India is still among the preferred market within Asia for Nomura as it remains one of the fastest growing economies despite hiccups, says Head of Equities – India Prabhat Awasthi.
Even in a worse case scenario Awasthi does not see headline index earnings to be weighed down by more than 3-4 percent to 12-13 percent due to demonetisation and believes bulk of the panic in markets from domestic and global shocks is over.
In a chat with Latha Venkatesh of CNBC-TV18 Awasthi along with Chief India Economist Sonal Varma and Head of Fixed Income-India Neeraj Gambhir shared Nomura’s outlook on Indian markets, earnings expectations, currency movement and economic growth among others.
Varma believes there are three near term hurdles to the economy; demonetisation, implementation of Goods and Services Tax (GST) which could lead to postponement of consumer demand, and reversal in the declining commodity price trend. Taking all this into account Varma estimates FY17 GDP to be around 6.8 percent and FY18 to be around 7.3 percent.
Nomura is constructive on the Indian currency. Gambhir expects the rupee to outperform some Asian peers. He expects 5-6 percent appreciation in US dollar against some weak EM currencies and the rupee to depreciate to 70 to a dollar in next 12 months.Below is the verbatim transcript of Neeraj Gambhir, Prabhat Awasthi & Sonal Varma's interview to Latha Venkatesh on CNBC-TV18.
Q: Almost since November 8, there has been this long developed market and short emerging market trade that is being played out. How much more is it to go? Are we going to see a lot more money move out of emerging markets?
Awasthi: To the extent that we have seen the rally or rather the sell-off in treasuries to the extent we have seen, I suspect a lot of it is done in the sense that we have seen very large outflows and the US 10-year is at 2.45 percent, largely anticipating the Fed hike. So, I think it is priced in at this point in time. Obviously, India was part of the sell-off and we had an added concern from some of the investors on demonetisation and that too is probably, at least in the near-term impact, people absorbed that there will be a slowdown, they are seeing that data. There is uncertainty but the bulk of panic reactions are probably over.
Q: In that case, what are you working with in terms of a dollar index (DXY) in the next six months and what are you working with in terms of a US 10-year in the next six months.
Gambhir: I will give you not six month, but a 12 month estimate that our strategy team has put out. First up, if you look at what the dollar is supposed to do, you are basically looking at, especially with respect to the emerging market currencies like for example, China, we are expecting somewhere close to 5-6 percent appreciation of US dollar versus some of these little more weaker emerging market economies.
Q: Does the DXY go from 102 to 108?
Gambhir: No, that is not DXY. This is basically; let us say what happens to a country like China or yuan versus dollar. As far as the DXY is concerned, we do not have an official forecast, but it is more like 3-4 percent appreciation over the next 12 months of dollar versus the other major currencies. Within that context, our view around INR is actually far more constructive. We feel that while rupee will be on a depreciating bias given the fact that we need to protect the currency against purchasing power erosion, we still feel that rupee will actually outperform some of the Asian peers, the large Asian peers. Approximately, 3 percent, that is the kind of depreciation that we will see in dollar-INR over the next 12 month’s time frame. Though you could see a lot of volatility around this as the flows move in and out, but fundamentally, it still feels like it will probably head towards 70 in dollar-rupee over the next 12 months timeframe.
Q: What is the view within the emerging market basket? Is the sell-off more or less over, according to you? Within the emerging market basket, what is the pecking order?
Awasthi: I can tell you what we think and our view on India, in our regional strategy it's still the preferred market within Asia. Largely because despite whatever hiccups you are seeing today, it still remains one of the fastest growing economies. Our reform process continues and we are still looking at acceleration in growth going forward. So, hiccups notwithstanding, the overall bird’s eye view fundamental picture of India still looks amongst the strongest in the economies that we track. And Sonal can probably elaborate on that further from macro perspective, but the strongest growth in gross domestic product (GDP) and therefore consequently in earnings. So, you just take out two quarters which are going to be impacted because of the domestic demonetisation, we sort of go back to faster growth path.
Q: Fastest is one thing but delta is quite another. What is your estimate of the growth hit from demonetisation, what kind of GDP growth in the current quarter and the next, and in fact, FY18, are you looking at?
Varma: In near-term actually there are three impacts, short-term negative effects on India and one obviously is demonetisation, but second, when the goods and services tax (GST) is implemented; in the run-up to GST implementation we are also expecting consumer demand to be postponed because manufacturing is expected to get cheaper and third, as a country, we have been gaining from these terms of trade because of lower commodity prices which is also reversing. So, the demonetisation is on top of these two factors, but specifically the biggest hit obviously coming in the December quarters, so our assessment is that growth in this quarter will be down slightly more than a percentage point. In September quarter we had a growth of 7.3 percent and now we are looking at a growth of 6 percent in the December quarter.
Our base assessment is some of the demonetisation impact will spill over into the next quarter as well where we are looking at a growth number slightly under 7 percent. But beyond that, our view is that it is obviously a big disruption but there is also wealth redistribution taking place, whether it is to the rural households or it is to the government which is going to be used or the money that is going to banks, vis-à-vis sitting under the mattresses. The velocity of money because of system rates now coming down, because of excess liquidity will be also quite a lot. The organised sector is going to get more market share as compared to the unorganised sector. So, there are relative effects on different parts of the economy, there is significant business model disruption for certain sectors that were cash disruptive, but once the cash shortage eases out, then some of these effects will start to show up and then you have states also announcing their pay hikes sometime next year. So, putting all of that together, yes, a big drop in growth, but then we are looking for growth to catch up in the second half of 2017.
Latha: So, what is the average growth in FY17 and average in FY18?
Varma: On an average, for GDP growth, we are looking at average growth of around 6.8 percent in FY17 and in FY18 we are looking at a growth number closer to 7.3 percent.Q: What does this do to earnings?
Awasthi: Earnings are a bit more interesting largely because – I guess you are talking about headline earnings, index earnings. My assessment is that it probably cuts the earnings down by 3 percent, 3 to 4 percent._PAGEBREAK_Q: What were you and where are you?
Awasthi: This is my expectation on consensus - the expectation of earnings growth was close to 15-16 percent. In worst cases it comes down by 3-4 percent and why I am saying that is because if you look at the composition of index; 25 percent is banks which actually have rallied, public sector undertaking (PSU) banks have rallied post demonetisation because of yields coming down. Fifteen percent is tech, no impact, 15 percent oil and gas; oil prices actually take it up, so that is going up. Metal are 5-6 percent on the upwards trajectory, pharma is 7 percent, so you start adding up you are just left with 20 percent or so which is what you call truly domestic.
Out of that 10 percent is fast moving consumer goods (FMCG). Now that you can argue that there will be some impact in the short-term but FMCG will be least long-term impact really speaking. If the re-distribution is something that is happening and we have a good monsoon eventually kicking in, that should normalise.
You are left with cement 2 percent and auto is about 8-9 percent out of which Tata Motors is 5 percent. So when you look at truly domestic impact it is very hard to find earnings impact which is why the markets are doing what they are doing because they are not falling off, because the discretionary consumption as we know it has no place or weightage in the index. One, its imported; our cell phones are imported, our white goods are imported, so we actually don’t have companies which have that much weightage. Maybe midcaps will have some impact but the largecaps and Index don’t have that much of earnings weightage from what is sort of slowing down dramatically.
Q: There is contradiction in your report in that case because you all argue India is a good candidate because it will be least affected by Trump’s inward facing policies and yet you say that the Sensex is not getting impacted because the large part of the Sensex is outward facing?
Awasthi: Outward facing not because of Trump. Banks have a large weight, not outward facing, but it is not getting impacted only because demonetisation, it has a very large weight. Oil and gas is not Trump facing, it is a very large sector. However, tech is 10 percent and I take that point that there is some impact but stocks are doing what they are doing as it is.
Q: You spoke about banks now although public sector bank stocks have been rallying which part of the financial sector are you confident? The non banking financial companies (NBFCs) have taken about 30 percent knock in the past six-eight weeks or from their recent highs. Which part of the financial sector are you confident and why?
Awasthi: The big banks basically. The thing is that if you look at the banking sector. One set is what finance broader economy, which is your large banks. There is a sector which finances consumption, discretionary consumption which is where your non banking financial companies (NBFCs) are playing. So, NBFCs are getting hit because they are the actual play on discretionary consumption. You don’t have any stocks. Who is financing cell phone sales, two-wheeler sales, car sales, AC sales – that is happening through the NBFCs space, not that much through bank space.
Q: You are not positive on NBFCs for now?
Awasthi: I think give it sometime and things will actually start to bounce back. However, if you are asking me is there an impact on one part of financial space? It will largely be on NBFCs and not that much on banks - that is my point.
Q: What are you working by way of Reserve Bank of India's action?
Varma: The RBI would watch data and data essentially is suggesting that they will cut because the November consumer price index (CPI) reading also showed core inflation numbers coming down, services contracted a lot more, rural consumption indicators have fallen quite sharply, so our assessment is post the Budget they will deliver 25 bps rate cut. However, beyond that some of the fundamental drivers of inflation, we feel, are stabilising. So one cut is what we are looking at given our view that underlying inflation is going to be around 5 percent, we have the RBI staying on hold.
Q: Do you think that even if it is one 25 bps from the RBI, the banking system can reduce the cost of money a goodish bit?
Gambhir: I think the fact that we are now in a hugely liquidity surplus environment, for a long time the banks were complaining that the liquidity is deficit and they have to borrow from RBI. However, now we are in a situation where liquidity is amply surplus and it is getting sucked out through repos and market stabilisation schemes (MSS). So banks have a lot of opportunity now to cut the rates on the liability side. There is no need to chase the deposit, as probably they were doing in the past, so there is a possibility that they can take that pressure off the liability side of the balance sheet and say that let's just do a little lower in terms of deposit rates and that can be passed on.
However, the important thing is that there is lack of credit assets in the system and with this kind of liquidity when deployed, so I feel the banking system will have to come back to the bond market and say that where can I put this money in.Q: What is the 10 year yield itself. At 6.4 it has moved away from 6.1, does it get to 6.Gambhir: But it could get closer to 6.25 but the real action is not going to be 10 year government bond, there is a lot more in the front end of the curve. It is lot more in the corporate bond space where if you look at 2 year and 3 year corporate bond they are currently trading at 100 bps spread over the government bonds, there is going to be a lot more in state development rules where the spread is about 60-70 bps. So, money will come into those kind of assets where the spreads are reasonably high and there is going to be some kind of change in those assets from both mutual funds as well as from the banking system.Q: You said that you are fond of some of the banks. If you can be a little more specific as to what kind and what others?Awasthi: Specific stocks I can't talk about it, but private banks as I said is what we like. One or two PSU banks we continue to like. So, what will happen is that as a result of the fact that your rates will come down some of the interest rate sensitives will start getting pushed up again. So, the next two months will be tough for example auto demand or with consumer demand staples but the fact is that as you go forward towards February and March because banks have excess liquidity incomes will grow because in rural areas and because of push your auto demand will come back pretty strongly, also because of lower rates. So, autos will become a play again as a sector.Q: Two wheelers as well?Awasthi: Two wheelers also I am sure, but the problem in two wheelers is if you look at the stock prices there has been virtually no correction. So, the fact is the immediate demand manifestations actually is higher in consumer staples names than on in auto names and two wheeler stocks have corrected 6-7 percent, demand is off 20 percent. While in staples stocks have corrected 20 percent demand is off 5 percent. So, you have got to be mindful here in terms of how you pick stocks here because there is certain amount of presumptions which has gone into the market as to how it has behaved but consumption will come back. In fact we have raised a number of stocks today in FMCG space to buy because we have been waiting for valuations to get cheaper, it never did happen but now that these stocks have come down we have sort of raised the entire sector to a buy. Oil sector OMCs continue to be sort of a play that we have liked that continues. In fact they have become slightly cheaper because of oil. Fundamental they are still strong. Downstream gas plays we have continued to like, that continues.Q: Will money be made in midcaps more?Awasthi: The challenge will be that, what you have to see, because these are highly leveraged companies in the sense that their operating leverage is very high. Small changes to demand, they find it very hard to manage. We have seen that in the past. Largecaps weather slowdowns in the short-term much better than midcaps. So, we will probably have a quarter or so where you have to wait for figuring out what is happening to earnings. Much easier to make that call into largecaps and even that is tough now because every 10 days, we are hearing a different story about demand. The changes in the demand patterns within a month have been so rapid and therefore, so much uncertainty exists that I would rather stick to largecaps rather than midcaps.Q: Let me go far out then. I know that the near-term ambushes are there. In a one-year frame, what would you say? The BSE 100 will return or the Nifty-50 or both?Awasthi: If we do not have another shock like demonetisation, we were doing very nicely before that. Hopefully we would have GST come through. Liquidity will be back. Hopefully rate cycle is such that it is pushing the growth upwards. This is what we expect. My expectation is that we will return about 12-13 percent in earnings which was earlier about 16 percent. On that, you take a 5 percent expansion in multiple because rates have fallen. About 17-18 percent is something that we should do.Q: Less than an hour ago, the Prime Minister appears to have hinted that the April 1, GST date may be difficult to maintain, but it is still a moving piece. If it is not April, maybe July. But on that issue, what is the Nomura team factoring in, in terms of a fiscal stimulus since the RBI quite unequivocally said that a dividend because of cancelled liabilities is not on the cards.Varma: We are not pencilling that in. For us, the main fiscal boost is coming through the income disclosure that is going to happen plus the fact that this is a stick in terms of the need to be more tax compliant. And this benefit you will see over a period of time. When the GST kicks in, t will feed in even further, but that is more like two years out. For the next year, the main fiscal benefit for us is the 50 percent tax that the government is going to impose on the income disclosure and the 25 percent additional deposit that they get. Specifically on the tax disclosure therefore, our assessment is about half a percentage of GDP what sort of additional fiscal gains can come in on account of this change.Q: How many rate hikes are you pencilling in from the Fed and therefore, when does this anti-emerging market trade according to you, end?Gambhir: The Fed rate hike cycle is very benign in our opinion. After this one hike that is scheduled for tomorrow, maybe another two hikes in the next year. It is something that our US strategy team is forecasting, economics team is forecasting. It is still is pretty benign, so I do not think that it is a big anti-emerging market trade. It is just that the market was too much in one direction and this change happened and hence, some readjustment happened in the market. I still feel that the environment in general, is pretty slush with liquidity. It is still too big, central banks are still generating more liquidity in the system. Fed is not really taking out liquidity. It is still holding its balance sheet pretty much there. So, it is still reasonably positive for emerging markets. You have got to have a good story like India’s to be able to attract those flows. So, that is where we play out in terms of us versus the emerging markets.
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