There is no case for de-rating of India: HSBC AMC

On Wednesday, Standard and Poor's (S&P) lowered India's rating outlook to negative and warned of a downgrade in two years if there is no improvement in the fiscal situation and the political climate continues to worsen.

In an interview to CNBC-TV18, Tushar Pradhan, CIO of HSBC AMC says, currently the black picture around India is painted only with the macro, the disappointment in the big bang reform expectations as well as what the government has been able to achieve so far. “I think if those get corrected at some point of time, India should be in the good books again,” he adds. There is no case for de-rating of India, says Pradhan.  “There is a concept called return on equity (ROE). If you look at each of the other comparative markets, the ROE for Indian companies has sustainably remained much higher than any of the other markets. I think for that reason alone, which is intuitive, you should deserve a premium,” he asserts. Going forward, he says, with the way the commodity prices are, with the interest rate scenario domestically, hopefully which might come off a little bit towards the end of the year, the RoE picture doesn’t seem to be changing dramatically. “We may not improve ROE but I don’t think we are going to lose that position. So from a de-rating perspective, I don’t think that is a case to be made for,” he adds. Also read: Don't think there is a case for downgrading India, says BoAML Below is the edited transcript of his interview with CNBC-TV18's Udayan Mukherjee and Mitali Mukherjee. Also watch the accompanying videos. Q: What is your sense on the market now? It has been a bit of a grind the last few weeks, will it continue this way? A: The general sentiment seems to be a little cloudy from a foreigners’ perspective. They being a very large part of our markets, I think that is how it is going to be for a while. The foreigners are a little suspicious in terms of how to take the India story forward. There are various reasons - the change in regulations, the barrage of negative news which has been hit. The entire positivity around the India story, which began in January, is taking a little bit of a breather. Though once clarity emerges, I think they will reassess. I don’t think India as a story is over. It is just that the interim negativity will cause people to just pause a little bit. Q: Big headwind for the market has also been what has been happening in the currency market. How have you read that? What is happening in the currency market you reckon? A: I am not a currency expert. But it is a combination of factors. One is that there is inherent weakness in the current account deficit. There are significant chances to kind of wonder about how worse can it get. I think it could possibly get worse. So, that is actually influencing the currency traders. The other thing is that the overall sentiment towards India as an investment destination also plays a part in how the currency works because that is an anticipation of inflows. If that picture also changes to flat to negative, there is an impact on the currency totally. So, I don’t think there is any one single reason to say why the currency is weak. But I think if you look at the fundamentals, the fundamentals just point out to you that you have a weakening fiscal situation, you have pretty significantly large current account deficit. That just simply tells you that your currency needs to be weak. Q: We have not seen too much by way of flows in the April series at all. What is your sense of what the global outcome will be through May? Do you think risk-on can come back and we will get our proportion of money or should we live with lowered expectations of money flows because expectations got elevated after the big inflow in January and February? A: In the first two months of this year, we suddenly saw risk-on. That was not only for India though we did see the benefit of it, it was across the board. So, you had significant inflows in Korea, Taiwan, and Japan. Across the board, if you look at last few weeks, the money has started to kind of dwindle, to start to not come in. Not that there is any outflow yet. So, there are no significant outflows from the total number for any of these markets, maybe except for Taiwan where it has seen outflows so far. But in India, above the USD 9 billion mark is where we have hovered. I think it would be very optimistic to think that these kind of inflows will continue into the month of May for significant reasons. One, the clarification regarding the general anti-avoidance rule (GAAR) is expected in mid-May. People will take their own calls in terms of how their outlook remains on India from the middle of the year onwards. So, I think we are definitely in for a breather. I think only if there is significant confidence building up back into the Indian markets towards the middle of the year, will we see flows back strongly towards the end of the year. But I think for now we should more or less accept the fact that people are going to wait and watch. _PAGEBREAK_ Q: In March and April, FMCG, pharmaceuticals, autos have done well. Would you stay with that kind of a leaning for another couple of months or do you think that trade should be switched around? A: I think every time there is some sort of movement upwards for these sectors, they hit the ceiling of valuations very quickly. So, at best, it is only a relative call, a relative place where you can find safety, when the rest of the market is not doing well. But from way of significant appreciation, I don’t think any of these sectors provide you an upside. But if you are thinking that the market will come off then obviously these are the sectors where you will find safety, for two reasons. One is that all of these companies have significant cash flow generation, which I don’t see change. I also think that the growth in these sectors is more or less in line with the overall nominal gross domestic product (GDP) growth rate, between 14% and 15%. There is no threat to that. So, as long as you remain reasonable and you keep a very longer-term objective on these stocks, you are not going to lose money. But again it is compared to growth, compared to all of the excitement that we thought January and February were going to bring to India. If that continues to happen then the sectors take a backseat. But I think for the time being, they may look relatively attractive as places to stay safe. Q: A lot of India watchers are pointing out though that India has sort of gone completely off the radar either in terms of institutional interest or even in terms of delivering better value or greater value. Is there a case to be made for this market to see a de-rating by the tailend of the year? A: I don’t think so. There is a concept called return on equity (RoE). If you look at each of the other comparative markets, the RoE for Indian companies has sustainably remained much higher than any of the other markets. I think for that reason alone, which is intuitive, you should deserve a premium. So, the key factor to look for in the valuation de-rating story is to see whether the RoEs significantly come off from your average that you have seen for the last five years or so. Going forward, with the way the commodity prices are, with the interest rate scenario domestically, hopefully which might come off a little bit towards the end of the year, the RoE picture doesn’t seem to be changing dramatically. I think we may not improve RoE but I don’t think we are going to lose that position. So, from a de-rating perspective, I don’t think that is a case to be made for. I think currently the black picture around India is painted only with the macro, the disappointment in the big bang reform expectations as well as what the government has been able to achieve so far. So, I think if those get corrected at some point of time, India should be in the good books again. But I think fundamentally the de-rating comes only when you have a significant de-rating in the ROE expectations itself for most companies. Q: It cannot be grouped sectorally, but have you begun to trim exposure either to PSU stocks or sectors and stories that have the potential of a great amount of government regulatory action or interference? A: As a portfolio construction theme, we always try to be away from things, which we cannot control. So, in that sense, we always have an outlook on companies which can be dramatically impacted by either government policy or external events to that extent. We try to maintain as less exposure as possible, given the constraints of portfolio construction. Having said that, I think any deviation significantly away from what we think the impact could be is an opportunity to get back into these. So, I am not saying that they perpetually remain sells or they will never enter our portfolios. But I think it is always a sense to look at relative valuations. So, when the picture change as gloomy and you find that the valuations now are discounting more than what the impact of any regulation can have, that is when they enters the buy zone.  I don’t think most of these companies have yet entered that zone. But I think very soon we will get there if the depression or the disappointment regarding regulatory changes reaches fever pitch and we suddenly see a lot of companies here get de-rated. I think it has not come there yet. But I think as soon as it approaches bare valuation, it might seem an attractive place to go back into. So, while we say that yes, these impacts do cause these companies to be relatively unattractive because they do tend to be more volatile in prices, it doesn’t necessarily mean that they could never be bought. That is our view.