Republican govt in US -ve for EMs; India safe bet: BNP Paribas

Whoever takes charge in the United States after the elections, one will have to look at the plans/programmes that he/she implements in coming days. However, a Republican government could prove negative for emerging markets (EMs) as they could turn out to be a close parallel to Reaganomics, which means larger focus on fiscal spend on infrastructure, believes Manishi Raychaudhuri of BNP Paribas. This could also lead to appreciation in US dollar. While it is good that markets have corrected in the run-up to the US elections, worries continue for countries with larger current account deficit as currency turmoil can cause volatility.“India would be relatively safe and will still in a position to outperform,” he said. Raychaudhuri added that: “this is the right time to focus on good quality companies on the secular, cash generators and companies whose return on equity have secularly been higher than the cost of equity. ”There are Indian companies that fit these descriptions and they come from a broad set of sectors, mostly the consumer companies, but also industrial companies and banks. He also believes that the inflow of money from domestic investors has potential to increase. Below is the transcript of Manishi Raychaudhuri's interview to CNBC-TV18's Sonia Shenoy and Anuj Singhal.Sonia: What have you made of the volatility that we have seen in the markets? Do you think that it could be a game changing event the US elections or do you believe that whoever becomes president it is just going to be 1-2 day affair and then the market is going to resume it uptrend?Raychaudhuri: Well, it is difficult to conclude at this stage. We don’t know the outcome obviously and secondly whoever takes charge we have to very carefully look at the pronouncements, we have to carefully look at the kind of programmes, kind of plans that he engages in, what he talks about over the next few days, but broadly it is easy to conclude that democrat government in the United States would be a continuation of what we have seen over past 8 years or so. That would not be so much of a concern as far as the market go, because that’s not really a big departure from the recent and medium term history.Republican government is something that we have to very carefully weigh the consequences of because it is kind of unchartered territory at this point of time. That is all we can say at this point of time. The only conclusion one can draw is that in the event of a Republican government it could turn out to be a close parallel to Reaganomics, which essentially implies larger fiscal spending possibly on infrastructure in the United States.It could also mean the US dollar appreciating and possibly slightly more sharply than the market expects right now and that eventuality could pose a risk for emerging markets, because that has never been good for flows into emerging market equities, so long winded answer no doubt to the question, but honestly one doesn’t exactly know at this stage and one would have to look for the plans and programmes of whoever take charge.Anuj: One thing which stands out is that the market is heading into the event after a decent correction, whether you look at the Dow which is now down for 8 days in a row, whether you look at India it is now down about 6 percent from the recent peak. Do you think the market is fairly prepared for an adverse outcome and in that case may price it in already?Raychaudhuri: Well, I would be happy if it is, but obviously one doesn’t know what the exact outcome could be. It is good that the market has corrected in the run up to the event and this has been a global phenomenon not just limited to India or to emerging market as a whole, we have seen even the developed markets correct on the back of this. But in the run up to the event I would possibly be a little careful about the economies or the markets, which have large current account deficit because currency turmoil in the aftermath of the event could be a significant source of worry for investors.If you look at some of the Latin American markets among the emerging market universe or a couple of Asean markets say Indonesia or Malaysia in the Asian universe, those are the areas that I would be slightly cautious about. India I think would still be relatively safe, it would not escape the kind of turmoil that we are seeing right now. I don’t think any market would, but it would still I think be in a position to outperform.Sonia: Let’s talk about certain sectors, because the sector of the week clearly has been pharmaceuticals on the downside. Most of the stocks whether you look at names like Sun Pharma, Aurobindo Pharma all down about 8-11 percent and the US is really clamping down hard on the price manipulation that some of these companies are doing, the price collision allegation etc. Do you think this is a great buying opportunity in the longer run or do you think that you move pharma stocks to the backburner?Raychaudhuri: We don’t of course cover the Indian pharma stock at this stage, but broadly I can talk about two clear trends that have emerged in the sectors and these are nothing new, they have emerged over last 1-2 or one and a half year possibly even longer. First, of course look at the companies which have a strong pipeline of generic drugs in the United States, which are coming up for approval by the FDA.Secondly, the companies that are able to sort out their differences with the FDA in a timely and meaningful manner. Obviously, there are a couple of companies which have been able to do this and those are the ones which I think would be in a relatively safe position once this whole concern get sorted out. Right now, I think the big worry of the market is most of these companies are big exporters to the United States and if there is a degree of enhanced protectionism in the United States the revenue stream might suffer. Just like for many other sectors even on this sector we have to wait for the election outcome and the plans and programmes and pronouncements as I talked about earlier.Anuj: Also important is that IT stocks are at 52 week lows, so we are in a situation where there is so much uncertainty and still the classical safe haven stocks are actually destroying wealth. So, investors are in a bit of a quandary right now because banks have done well but they have also sort of hit their maybe peak valuations so struggling at higher levels. What does an investor do in a situation like this?Raychaudhuri: IT is of course in this case distinct from pharma because in case of IT we have seen actual profit warnings, we have seen actual order cancellations by the developed market companies like some of the European banks etc. So, the fact that IT has derated over past couple of months and derated significantly there is proper mathematical and numerical reason behind that. We have seen earnings estimates being cut down, we have seen companies coming up with profit warnings and pretty large frontline companies as well.Having said that we are not yet completely taking our foot off that pedal, we are not giving up on the IT sector. We think that the frontline Indian IT companies still have the potential to win orders. We just need to put this particular period of uncertainty behind us. However our approach in this sector has to be clearly very selective.The companies which have corrected the most and the companies which have not faced those revenue pressures that I talked about, they should be on top of the list right now.As far as your broader question goes, that is what should investors do? This is the right time to focus on good quality companies on the secular cash generators and the companies whose return on equity have secularly been higher than the cost of equity. These are two main themes that we are trying to play not just in India but across Asia, companies which are free cash flow generators, which trade at a decent free cash flow yield. Even better are the companies which are actually distributing part of that cash flow as dividends or in the form of buybacks and the companies which are secular excess return generators, whose return on equity is secularly higher than cost of equity over past 10 years or so.In case of India there is a decent set of companies that you can find which would fit these descriptions. They come from a broad set of sectors, you will find mostly the consumer companies both consumer staples and discretionaries but you will find a few banks, you will find a few industrial companies. So, it is a pretty broad set of large frontline liquid names that you can find over there. So, that is the best part of India. It is not only doing reasonably better macro economically, it also offers investors set of large liquid companies which are not only better in terms of excess return generation but also relatively better in terms of their corporate disclosures and management.Sonia: The other big story that played out this week, in fact there were two of them, one of them was goods and services tax (GST) and you had ITC which was the biggest gainer this week on the GST overhang now out of the way and the rate not being as high as one would have expected. Do you expect a rerating in ITC now, post this news flow?Raychaudhuri: I would not comment exactly on specific stocks but we think that the consumer discretionary sector - tobacco in particular would possibly turnout to be a gainer out of this entire GST announcement. We don't know at this stage which manufactured goods or which commodities would be in which tax bracket. We have only heard the announcements about the tax slabs. I think over the next few days we will get to know about that fitment as they call it, that is placing different classes of commodities, goods and services in different tax brackets. So, that is when the analysis would obviously become easier. However going by what has been said till now that is the topmost tax bracket of 28 percent and a cess on top of that for the so called demerit goods, it seems that even for those so called demerit sectors like alcohol or tobacco, the total tax incidence might not be as bad as the market might have apprehended earlier. So, I think the point that you tried to make is right on balance.Anuj: The problem for this market is that we have seen a FII outflows pickup a lot, more than the actual selling picking up, the buying has come down quite significantly and while this domestic buying that supporting the market clearly that is not enough. Is that a risk that going forward if that selling picks up than the market may see significant correction?Raychaudhuri: That’s kind of obvious. In any market place not just in equity market if selling pressure is significantly higher than the buying support the prices of the commodity that is being bought and sold would decline. This one point I would like to make first this is essentially a degree of risk aversion to the classic risky assets that we are seeing.That is why India is not the only market to have been affected we have seen this across Asia, across emerging markets and across global equities. If you look at even the developed markets they have actually declined significantly during last couple of weeks. Until and unless we put this period of uncertainty, put this period of likely risky outcomes behind us, I think this kind of volatility, this kind of uncertainty would continue for a while.Second, the point that you have made about domestic flows of late we have seen curious and I would say hopeful pattern, the domestic investors have come in exactly as a bulwark against FII selling, so I have a chart hidden somewhere which shows that FII buying or selling and domestic buying or selling form almost a mirror image of each other, so when the FIIs are buying domestics are selling and vice versa when the FIIs are selling domestics are buying. There are a few markets in Asia which actually conform to this trend particularly in Southeast Asia and India.I think domestic buying has the potential to increase quite a lot. One simple arithmetic would support my case if you look at the total savings in India that is about 20-22 percent from the household side in an economy size of about USD 2.3 trillion that amounts to USD 500 billion half of that goes into financial assets.If just 10 percent of that goes into equities that is about USD 25 billion that almost close to the highest ever FII inflow that we had seen in India, which was about I think USD 27-28 billion in 2010. Now this 10 percent number might seem outlandish at this point of time, but remember that in the early to mid 90s household used to put a lot more money into equities about 10-15 percent of their financial assets.If we go back to that period and that is not really a very tall ask. We could see significantly higher inflows from domestic retailers, which would possibly be channelize through the domestic institutional investors and in this respect we have only scratch the surface.