Subdued monsoon not to hurt rural economy:Kotak's Sanjeev Prasad

Prasad said a rate cut by Reserve Bank of India will depend on how inflation pans out near term. He expects a 25 basis point-rate cut in the next six months. Private banks and sone public sector majors like State Bank of India will benefit from lower rates, he added.

Below is the verbatim transcript of Sanjeev Prasad’s interview to Anuj Singhal & Sonia Shenoy.

Anuj: As you are in Singapore what has been the feedback from the investors? Is this going to be a genuine bull market correction or are we now in a phase where the market will have to live with the reality of much less quantitative easing (QE), much less liquidity and will have to arrange its hopes accordingly. How do you see market playing out from here?

A: It looks like the market is in some sort of transition. It has clearly been a liquidity fuelled rally for the last few months, if you look at the events post Brexit referendum on June 23, emerging market has done very well, they are up somewhere around 10 percent along with India has gone up 7 percent or so. These are all in dollar terms. So, clearly there was a phase where people got very excited about emerging markets assuming that central banks will continue to be fairly accommodative and so on and so forth.

The challenges now are people are starting to re-examine this hypothesis in terms of how much more can central banks continue to do because yields have already come down to very low levels, negative in some cases and clearly there are some negative collateral damage of negative interest rates. So, that is one problem. Second problem is how much QE the central banks can continue to do given the fact that they already own large chunks of government bonds, corporate bonds and even equities in some cases.

So, there is maybe some sort of rethink that there is natural limit to what the central banks can do which means at some point in time the market will have to start focussing more on fundamentals, earnings etc and there the picture is not as rosy as what the stock prices would like us to believe because the stock prices have got rerated on the bank of lower yields everywhere in the world. Clearly India is in the same category but valuations are expensive and at this point of time neither the global recovery is looking very strong. India's own domestic economic recovery is starting to stutter, last two months have been fairly disappointing whatever data points we track and earnings numbers as of now we are still looking at reasonably good numbers but clearly with some downside risks. So, I guess you will see some phase of consolidation if not correction in the market.

Sonia: The other minor irritant that came yesterday was in the form of the monsoon forecast where the India Meteorological Department (IMD) is saying that the monsoon could be below average this time around and it will start receding in the next couple of days. Would that worry you because a lot of themes have played out substantially based on the monsoon?

A: I think 4-5 percent deficit compared to long term average, I don't think will make much of material difference but compared to the 6 percent above normal forecast which was there at the start of the monsoon season from the IMD, is a bit of a disappointment. I don't think it will affect materially to the rural economy compared to what the expectations had got built in. But the problem is expectations are running very high on the rural economy side and this is something which we have been maintaining for the last two-three months now that one good monsoon is not going to change the dynamics of the rural economy. There are lots of other factors at play over there. The non-agriculture part of the economy as far as rural economy is concerned is not doing very well. Clearly not much of construction, mining activity happening which is also relevant for rural sector. So, there are other factors at play.

You can look at global agriculture price they are still soft. So, I don't think one good monsoon would have changed the dynamics anyway and we are seeing a somewhat weaker monsoon forecast compared to what people had assumed earlier. Maybe people will have a rethink on this whole thesis. A lot of that has already played out in the form of stock prices moving up rather rapidly. If you see two-wheelers for example, I just hope that the festive season demand conditions are good. Otherwise we could end up with a situation where even though you have been seeing very strong wholesale numbers for the last two-three months and that is what has resulted in a big spike in the prices of two-wheeler companies but festival season demand is not great, you will have a serious problem. Already we hear feedback from dealers that inventory levels are very high, more than two months now. So, unless and until retail demand is very strong you will have problem in the months of November-December for sure when you start seeing some of the inventory unwinding which will result in the overall wholesale numbers at that point in time.Anuj: What is your call on autos now? In specific if you could tell me your house view on Tata Motors which has seen such a huge rally and also Ashok Leyland where we have of course news as well but we have seen a bit of a de-rating in the stock?

A: We have been positive on parts of the auto sector. As of now we are positive more on Maruti Suzuki and Tata Motors. Two-wheelers, we are quite negative for the factors that I highlighted earlier, there is a lot of excitement about very strong volume numbers which the company have been reporting for the last two months or so but our channels checks on dealer levels are just that retail demand is not that great and there is lot of inventory build up happening at the level of dealers. So, unless the festival demand is very good you will see a slowdown in wholesale number whatever company report in two months time and that is going to be fairly significant.

Tata Motors, we have like the stock for a long time, it has done quite well. Our target price is Rs 580, so there is still not a lot of upside left from where we are but I still like the medium-term story over here in the sense if the volume numbers continue to be very good they can continue to launch new models, all the new models are pretty good and if you look at slightly 2-3 years forward it will see even significant benefits coming from whenever the Slovakia plant starts. As of now they have seven platforms. Eventually they will get down to about four by fiscal 2020 and that should result in fair amount of savings as far as the company is concerned.

However, short-term, this company has done very well. Remember on the day of Brexit we were talking about the same stock, it was down to Rs 440 and we were asking people to buy, the stock is now around Rs 560-570 now. So, it has gone up something like 20 percent odd in a matter of two-and-a-half-three months. So, the upside maybe limited in the short-term but we still are okay with the medium term prospects of the company.

Sonia: You have recently increased your exposure to State Bank of India (SBI), you have added about 100 bps and you have a 400 bps weightage there now. The expectations of a rate cut have risen after the recent inflation number softened. What is your own expectation as far as how many rate cuts we can see over the next six months and how do you think banks could benefit?

A: In next six months 25 bps is what our official forecast is. At the best case we could get maybe 50, but it all depends on how inflation numbers pan out. Fifty bps is already priced in; if you look at how much yields have corrected in the Indian market over the last three months, 50 bps cut is already priced in to a large extent.

Now, the critical thing is what happens in fiscal 18 and where your inflation numbers eventually end up with. We are looking at about 4.5 percent for March '18 and if that is the inflation trajectory one is looking at then I don't think there is much scope to cut policy rate significantly in fiscal 18. If you look at the current policy framework and assuming the government and the Reserve Bank of India (RBI) follows it strictly then you have a scope of policy rate to fall maybe 100 bps from where we are. So, we will be about somewhere about 5.5 percent or so. You can take the policy rate 18 months down the line assuming inflation is at about 4.5 percent. So, we could possibly see maybe 25-50 by March to June and another 50 bps in fiscal 18 subject to inflation numbers softening.

Do keep in mind the fact that we have no idea what monsoon will be like next year and food prices particularly vegetable prices can be very volatile in the country and also you have some negative developments in the form of 7th Central Pay Commission (CPC) which can push up inflation. Forget about headline inflation impact of HR increases but even you will have secondary order impact of somewhere about 40-50 bps. On top of that whenever Goods and Services Tax (GST) gets implemented, the general view is that it could also be inflationary to the extent of 30-40 bps again. So, I suspect on inflation side we will not have much cause to cheer and policy rate cut probably 100 bps from where we are. I am talking about 18 month's time frame, not in the next six months.

Coming to banks yes, they will definitely benefit from lower interest rates but do keep in mind the fact that that only benefits the investment part of the portfolio, the net interest margins (NIMs) will also get hurt if interest rates come down too much and that is something you have to keep an eye on.

SBI we like for the simple reason that valuations are quite fine. Earlier it was trading at less than one time price to book, even now if I adjust for Rs 40 which is the value of all the subsidiaries put together even in that case the stock is still available at just about one time price to book on a March 18 basis and despite all the non-performing loans (NPL) challenges it is one of the few banks which has the balance sheet to withstand NPL challenges and given the way the banking industry is going. I will assume SBI will be one of the strong survivors in the sense 70 percent of the bank business is in the hands of the public sector undertaking (PSU), 20 in SBI. So, the private sector and SBI will continue to do very well over the next several years. So, that is the call on SBI.

Anuj: How much do you think this market needs to correct before we can find some value?

A: It depends on sector to sector, stock to stock. I don't think there is any general level I would look at. The way to look at, it is if you look at the broad market itself it doesn't look too crazily valued. It is about 16.5 times March '18 basis, even if take some haircut to earning numbers which is currently at 535 for Nifty 50 index even then it will be at about 17 times. So, it is not atrocious in the context in whatever is happening globally. The problem is in pockets of markets and I would say large pockets of markets in some cases, valuations have become pretty expensive.

You look at many of the midcap names, consumer staple names, cement companies they are all trading at -- if I knew some more rationale cost of equity somewhere about 11 percent even that is on the lower side compared to the historical levels. In many cases stock prices are overvalued to the extent of 20-40 percent. Clearly stocks prices are not going to correct 20-40 percent; it is just that they may be here for some time till the time the fundamentals and earnings numbers catch up. So I suspect in many cases it would go through a phase of pretty long consolidation.