US Fed to be hawkish; RBI may cut rates: Geosphere

In the light of demonetisation, banks are lowering their interest rates, and might seem to be positive bets. But Sanger said the NPA situation makes them ‘treacherous’. High-quality banks with not much exposure with real estate and jewellery could be interesting, he said.Below is the verbatim transcript of Arvind Sanger's interview to Latha Venkatesh, Sonia Shenoy & Anuj Singhal.

Latha: I remember you being skeptical about demonetisation, the day it was announced. All of us welcomed it as a good long-term reform but the near term pain is now looking very bad. What is your sense? How much and how long is the near term pain?

A: There is very little precedence for this. We do not have growth economies that have done this. It has been done in many socialist economies in the past. There was an article yesterday, talking about North Korea, former Soviet Union, Nigeria, not exactly the frontlines of growth developing economies that have done this kind of step in the past.

The problem is we do not have any roadmap to know how this will go. I understand from reading and hearing and talking to people, the long-term noble objectives of this government in terms of trying to reduce the amount of black money, trying to move people towards less cash in the economy. However, the reality is that we cannot wish away the fact that there are hundreds and millions of people in India who are going to work in the cash economy before and after this demonetisation business. You are not going to have, suddenly, 500 millions of credit cards in India, you don't have the point of sales facility, you don't have the back office facility, you don't have the infrastructure, it doesn't exist and it doesn't get made in two weeks or 50 days. So that is not going to change in terms of the short-term challenges. Hopefully the government in 50 days, as they have asked for by the end of the year is able to solve the cash crunch that the economy is facing right now.

The bigger challenge is going to be some loss of confidence and somewhat destruction and yes, we can all say that this is ill-gotten gains that deserve to be crushed but the reality is for getting rid of those ill-gotten gains there will be spill over effects on places like real estate, consumption of discretionary goods and even things like fashion and what have you. Industries like the commercial vehicle (CV) business, the whole target is some of the non banking financial companies (NBFCs) that provide financing for CVs, they don't know what is going to happen, real estate, nobody knows what is going to happen. So it's one of these where we are all groping in the dark but the effect is likely to last for at least a couple of quarters and then the real question becomes what is the revenue loss to the government versus what the government will get back potentially, if they will be able to do it in some kind of a dividend that has been discussed as a possible option. We don't know if it will happen but if there is a dividend to the government of few thousand crore from the money that doesn't get turn in - will that be more or less or equal to the loss in revenues to the exchequer. So I think all of these are unknowns and unknowable right now.Anuj: That is the problem for this market. It is a bit of a black hole situation in uncharted territory. How do you take a bigger market call? Do you say these are one or two quarter issues and if the market corrects that is a great buying opportunity or do you say that the demand destruction and earnings destruction could last for a protracted period and maybe it is time to step out? How do you approach it from market’s point of view?

A: I would say that this is somewhere between 2 and 4 quarter effect and there could be some severe down drafts in one or two sectors. But I would say that for some of the stocks that are correcting in a big way, I do think this will be more of a buying opportunity than a selling opportunity, but we do concern that is there more action coming against real estate, is there more action coming against gold and diamond and jewellery business, are there areas where we should avoid because this may not be the last shoe to drop.

So, there are certain sectors like real estate, like jewellery which become in our opinion, not that they were at the top of our list, but those become sectors where we would rather not see this as a value buying opportunities. But there are other sectors, whether it is infrastructure or even cement which is going to take a hit in demand, but if the stocks come down enough beyond 2-3 quarters, the infrastructure spending that is already underway, that hopefully gets further boost from the government to offset some of the demand destruction and housing will stabilise when interest rates come down.

But the one other point to keep in mind as a foreign investor we have to be very concerned about is that the RBI is going to embark on a rate cutting cycle and people are talking maybe they do as much as 50 basis points in the next meeting. I do not know whether it will be 25 or 50. But we know that the Fed, as given what is going on in the US and with Trump, it is going to be raising interest rates. So, do we have to worry about the rupee because that interest rate differential is going to start to create some headwinds for the rupee? So that is the other concern we have as foreign investors, that we would wait and watch as to how the two interest rate policies could be diverging because we are expecting the Fed to become much more hawkish if the US goes through with interest rate cuts which are fairly aggressive and maybe some kind of an infrastructure programme. So, that is another headwind for emerging market’s investors looking at India and other emerging markets.

Latha: Are you picking stocks now at all? There are obvious beneficiaries of the currency like IT stocks whose downturn began much earlier. Anything at all you will dip your toes into?

A: So far, we have not dipped; we have actually taken a little bit off the table. We have not dipped yet. We would be looking, and I am meeting companies and I have seen some of that look interesting. My sense is that between the currency issue and getting a better handle on how bad it is going to get, we are going to be dipping our toes very slowly into the water. Small steps at a time, but we definitely see, at this juncture, more buying than selling opportunities. But it does not mean that we are going to be just one direction and we are not going to be rushing in because for us, we have two worries – the fundamental earnings issue and the currency issue. And bank is a very interesting thing. Banks and non-banking finance companies (NBFC) - that is an area that we are looking at quite interestingly.Sonia: You were discussing whether the government could come out with more steps; in fact we do hear that there could be a clampdown on benami property in the real estate market; property which is bought in somebody else's name. So that could be another hit on the property market that we could see perhaps over the next couple of months or so, but coming back to the subject of banks because eventually it boils down to how much the NPAs could rise as cash crunch progresses over time. What is the sense you are getting about how to approach financials now especially public sector undertaking (PSU) banks that have started to see some action?

A: I think it is an interesting question because you are getting suddenly a huge amount of money coming in whether that is permanent or that is temporary, we do not know but that creates some liquidity in the banks, an ability to make loans but ability to make loans is not the same as demand for loans because banks have not been constrained, at least the private banks have not been constrained for the most part because their balance sheets were not allowing them to make loans, it was more a question of was their demand offtake strong enough and healthy banks like Kotak Mahindra Bank and HDFC Bank and others have been seeing slowdown in demand. So I do not think this is demand positive and for those banks whether its PSUs or NBFCs or some of the private banks that have run into trouble, this certainly is not going to help in terms of NPA formation which we have been thinking for the last two quarters, towards the end of that cycle but it looks like this would extend the cycle and if there was a hope that this extra income that the government gets, can be used to recapitalise the PSU banks and that is the hope then the offsetting question is what is the loss to the exchequer from tax and excise and other receipts. Are they going to make up for small things like the tolls that the toll companies are losing for no toll being charged? There are a lot of things which are going to cause the exchequer money. I am not convinced that one goes blindly into the banking sector saying it is a clear beneficiary because interest rates are coming down. I think the NPA situation again makes it somewhat treacherous and the high quality banks with not much exposure to things like real estate or jewellery or others could be interesting at some point and some of the NBFCs could be interesting but we have to keep a very close eye on how it is developing.

Anuj: IT stocks, would you buy Infosys and TCS at current levels, at current valuations?

A: This is one area that we have not looked at in the recent past because I thought there were structural challenges which are causing growth slowdown. So the growth slowdown is not going to magically turn because of either weaker rupee, in at least dollar terms, or because of Trump's election, but the weaker rupee could create some positive growth dynamics in local currency terms. So at the right valuation, some of those become safer haven because they are not affected by India consumer demand. 

Sonia: In your assessment, coming back to your market view, how high do you think is the possibility of India entering into a bear market over the next six-ten months?

A: We have already come a long ways. I am not sure how far a long we are from top to bottom but we are already in double digits and so I am not sure where this ends but there is a pretty good chance that we have another, at least 5 percent to go if we get bigger shocks in terms of consumption slowdown. However, those are mathematical measures but I do see another 3-5 percent downside potentially as a magnitude of this slowdown becomes more visible, but I remain optimistic. India is still a long-term growth story. This just causes a lost - maybe two-three quarters of growth and we were all counting on growth and the biggest danger, in my opinion, the foreign investors, this is the time and this is why there is downside to Indian market is as foreign investors get sight of that and start worrying about the rupee, you could get some kind of a self-fulfilling outflow if people worry that this growth story is developing for the next couple of quarters and at the same time the US dollar is strengthening and US is doing things that make emerging markets less attractive. So I think that is the real risk of a double whammy for the Indian market if foreign investors were to take flight.