What to look for in RBI policy tomorrow? 'Not rates'

Ekta: What is factored in into the market with regards to the credit policy tomorrow? Commentary will be the most important thing but what is your expectation and what is factored in?

A: I guess the market has discounted the possibility that there won't be any rate cuts in this policy and this expectation is not very misplaced. However, the press conference interaction with the Governor would be very important for a number of thing because on a more fundamental level, close to USD 7 billion worth of outflow that we are likely to see once the foreign currency non-resident (FCNR) deposits mature between September and December, how is the Reserve Bank of India (RBI) prepared to deal with that, would be one of the things that the market is going to be looking forward to. Also, given the fact that there are lot of speculation about the second term of the Governor. I am sure someone will pose this question, and how the Governor respond to this question will also be important from the market's perspective.

So while the rate cut may not be the central focus of the policy but these two issues as to how the RBI is prepared to deal with currency and also with the second term of the Governor would be more important.

Nigel: We are at around 8,200 or thereabouts, so the Nifty is trading at around 16 times. Going ahead, for the yearend where is the fair value of the Nifty? Do you think we have overrun ourselves in the near-term or do you believe that the earnings per share (EPS) need to improve first and then only we could try at higher multiples? What is the yearend target of the Nifty?

A: The market is factoring in acceleration of the earnings per share in FY17 and FY18. One of the biggest dampening effects on the EPS of the broader indices has been the performance of the banking and financial sector stocks in the last financial year. Post Bank of Baroda (BoB) results in January of 2016, when they gave the impression that they had more or less recognised all the non-performing assets (NPAs) in their books. I think we were quite shocked to see that this was not the end of the story. There was more that they had to disclose in the April results. This followed by the shocker that we got from Punjab National Bank (PNB) with the record losses of close to Rs 5,600 crore, raise the misgiving that maybe we will not see a very strong earnings growth in FY17 also, but the later end of the results, the ones which were brought up by State Bank of India, Canara Bank and Bank of India in particular, has given the impression that if FY16 was a year highlighted by write-down maybe FY17 and FY18 would be years which will be marked by write backs and if that is to happen, we will probably see a strong upsurge in the EPS growth in these two financial years. If we do not get that entirely in FY17, I am quite sure that we will get that in FY18 and the market is beginning to discount that because other than that I do not see why the market should have crossed the milestone level of 8,000 points if there were so many misgivings about the earnings trajectory in FY17.

Ekta: Talking about the pharmaceutical space, have you managed to look at Biocon? That stock is at fresh highs, big inroads made in Japan with their insulin drug and now, Mylan is coming into the fray with their co-development deal. Your sense in terms of where we could see Biocon go?

A: I will be constrained in terms of discussing individual stocks, but if we could say limit the discussion to pharmaceutical sector, the one which is passing through a lot of headwinds and a negative perception from the market, we just go back and see as to where the pharma story start in India. It all started with the initiatives that the pharma companies had started taking in terms of developing their generic capacities and also in their research and development (R&D) pipelines. This story played out quite well.

In fact, if you look at the last two calendar years, 2014 and 2015, between June, 2014 and June, 2016 by and large the market has been flat. In fact, up to the month of April, it was actually flat at 25,000 points. Between these two years, while the market has given 0 percent return, the pharmaceutical index has given return of about 45 percent. So, in a market which was flattish, it was the pharma that ended up outperforming the market.

Now today, those pharma companies which had a very strong pipeline of drug discoveries, including Biocon and now that you mentioned Lupin also, the market is discounting those pipelines very well, but there are always surprises. Biocon has surprised us on the positive in terms of the successes that they have met, in terms of penetrating markets and also in terms of their new discoveries. This story is going to come back to the pharma sector all over again. There have been near-term headwinds that we have seen because of the Food and Drug Administration (FDA) observations, but that is probably structurally good for the industry because it is making their manufacturing processes more compliant and therefore, more resilient.

So, I would say as a contrarian call, pharma might actually make a good case for an investment now so that the near-term will obviously be taken up by the outperformance of the cyclical stocks. But say three years down the line when this cyclical rally will begin to say plateau to some extent, you will be able to support portfolio outperformance with what you will get from the performance of the pharma stocks then.