GST for first 12 mnths will be disruptive: Credit Suisse

In many microfinance institutions (MFIs) the lending behaviour was starting to get risky and people were jostling for market share. Once in systems like these you see a temporary slowdown. For many MFIs and non-banking finance companies (NBFCs) the concerns can be longer-lasting.

After the effect of demonetisation subsides, then GST disruption will start to keick in, he said, adding that these radical reforms will cause some short-term pain.GST for first 12 months will be disruptive for the economy, he said.

The next twelve months will be one of time correction, he said.Below is the verbatim transcript of Neelkanth Mishra’s interview to Latha Venkatesh, Sonia Shenoy and Anuj Singhal on CNBC-TV18.Latha: There is a kind of seismic move happening in global markets, if you can explain that to us, this sharp rise in US yields, sharp fall in emerging market (EM) currencies, is there more of this that we will see and therefore will there be a bigger fall out on Indian equities?A: That is risk that we have to watch out for. The reaction in the EM currency so far seems to be a very reactionary move at least in my understanding the external accounts readjustments that needed to happen in economies like Brazil, Indonesia have more or less happened. There is knee-jerk reaction that people have. Some of these economies do have bond markets where there is significant foreign participation  very unlike India and therefore a rise in US yields can have an impact on the local interest rates also starting to move up and so economy like Singapore and Hong Kong -- therefore there is some risk.The kind of panic that used to happen earlier where some of these economies would start seeing intense stress very quickly, I would say that is a bit unlikely because as I said most of the external account adjustments have happened and other than oil -- because many of these economies are also commodity exporters -- almost every other commodity seems to be holding up if not doing very well. So, I don't expect this to be as turbulent as it was. Let us be clear that if the rise in yields portends better growth or it is happening because growth expectations are reviving then there is less of a risk. Therefore I don't expect this turbulence to last a long time.Anuj: The other issue is would this also mean going forward we will have a Fed rate hike and with all these factors adding up is there a risk of prolonged period of uncertainty for EMs including India?A: The Fed rate hike, yes our official view has stayed unchanged, so we do think that the Fed will hike in December. Then the question will be when the next hike happens, will it happen in March or June. The point is that it is more or less priced in.The uncertainty will be quite a bit more limited than what we had seen in earlier episodes when commodity prices were falling, when the external account balances of EMs were much weaker and therefore they were much more susceptible to sharp changes in the direction of capital flows. I don't expect that to happen this time.Latha: I take your point that if the rise in yields is because of the growth of the US economy, things could get neutralised. But there could be a time gap between that. First the yields rise and you don’t see demand on the ground for metals and stuff like that. So in the meanwhile, do you think EM equities can have a rougher patch than we are prepared for?A: I would debate that. You can expect or assume that perhaps financial involvement in metals like copper or aluminium or zinc can be driving the prices up, that theory remains but you cannot speculate too much on iron ore because it is very high volume, it takes a lot of space to store. It is a very physical commodity as it gets.If you see thermal coal, thermal coal prices who would have believed are above USD 100. Coking coal, it almost seems like steel bull markets, if you remember USD 300 plus. These are very hard physical markets. So, there is demand on the ground and how much of that demand is just restocking and if you remember in April we were having this debate on how long the strength in steel will last my expectation was that two years of steady price declines means that everyone in the supply chain has reduced steel inventory to the largest extent possible and as prices bottom out and as they start to rise people suddenly start demanding a lot more of that. That is exactly what is happening.In metals like zinc, there is a clear shortage that people are now starting to expect, which is the reason for the strength. In aluminium where a lot of the cost is power cost. So, if thermal coal prices are at USD 100 plus, I see no reason why aluminium shouldn't rise from here. So, this is not as speculative and at the margin, you would expect if the dollar was appreciating and interest rates were rising then the financial speculation in commodities should have come down, not gone up. So, there is a physical demand, how much of it is restocking and how much of it is steady demand is something we will discover over time. But for now the demand should stay.Sonia: Wanted to talk about the issue closer home which was the demonetization of the currency that we got day before yesterday. What impact do you think it would have on consumer discretionary, on the wholesale channel, on NBFCs, MFIs, etc? Are we staring at a protracted negative impact?A: There will be sectors where there will be short-term but very intense impact, but at least in the case of non-perishables you should see demand reviving once the currency situation normalises. There will be sectors where the demand destruction could be permanent. So, for an MFI, for an NBFC, given that the last mile collections, in many cases disbursements also cash based, there will be one or two weeks of disruption at least, if not much more, because in many of the geographies where these firms operate, the cash would take a while to reach.You have to understand that unlike the 1978 demonetization, here 85 percent of the currency is no longer useful. There will be phases, like the first few days, some people were accepting the Rs 500 and Rs 1,000 notes, but again as the expectations change, those acceptances have also started reducing. So, like one big MFI which was accepting Rs 500 notes is no longer accepting them from today.So, for sectors like MFIs and NBFCs and even staples, domestic pharmaceuticals, even cement, the disruption in the supply chain could be quite intense, but hopefully it will be short-lived. So, as the new currency floods through the system over the next few months, things should normalise. Within this category, there will be sectors like MFIs where the customers do not have much buffer.Anuj: Is that what is driving your underperform rating in names like Bajaj Finance and Bharat Financial Inclusion, which have otherwise been good wealth generators and after this near-term worries are done, do you think these stocks will become buys again at lower levels?A: For some of the MFIs and NBFCs -- these downgrades were made much earlier and the fear we had was they had become overvalued. Not to take specific names, but in general, in pockets like loan against property (LAP), in many MFIs themselves, the lending behaviour was starting to become very risky, which is another fear which I was alluding to just now, which is that once these -- not pyramid schemes, but where people are lending to pay interest, that kind of behaviour had started to creep in, people were jostling for market share. Once in systems like these, you even see a temporary slowdown in fresh cash injection and new stresses can emerge.So, therefore, even though the currency disruption should get over in a few weeks, for many of these MFIs and NBFCs, the concern can be somewhat longer-lasting than that. Then there is a category where there is likely to be permanent wealth disruption. So, the cash that does not come back into the system, suppose it is Rs 3 lakh crore or Rs 4 lakh crore or Rs 2 lakh crore, it could be anything, that cash not coming back into the system is wealth destruction and very little of that was money under the carpet. It is like a parallel black economy, which this cash was being used for transactions, for land, for real estate and so on and so forth. Those transactions slow down and you see decline in land prices or even if they are temporary or 3-6 months, a decline in real estate prices and that can create second order effects on banks that have real estate exposure on NBFCs that have LAP exposure and that demand destruction can be longer lasting than just 2-3 months.So, there is of course an expectation as well as the gains that the RBI will have on its balance sheet and there will be a continuing debate on whether it should be used by the government, whether it should be transferred to the government and if it is transferred to the government, how will the government use it. Those debates will continue for a while. But outside of that, the demand destruction can slow down the economy.Coming as it is, just before goods and services tax (GST), the GST implementation which is supposed to start from April 1 -- while it is a great development for the economy, from the medium-term perspective -- from the 6-12 months perspective, it can be very disruptive for the economy. So, we are now staring at a period of maybe 12-15 months where the economy will be finding its bearings. I have been telling investors that look, everyone wanted radical reforms, the demonetization and the GST are radical reforms, but radical reforms do not come without pain and this pain can be much longer than just 1-2 months.Latha: 12-15 months? Nobody told us that long. We were under the impression that it would be a quarter or so. That is a little unnerving.A: No, a quarter or so for the demonetization, but then the GST implementation disruption starts to happen.Latha: Obviously, the winner all the way would be the banking space because they probably get more deposits cheaper as well, probably bond yields will fall if the government cuts its borrowing because of higher tax pain. How much of a gain do you see the banking sector have?A: Banks -- the last I thought -- were in the business of lending, not collecting deposits. I am just joking, but the point is that if you see a surge in deposits, but the credit demand is not as strong, of course, there is expectation that as the black money market slows down, you will see more formal system borrowing for even working capital and all of that, but that is like 3-6 months later. You have to understand that the money coming into the banking system in the form of deposits in the first two months or three months is likely to go back because the usage of currency will not fall off in one shot, because people are used to operating in a certain way, this shock should push people more to the formal systems and more electronic transactions, but that behaviour change will not happen in three months. So, it will come in and then new currency becomes more prevalent and then it will slowly go back to the older system. So one, this is temporary.Secondly, if you have lower rates on the deposit side, on the liabilities side, on the assets and lending side, there is no demand, which has been a problem, then you are not going to benefit. You are going to compete it away. The fall in bond yields, we have been saying that interest rates should fall and can fall.Sonia: I wanted to get your quick thoughts on the market as well. 8,000 on the Nifty was the low that we hit on the US Election Day. Do you think in the very near-term that is a level that can be sustained and what do you see as the upside?A: Near-term projections are quite a bit tricky. We have seen every single forecaster going wrong on the elections. There is a lot of elections going up in Europe in the coming months. There is a lot of monetary policy changes that will happen. So, predicting near-term moves is very tricky, but I would say that my expectation over the next 12 months for the Indian market is more of a time correction because whatever changes are happening are very positive medium-term. It is just that the earnings will get disrupted and the disrupted earnings mean that the investors may be a bit more wary of stepping in even though they are aware that there is a medium-term improving outlook.So, I am more in the camp of a range-bound market for a while till we start seeing clarity that the disruptions because of the demonetization in GST are behind us. And then we get into the next really strong upside. But till then, I expect more of a time correction. You have to also understand that as bond yields rise, the valuation argument that people made that yields are going to be low forever and therefore, paying 40 times earnings for a stock is fully justified. Those arguments are no longer valid. So, you will have to roll forward for maybe 10-15 percent in earnings, price-earnings ratio (P/E) multiples come down and then you start playing for the real earnings growth.