Developed markets may no longer continue to outperform the emerging markets, says Chief Executive Officer of Deutsche Bank India, Ravneet Gill. The rupee too, continues to perform better than other emerging market currencies, he adds.
Investors are looking beyond the demonetisation impact now. There may be a lot of volatility and a hightened level of sensitivity, but in the long-term, the foreign institutional investors continue to remain positve on India, says the Chief Executive Officer of Deutsche Bank India, Ravneet Gill.
Developed markets may no longer continue to outperform the emerging markets, says Gill. The rupee too, continues to perform better than other emerging market currencies, he adds.
Current fiscal may see a Gross Domestic Product less than the pre-demonetisation estimates of 7.1 percent, says Pratik Gupta, Head, Equities of Deutsche Bank India who is expecting a strong recovery. The GDP is expected to grow 7.5 percent in financial year 2018.
After last week's H1B visa scare, the IT stocks witnessed a significant correction. This correction only makes them more attractive as the issue may have a maximum of 2-3 percent impact on IT's FY18 earnings, says Gupta. Well-run IT companies should continue doing well.
In the next 6 months, the RBI may cut rates by around 50-75 basis points, says Rahul Chawla, Head, Global Markets (Debt) at Deutsche Bank India. The CPI inflation may continue on a downward trend.
Gupta is cautious on banks in the short-term, but positive in the long-term. This is due to the concerns about NPAs being largely priced into the market.
He is also positive on auto stocks, saying earnings will bounce back for them. He prefers four wheelers over two wheelers.
Below is the verbatim transcript of the interview.
Q: While yes it is a New Year, over the weekend and over the week the cues have been somewhat negative in the sense first it was Ford and then Toyota also has been told by Trump not to manufacture outside, the H1B visa bill introduced, is it all looking like the short emerging market (EM), long developed market (DM) trade is going to continue?
Gill: If you go back to the second half of 2016 as well, I think the presiding theme was that you could see a reversal of flows from emerging markets back into the developed world. If you see India’s own flows, it hasn’t really quite panned out that way. I think we are living in an environment where you will see a lot more volatility. There is so much happening, if you look at India, you look at the world around us, you look at some of the political developments that happened in the rest of the world, I think to use a term which is now very common in terms of the new normal, I think that is pretty much what it is.
However, do we see a divide coming through with respect to this being again becoming a developed world story rather than emerging market, I don’t quite see it that way. I think even if you go back to last year, the first quarter was very turbulent and then things eventually settled down. I also think that right now we are at a slightly heightened level of sensitivity relative to what has happened locally which in itself has been broadly positive. It is just that the level of dislocation has been so high that we haven’t been able to make full sense of it. However, my own sense is that things are not as worrying as they may seem and a lot of this political rhetoric will actually settle down.
Q: I will come back on what is really the foreign institutional investor (FII) view especially with respect to India but since you touched on demonetisation as well, over the weekend or just before that, we also got the gross domestic product (GDP) numbers. I know it is extremely macro but even with seven months of data, the Central Statistics Office (CSO) has downgraded its forecast or rather it is giving you a forecast of 7.1 percent, 0.5 percentage point lower than the last year. Now, if you factor in -- your GDP growth if I remember Taimur was saying that it was 7.1 percent after taking into account. So, now are you going to worry afresh about your earnings as well for the second half?
Gupta: Firstly for FY17, the earnings estimates have anyway taken a hit after demonetisation. Various sectors across the economy have been hit. So, I think from an investor standpoint, they are anyway looking beyond FY17 and the questions are more around what will be the extent of the recovery in FY18. There what we expect is while FY17 you will see lower GDP growth, possibly lower than the 7.1 percent which the CSO is saying based on the pre-demonetisation estimates, but FY18 we think we should see a pretty strong recovery.
Our economist expect 7.5 percent GDP growth next year, our analyst team expects the index earnings growth t0 rebound to the 18-20 percent mark and this assumes no extra stimulus in the Budget which is coming up which is another event, so, I think investors are looking beyond the demonetisation slowdown which is already played out and priced in to a large extent in our view.
Q: I will come to where that 18 percent comes from and I would assume that you have some Budget expectations but before that, the 6.11 percent was the best 10-year yield and then that got washed away. Now, we are closer to 6.4 percent. Is fixed income going to give us much in 2017, will we even go sub 6 percent or is 6.11 percent the best we will get?
Chawla: The view is that, coming to the fact that in terms of rate cuts we still believe that there is an appreciable amount of rate cut ahead of us. We think that we have got 50-75 basis points rate cuts in the next six months. We think it is going to be front-ended. In terms of treasury yields, we also today are factoring in a forecast of about 6.2 percent. So, we think that there is a trending of yields downwards.
A lot of it has got priced in because the market has been flushed with liquidity and people are anticipating and the other thing that we have to keep in mind is a positive that could flow from here is the fact that the consumer price index (CPI) inflation data could trend lower than the 5 percent that we had projected; it could come down to about 4.5 percent which would give adequate room for the Reserve Bank of India (RBI) to think from a monetary policy expansion point of view.
Q: I was going to ask you more about Budget being a stimulant, 50-75 basis points you are outliers. The best I have heard is one to two rate cuts, you are looking at two to three rate cuts, all of it coming in six months you think, first three policies of the year or just in two policies of the year?
Chawla: Our view is it could be three, it could also get accelerated. They do want to have a quicker impact of trying to revive the economy. Clearly the private consumption needs to be revived as well along with public spend.
Q: So you would look at lower than 6 percent yield on the 10-year in the first quarter?
Chawla: Potentially, we are targeting a 6.2 percent but there is a certain upside if the rates cut tend to be a little more on the positive side upfront.
Q: If it is 5.5 percent repo rate then at some point it goes below 6 percent?
Chawla: Typically you would have a differentially of about 50 basis point odd so it could touch 6 percent definitely.
Q: What are you hearing from the FIIs, while they have definitely deserted emerging markets in favour of developed markets, India has been deserted a little more. However, are you getting a sense that this will turn sometime soon, what is the in-house view?
Gill: If you look at the FII view, it gets reflected also in terms of how the rupee has performed and if you look at the emerging market currency, rupee has definitely been one of the better performers which would tend to suggest that the view on India remains positive, remains constructive. I think if you look at all the emerging markets right now and you look at it from a growth perspective, from fiscal consolidation perspective, you look at the twin deficits, I think India still really stands out.
The question is that nobody saw dem0netisation coming and if you see a economy where cash to GDP is 14 percent which is effectively the highest, even if you see the comparable emerging markets like Brazil or South Africa, they are at 4 percent and 5 percent, I think the level of dislocation has been huge. People have still to make sense of how long could the impact of this be. The question really is that -- my own sense is that in two quarters India would have digested this and you will start seeing a stability return to the system.
Q: FII flows is not there for two quarters you think?
Gill: No, I don’t think so. I think FIIs will remain engaged. Right now it is very difficult to make calls with regard to how quickly demand will come back, what earnings growth will be. However, if you look at it at a philosophical level, at a broader macro level, what is six months in the life of a nation? So, yes, it is two quarters of earnings and analyst get driven a lot by that. However, to come to think of it, our generation has always complained that India only believes in incrementalism so if India takes a step which is really large, substantive, transformational, I think we need to see it in that context.
Did the system need to be cleaned up, was the cleansing required? To my mind if you see the performance of this government, this is the first real expression of Swachh Bharat, of cleaning up India and the cleansing. Even though people keep talking in terms of all the cash having come back into the system, it has come back now into the real economy and it is in the formal economy and the impact this will have respect to tax collections and our saving rates being more productively channelised, absolutely so I see it as a positive all the way through and I don’t think that the FII view is very different from that.
Q: IT has taken a bashing more so in the last few days as it were. Is it now cheap enough to be bought in your sense or is there a secular damage that these IT earnings can face?
Gupta: We were actually, if you recall, at the start of last year we were underweight on IT but given the price correction, the underperformance of these stocks, now we think these stocks are looking pretty attractive especially after the correction last week on the H1B visa fears which we think will at best impact earnings by 2 to 3 percent for FY18. If you look at the stock prices right now, they are valuing these companies on the basis that you will see roughly single digit earnings growth for the next four-five years - that is the bare-minimum which we think these companies will deliver maybe there are upside surprises from better cost savings and don’t forget these strong US dollar is something which was not been factored in and the possibility of this dollar strengthening even further.
Second, with Trump coming in, reviving corporate America we have seen corporate capex which is has been very depressed for the last couple of years could get a life of its own. We could see discretionary IT spending come back in a much bigger way than what the street is expecting right now. We think some of the well run, the largecap IT companies they could do pretty well and that should be a core portfolio holding from this point onwards.
Q: You can name names?
Gupta: Unfortunately no.
Q: More importantly Bank Nifty, I am a little surprised that the way in which it has supported the Nifty in the past few days when IT took a bashing is this just technical or is there something in banks that attracts you?
Gupta: Banks firstly, the way the valuations have moved up in the last few days as well as given the impact of the demonetisation move, the slower credit growth we are seeing, from a tactical perspective we would be cautious on banks but structurally in the long-term we would be positive versus, let us say, NBFCs. We think the fact that you will see lower cost of deposits, with technology kicking in, the operational cost coming down etc; banks are poised to do better. However, in the short-term we would be little bit cautious.
Q: So you would wanted to get cheaper before you buy or you want to see a one quarter of NPAs getting ironed out? They have got some bit of a leeway in terms of under Rs 1 crore loans which perhaps is more useful for NBFCs, so therefore you think something might come up horrible in March 31st quarter?
Gupta: The NPA concern is largely in the price specially the NPAs on the corporate side even and after demonetisation the SMEs and the agri NPLs are also - investors are expecting those to spike up, even if they are not recognised in this December quarter perhaps by the March quarter. The bigger concern in the short-term is the impact on credit growth given the overall economic slowdown, the fact that you could see spreads compressing in the short-term. So, this is more of a tactical one to two quarter phenomenon which we have to look past. However, longer term like we said we prefer banks over NBFCs now.
Q: What is your hierarchy in terms of sectors itself? Where are consumer discretionary autos for instance and even for that matter others like Titan of the world, the big fear is that demonetisation is going to hit the psychic of the rich consumer?
Gupta: After the correction in the stock prices as well as the fact that a lot of it has been priced in, it is already anticipated in terms of the earnings for December quarter and perhaps even for March quarter. We are now actually turning far more positive on autos and consumer discretionary than we were three-six months back when valuations were very high, these stocks were priced to perfection and as it turns out demonetisation unfortunately impacted earnings growth. We have seen the stocks correct quite a bit.
However, don’t forget the impact of lower interest rates, as Rahul was alluding; interest rates have already come off with more downside going forward that should stimulate demand as well. So, we think you would see a fairly strong recovery in FY18. Autos in particular, we think while valuations are above trend, but you also have earnings which are cyclically depressed and could bounce back very strongly in FY18.
Q: Four and two?
Gupta: More four than two.
Q: I just wanted to ask you do you think this 7,920 has held or 7,900 on the Index. Is it downside at least protected for the markets because you keep saying that there is a near term negativity?
Gupta: If you look at what has happened in the last few months also as Ravneet was alluding to earlier, we have seen significant emerging outflows, but India has not seen the absolute level of index go down that much and one of the reasons for that is very strong domestic inflows. Even in the month of December we have seen about Rs 10,000 crore worth of domestic equity inflows. This in our view is the secular trend given the relatively poor investment alternatives real estate, gold, even fixed income at these interest rate levels the upside is not that much. So, therefore equities we think will continue to attract more flows and that should keep the market supported - that is one and second the lower interest rate should also help equity valuations, when you discount the earnings back the valuations also gets support. So, we think not that much downside unless something major happens globally.
Q: Therefore what is the upside for equities give me a Sensex or a Nifty level or even earnings, a return growth for the current year?
Gupta: Earnings we are expecting a very sharp rebound because FY17 earnings have been depressed, FY18 goes up, so FY18 we could expect almost 20 percent earnings growth but the returns will be a little bit lower. We expect roughly about 10 percent upside at the Index level mainly because a lot of it is priced in and really you have to play sector by sector, stock by stock.
Q: Sharp growth in earnings of 16-18 percent in FY18. One pump-priming factor will be the lower rates that you are expecting. What are you expecting from the Budget?
Gill: What the Budget really needs to address effectively speaking is somehow reviving the entire investment cycle. It has been there for a long time. Initially, we thought it will take six months, nine months, I still do not see any private sector Capex happening over the next four quarters at least. There is still a lot of leverage, still a lot of over-capacity which means that the investment has to come from government spending. And to that extent, if you look at sectors like roads, railways, defence, power, I would definitely like to see a lot more happening over there in terms of government spending.
Equally, if you look at it from the point of view things like affordable housing, the Prime Minister has talked about it very briefly in the December 31 address, you will see a lot happening on that side.
Q: Let me put it this way, this is a favourite question we have with all of our top-experts. ‘If I were Finance Minister,’ what would you do? I want you to start your sentence that way.
Gill: Very often, we have said that a higher fiscal deficit is looked down upon and to that extent, we need to rein it in very aggressively. At the end of the day, whether it is analysts, whether it is the rating agencies, they look at the quality of spending. So, it is going towards consumption, it is going towards subsidies, they look at it a little negatively. But if it is going towards infrastructure, it is going into Capex, there is a little bit of a positivity around it and in no way will it impact India’s credit rating.
So, if I were FM at this point in time, I would take a slightly more aggressive bet and go out there and spend aggressively as part of this Budget. And I do hope that you will see more government spending in this particular Budget as well as tax reforms.
Q: Tax reforms would be corporate, personal? What kind? Both?
Gill: Maybe it sounds a little self serving, more personal than corporates at this point in time. But, if you look at it, one of the main reasons for demonetisation was that you want to make sure that the unaccounted economy contracts a lot. To some extent, that purpose has been fulfilled. Equally, on the other side, which is the more official hoverboard kind of economy, you need to reward that as well. And I think that the government will take a very balanced, calibrated view in that regard.
Q: Your theory has been that there could be some aggressive rate cuts. But, there are two things that the world is telling us. One, this rocketing of the dollar, of the dollar index, even if it has left the rupee unscathed so far, that could be something which the RBI will have to watch out for and Fed hikes. How will these two play out on bond markets in particular and the RBI in general?
Chawla: Our view, if you compare it vis-à-vis the currency itself, starting from there, we believe that there is some amount of depreciation that will step in. That is something that we are factoring in, in the rate cut that we have mentioned. We think the rupee depreciation would trend in terms of our projections closer towards 72.5 per dollar number with 70 per dollar becoming the more normal. So, there is some amount of, obviously for export competitiveness as well in our export oil companies, we need to have some revenue offtake from that.
So, we think there are some of these things that are factored, but our domestic economy, the fact that to the point that both Pratik and Ravneet mentioned, you need to revive the growth. And t6he growth has to be revived by giving more money either directly or by way of rate cuts. So, I think the government will have to take that potential view in mind and keeping the fact that their 1 percent real interest rate target could be achieved by achieving these rate cuts still.
Q: Since there is a big monetary push to consumption that is expected and a big fiscal push again, probably tilted towards consumption that is expected, your top sectors.
Gupta: Like it said, you cannot take a macro view in my view, this time around because you look at which sectors are cheap where valuations have come off and become very attractive. That would IT services, for example. If you want to play consumption, we think autos and consumer discretionary. The other way is also infrastructure push we are expecting, there we think to play that sector is through cement. Now, cement obviously, you will see a very sharp slowdown in demand. We expect cement industry demand to be down to as low as 1 percent for FY17, but for FY18, you could see demand rebound to 7 percent, specially, if there is a push on affordable housing. So, cement is one sector we think stands out as something which we should play.
Going back on the valuation plays, the other sector which stands out is oil marketing companies, the power and gas utilities. There we think specially, the oil marketing companies, these are still stocks which trade in single digit price-earnings ratio (P/E), high 20 percent plus return on equities (ROE), we think the street is still underestimating the kind of earnings growth we will see at these companies. So, that is another sector we like.
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