everything gets driven and connected with Vodafone. I have not read the notification exactly, but I have read the commentary on that in the respective papers. I would like to believe that it has never been their intention. It is not government’s intention to try and attack foreign portfolio investors (FPI) and FIIs and bring in retroactive tax through this process of equating transfer of shares in Indian companies through funds with the Vodafone case.I also recognise that it is very natural for people to come to the same conclusion that if there is an underlying stock, which is an Indian stock that is moving out then clearly, Vodafone would apply. I have no doubts that the government will provide a clarification on the subject sooner rather than later.So, I have some sympathy for Finance Minister Jaitley. I also have some sympathy for the FIIs who are reading Vodafone into this and I hope the government will provide the clarification.My own belief is that it is not the government’s desire or intention to try and attack the transactions. I think Finance Minister Jaitley has, on more than many occasions, said that he is not going to support the concept of retroactive tax. And it is time for us to believe in that. Let us wait and watch, let us see what CBDT comes up with appropriate clarification. Hopefully, the matter will get resolved at that end.