RBI move on CRR good for banks; next 6 months seen tough:HSBC MF

The latest RBI directive to banks on cash reserve ratio (CRR) requirement for banks is good in a way as banks won't be under pressure to lend the surplus liquidity with them in the wake of demonetisation, feels Tushar Pradhan, Chief Investment Officer at HSBC Asset Management."In the short term, of course the cost of money goes up a little bit for them because that kind of liquidity goes away but I think it is also a move to ensure that the banks don’t drastically reduce deposit rates because they really need to deal with that liquidity at this time," he tells CNBC-TV18.Pradhan feels the next six months will be tough, and sentiment will remain bad as the economy gradually tilts from formal to semi-formal in the medium term. Below is the verbatim transcript of Tushar Pradhan’s interview to Latha Venkatesh, Anuj Singhal and Sonia Shenoy on CNBC-TV18.Latha: Let us start with global backdrop. The market has given us some support around the 8,000 mark but do you think the pro developed market (DM), anti-emerging market (EM) trade will yet play out and this is not the low?A: It is difficult to call as always but I think what is happening globally is more of a risk off for the moment because just as what we are looking at in India is to just wait and watch for a while. I think everyone in the US also is waiting and watching. I think there were pretty significant signals to indicate that interest rates are going to go up in the US but that was nothing new. We knew that that was a general direction, maybe the speed of which night actually accelerate now and that is why people were kind of moving money away from the EMs into the DMs for a while. However, I think once all of these clouds kind of go away, the question will come back to growth and again it all depends on the decisions taken in the US to indicate what is going to happen to ensure that these growth rates are sustainable. If the growth rates are going to struggle then we are going to go back into that kind of not here, not there kind of situation. Sonia: In your funds you have a lot of exposure to the private banks. What did you make of the recent move in the cash reserve ratio (CRR) from the Reserve Bank of India (RBI) and the impact that it could have on the banks near term?A: At the margin I think that is pretty positive because I think most of the banks were struggling to kind of have some source of money to be deployed in with the kind of liquidity that they were looking at. So, I think this is just a stitch in time. I think it is necessary for the banks to kind of feel a little relieved so that they don’t have to pump that liquidity into something which they would not want to. So, I think in the short term, of course the cost of money goes up a little bit for them because that kind of liquidity goes away but I think it is also a move to ensure that the banks don’t drastically reduce deposit rates because they really need to deal with that liquidity at this time.Anuj: In the long term the market always will track earnings, give or take 2-3 percentage points. Are you pretty sanguine that maybe one or two quarters down the line, once the hit is over the earnings recovery would be back on track, the greenshoots that we had seen?A: I want to take a little bit of time to digest this question because it is not a simple answer. I will take you back to the times when we had consistently lower economic data. So, we had gross domestic product (GDP) which was getting lowered every quarter. We had Index of Industrial Production (IIP) data which was coming down, we had inflation which was very high, we had interest rates which were very high and yet when we looked around us, there was pretty significant conspicuous consumption. Cars were being bought, there was absolutely no place in restaurants, it was generally as if there was a huge disconnect between the official numbers and what was happening on the ground and we always used to wonder about it. My suspicion is going forward you are actually going to see an improvement in the official numbers because if you see what is going to happen is there is a large mass of people who are in the informal economy and once the informal economy starts to move in the formal economy, even 1 percentage at a time, you are actually going to see pretty much increase in the metrics that we look at including GDP for example. While on the other hand, the sentiment will continue to become very bad and there will be a sudden change in terms of how business operates on the ground. So, you will be faced with a situation where people are not optimistic. They will kind of be very wary about predicting what is likely to happen, they will not stock up, and inventories will kind of struggle to come off. However, the official numbers will continue to look pretty positive from where we are right now.So, just to give you a very simple answer to your simple question, it is going to be a tough six months, not only from the just visible numbers perspective but the whole environment. I believe the environment is likely to get a lot more confusing. While you will get some data which is pretty positive on the margin, you will wonder why people are not really getting excited. Latha: How as a fund manager will you live through this period? Which kind of stocks or sectors will you prefer, which kind of fundamentals will you prefer, is it the age old Asian Paints and HDFC Bank who have a record of not doing anything wrong? How will you trade these shoals?A: I would think that this calls for a lot of patience as always with markets. I think what is likely to happen is it is going to take some time because the way the economy is going to go forward is not going to be the same. So, it is not actually a return to business as usual as we know it for many years. There is going to be a change between how people do business from here on, so, which means there were people who were on the fence, who were out of the formal economy and they might just make this decision once and for all to say that it is too much of a hassle to remain out of the formal economy and just join it by either doing the formal thing and declaring and your income and just coming back in which of course the government should and it is trying to make sure that it is actually an easy transition in. Once they are in then you actually have expanded your economy pretty significantly. So, how much of this, how much of the total percentage actually moves back into the formal economy is the moot point which means that the economy changes forever from here on or you believe that a large part of the economy continues to remain informal and they just wait for the recharge to happen, so, which means the new notes come in back into circulation and we go back to how we did business in the prior years. So, I think this is a very historic moment in a sense that we don’t know the answer yet because we don’t know how far that shift is likely to come back into the formal economy. Coming back to your question, I think it is for fund managers to kind of analyse what part of the economy has incentive to come back into the formal economy. There is a large service economy which is also pretty informal. I think the hassle for them to remain out of the formal economy will be high. So, I think there will be a large percentage of that to come back in. The general establishments, last mile for distribution of FMCG, it is a 50-50 guess at this time whether some of them will come back in. You take textile for example, large mass of people who pay salaries in cash. I think for them to stay out of that economy and continue to pay salaries in cash will be a big question mark for them. So, I think it is all pretty much positive on the margin the way I look at it.If I were to look at sectors, I think it would be very hazardous to call sectors right now. However, I think I will take your earlier comment to say that should we stick with the people who did things right, they have basic undiminished demand for what they produce, they are secure in the sense that the demand is fairly inelastic for their products, I think those are the companies which are likely to sustain valuations through this time. However, if you are looking to be more adventurous, then I think a little bit out of the box thinking is required and you might find that there might be pretty significant upsides to what I call a dramatic shift in our economy in terms of how it is expanding. Latha: Is this the 1991 moment? After the Manmohan Singh Budget, I really don’t remember how the Sensex moved [immediately] but in a couple of years India was the turnaround scrip. Can it be like that? A: Again, as I said, we have to wait and see because even when that happened, there was initially a lot of second guessing, not sure whether we are moving in the right direction, so on and so forth. Even if you look at the second phase of reforms post the first election of the BJP government some years ago, I think there also there was a lot of confusion regarding what was the longer term impact of that and we saw most of the impact coming in not only two to three years but maybe 5-10 years after that move. So, I think very difficult to say how this is going to pan out. However, I think if you look at it economically, if you look at where we are going, if you look at the movement from the informal economy to the formal economy, I can’t debate the fact that it is very positive in the long run. Sonia: Just wanted to quickly check with your view on IT stocks because in your funds you do have high exposure to names like Infosys and Tata Consultancy Services (TCS). Given that there are still some immigration related worries and lower client spends, etc. do you get a sense that there could be a couple of more quarters of pain? A: I think the reason the pain was there in the first place was led by a couple of factors. One is that, everyone was a little hesitant about what the discretionary spend in the US was likely to be because it is all dependent on who got elected and so on and so forth, whether it was business as usual or they needed to re-write the script. Now, what has really happened is that surprisingly for everyone, not only the verdict was one but the fact is that the US markets have taken the election very positively and it is trading at all time high really. So, which means that the US business confidence seems to have come back and if that is the case and obviously that is a very large positive from a business perspective for most Indian IT companies. Anecdotally, the channel checks that we have done in for IT companies, they seem to indicate that it is not going to be fairly dramatic even if there is a rise in visa cost. I think that is going to be at the margin not really very dramatic to alter earnings per share (EPS) estimates to very large extent. On top of that, if they think that the business climate changes and that there is more positivity and there is more discretionary expenditure then I think on the overall it is actually going to be pretty positive for the IT companies. Again, as I said, these are just very initial reactions in terms of what we think would happen.