Govt, RBI now in tandem to push economic growth: Macquarie

It has been a rocking start to 2015, global volatility, a surprising rate cut from the Reserve Bank of India (RBI) in terms of timing, poor foreign institutional investors (FII) flows, excellent domestic flows and the big question whether 2015 can be encore to what has been a cracker of a 2014. The House of Macquarie will speak its mind today about how this year might shape out and to do that we have Bharat Rawla, Managing Director and Head of Macquarie Securities India and Rakesh Arora, Head of Research at Macquarie. Below is the transcript of Bharat Rawla and Rakesh Arora’s interview with Udayan Mukherjee on CNBC-TV18. Q: What are your expectations with the interest rate landscape because that recent news, how much of tailwind can it be for the stock and the bond markets? Do you see it as a one-off or do you see it as a serious start to a down cycle in interest rates throughout the year? Rawla: The rate cut is very welcomed, it is a surprise in terms of timing but personally I am not surprised because RBI Governor is a sharp guy, he knows what he his doing. He doesn’t need a lot of guidance and market talk to dictate how he wants to cut rates. So, it is very welcome. The markets are rallying this morning which is good. As a house, we expect another 75 basis points cut over the next 12 months but clearly very welcomed by the markets, very good for the financial stocks. Arora: Just two months back consensus was at zero rate cut, we were at 50-75 basis points. We have moved to 100 basis points, I think consensus is now 50-75 basis points. So, I think there is a little bit of catch up which the market is doing in terms of expectation. 25 basis points is just the start so there is further easing likely on the cards. Now, we have got two hands trying to push Indian economy, government was already there now we have got RBI Governor also coming in so probably things pick up dramatically in the year ahead. Q: Are you upping your targets for the full year or do you think 2015 because of the slow pace of improvement in growth might be a modest year in terms of returns compared to 2014? Arora: We are forecasting around 19 percent returns for the market in 2015. So, our Nifty target is 9940. Compared to last year it is little bit of a modest increase that we are projecting. However, the last year was a turnaround year for Indian economy. We had stable government after 20 years and that lead to the re-rating. So, out of 35 percent odd returns which market gave last year, 15 percent was re-rating, the PE re-rating that we saw in expectation of better growth. So, you can’t expect re-rating to happen every year, it has already happened and now it will be back to earnings growth. So, 19 percent return is consistent with around 19 percent earnings growth that we are forecasting for the market for next year. Compared to the other markets in the region India is still very well placed. So, India is among the top three countries in the region that we like. In addition we like China and Philippines, so, India is among the top three countries we are recommending investors across the region. Q: Where does it leave foreign inflows because December was a weak month for foreign flows, we saw selling of about Rs 4000 crore; not to take anything away from the huge inflows that we got through 2014 and even 2015 has started on a tepid note in terms of flows. What would you put it down to and do you see that reversing any time soon? Rawla: On foreign flows, December being a slightly quiet month is not surprising. Historically it is a quiet month but having said that in terms of business it was a very strong month for us and for the street as well. In terms of flows, we are into the second week of a new year. People are still sort of assessing how they want to place their bets. So, I am not surprised that it is off to a slightly slow start but it is not an anomaly. We have got the rate cut today which is a catalyst and the foreign investors are really looking towards India and they are looking for catalysts. Rakesh talked about earnings growth so what we are looking to see is whether we have topline growth. We need to get this quarter's earnings under our belt and then you will see the inflows coming in. There is definitely still a lot of interest. Clients are still talking about India, it is a place they want to be, so I won't be surprised that if you see the inflows picking up post results. Q: But in terms of just figuring out where the outflows may have come in from, is it redemption because of a general global risk off mood, redemption in emerging market funds or would there be different kind of investors who might have lightened up over the last six weeks? Rawla: I don't think that we have had a redemption in funds, that is nothings that we have picked up unless Rakesh, I don't think we have, right? Arora: Last two quarters the global liquidity has been going down quite dramatically and that has been one of the reasons that some of the money has left towards US and this risk off trade was on. However, for 2015 we are very confident that liquidity position globally would ease. Bank of Japan has already done a little bit of easing and they might do more. European Central bank (ECB) is the next one and if required US Fed will also come in and chip in probably QE4 if things do not really recover. So, we are pretty optimistic about liquidity picking up globally and that should really stabilise the FII inflows that should happen in 2015. 2014 was little bit tepid compared to what happened in 2012 and 2013. I see no reason why 2015 would be any worse. We should get at least USD 18-20 billion inflows from FIIs this year. Q: When you speak to your global clients do you sense that they are apprehensive because of what might happen in the events stacked up at the end of January, the Greece elections, etc? Do you see that injecting any major volatility in global equities in the next couple of weeks at all? Rawla: I think there will be some volatility with Greece with potential discussions about them leaving the euro. However, at the same time crude is helping alleviate a lot of global macro headwinds so to speak. India is slightly isolated in its own way. I don’t know if you picked this up but the World Bank cut their global gross domestic product (GDP) growth rates yesterday. Russia, they were looking for a 1.5 percent growth in 2015, they have got it down to a negative 2.9 percent. On the euro zone they had 1.8 percent growth forecasted in 2015; they have cut that to 1.1 percent. So, there are a lot of headwinds in Europe in 2015. I think the US is strong. Emerging markets (EM) cannot be put into one bucket because BRICS in itself with Russia out of the equation doesn’t stack up. So, India is looking good but we need to see some topline growth, we need to see some activity from the government that makes investors comfortable about where India is over the next three to five year. So, the jury is still out but we are hearing and seeing good things out of the government but the investors need to be a bit more reassured. However, there are headwinds and we can’t get away from what is happening in Europe. Q: Coming back to the global aspect, the other big thing over the last few weeks has been the virtual collapse in the commodity complex. First it was crude and more recently copper, what would you attribute that to and what are the key takeaways from both the macro as well as micro perspective for Indian investments in terms of portfolio allocations? Arora: Strong dollar normally is coupled with falling commodity prices because other currencies depreciate and the cost of production comes down. Oil is one of the big components for mining costs and given that oil is a new normal we have overnight cut our commodity forecast across globally because now we think that the cost can move down sustainably to a lower level. So, one there is oversupply in the market which was there for the last two years but now there is as I said liquidity tightening in the last two quarters so that is unwinding of financial positions in the commodities. Now the cost itself is moving down so that is all feeding into one into another and commodity prices have come down. For India per se it is good news and this is one of the critical reasons that we are positive on India right now. Oil prices fall and commodity prices fall has solved a lot of India’s problem which would have been difficult otherwise like inflation and fiscal deficit. So, we remain positive on India. In terms of positioning for India, you have to be playing two major themes out there. One is interest rate cut so you have got banks, autos, etc which benefit out here and the second is infrastructure build because of all this fall in subsidies, etc government will be in a much better position in the Budget when they come out to allocate more money for infrastructure spend.

They have also raised excise duty, etc on oil to fund road projects so I think infrastructure build is the second big theme which will play out in 2015. We are pretty gung-ho about three sub sectors out there, one is roads, the other is railways and third is power transmission. So, these are the sub sectors where we are looking for a major impetus from the government this year. Industrial companies, banks again feature very well for playing this theme. So, overall we are very bullish on banks, autos and industrials – these are the three critical sectors where we are strongly overweight.

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Q: Rakesh was making the point earlier about the PE re-rating having happened in 2014 already and 2015 needs to be year of the market consolidating and moving up with earnings growth. On that score there has been a little disappointment in the last two quarters, investors are not terribly happy that it is taking so long for growth to pickup and be reflected at the earnings level. You are sure you will get that 19-20 percent earnings growth that you are penciling in for this year? Rawla: We will get the earnings growth, the question is where does it come from, does it come from topline or does it come from margin expansion? What we would like to see is topline growth. So, what we have forecasted for the third quarter earnings is 9 percent growth in earnings. However, what we want to see is topline grow and our client base, investors in India are going to be comfortable about longer term aspects of our market if we are seeing toppling growth. Capex for example we are not seeing a lot of capex from private companies, capacity is not been used as yet so we are probably looking at another 12 months or so before topline growth kicks in. So, till that point it will be a market which is a bottom up market; people have to pick their stocks and make their bets and they have got to do their work on companies as oppose to broad based sectors and the market in general because as Rakesh mentioned the re-rating has happened and now it is a stock pickers market. Q: Going back to the point about commodities, you spoke about the macro impact but just in terms of your portfolio allocation or strategy towards two sectors, oil and metals, how would you translate that to playing those two important sectors in 2015 in the light of what is happening globally? Arora: The obvious answer is underweight both these sectors because no amount of volume growth can compensate for the huge sensitivity to price increase or decrease to earnings. However, from India’s perspective the whole metal and mining space is going through a big change. In fact the coal block auction scheme which government has come out with or the new Mines and Minerals Development and Regulation (MMDR) Act amendment which has been recently passed, all these are pointing to a change of era and a start of rediscovery of the mining sector. This is going to push production to a much higher level both for coal, iron ore and maybe even bauxite, etc. Indian prices have sustained at a much higher level despite global prices were falling. So, to give an example iron ore prices went up in India by around 8 percent in previous year as compared to a 40-50 percent fall in global price. So, we are expecting that with the increased production that India is going to see, commodity prices in India will now start to fall. So, while we are excited about the mining production growth, commodity prices are going to come under pressure and this doesn’t augur very well for the profitability of the mining companies. So, staying away is the call at the moment. We do like certain stocks, we like Coal India, Hindustan Zinc, Jindal Steel and Power and Hindalco. These are our preferred stocks in this space. However, overall we will be underweight this sector. Q: Oil, upstream and downstream? Arora: Upstream companies definitely have to bear the brunt. Now, oil prices are almost at the same level where Oil and Natural Gas Corporation (ONGC) was realising post subsidies. Only if oil prices go up the benefit of subsidy reduction will flow into ONGC. So, ONGC looks very cheap but I don’t think there are too many triggers at the moment. Investors might have to wait for too long. Downstream companies do benefit and are benefitting quite a bit and stocks have risen. We continue to like HPCL the most out of that whole lot. However, overall not pushing too much of overweight on this sector also; more of a slight underweight. Q: We spoke about FII flows but the other big emerging theme seems to be that domestic inflows are becoming as important a factor as foreign flows; last two months that seems to be the trend. Do you see that being a dominant theme in 2015, the return in a sense of the domestic investor into equities? Rawla: I definitely agree with that and I think for us sitting in India, it is easy for us to gauge retail investor and domestic investor coming back into the market. A lot has changed in the last 18 months. 18 months ago people didn’t want to get back into the markets, it is not because they were burnt it is just that they didn’t see any growth or they were probably feeling a lot better keeping their money in fixed deposits. However, talking to people over the last 12 months, people want to be invested in the market. Similar to FIIs, people want to see the catalyst; they want to see some action in terms of positive steps taken by the government. However, generally there is euphoria with retail investors and they are just thinking about when they get back into the market. So, we will see a lot of inflows into the Indian mutual funds. As our business itself, we are seeing a lot more activity with domestic clients than we did say 8-10 months ago. So, it will be a big theme in 2015. Q: I am going through your top largecap and midcap portfolio and some of the names are predictable like ICICI Bank, Maruti Suzuki, Tata Consultancy Services (TCS) but the interesting thing is industrials where while people buy the thing that this is a turnaround time and autos and banks will do well, not everybody is convinced about industrials. But you have got names like Crompton Greaves in your portfolio; you are sticking with the bluechip Larsen and Toubro (L&T), do you think industrials will pay off in 2015 or could it be a question of them trying investors patience? Arora: Industrials will play out in 2015; we are bullish on company like Crompton Greaves. Government has earmarked USD 7 billion funds for power transmission and that should benefit companies like Crompton Greaves which are in transmission equipments, etc. Secondly also remember that all this fall of copper price, etc is feeding directly into their margins. So, margin expansion is going to be a continued theme for companies like Crompton Greaves. We have seen in the last few quarters margins for industrial companies have been going up and that has been the positive surprise. I think we should see much stronger margin expansion in 2015. Similarly, we are bullish on mining sector in India. Cummins is a great play out there that supplies to this sector and growth is going to go up, again commodity prices falling off augurs well. So, apart from the infrastructure push we expect from the government there is a margin expansion story also out there and this is one sector which is going to surprise. We have almost 30 percent higher than consensus earnings estimate for industrial sector and this one standout that we are pushing which is anti-consensus at the moment.