With capital markets struggling for growth, Edelweiss, the country’s top institutional broking firm, is diversifying to become a full-scale financial services firm. Edelweiss Chairman Rashesh Shah discusses his plans and his outlook for the capital markets with Palak Shah. Excerpts:
What has gone wrong with the India growth story since UPA-II came to power? Have scams and inflation vitiated the investment climate?
The lack of reforms has become a major hurdle for the India growth story since the UPA-II came to power. Scams, inflation and the current political deadlock over 2G spectrum allocation have accentuated the problem. UPA-II came to power with big expectations. But it has been 18 months now and the government has done nothing to resolve the problem of supply bottlenecks in various sectors. India’s inflation is not so much due to the demand pressures as supply-chain constraints. The moment there is growth, inflation will rise and this can only be controlled by removing supply bottlenecks, which require reforms. This was evident in industries such as aviation, telecom and even broking. High operational costs acted as a supply bottleneck, but reforms solved the problem and growth was smooth.
Our inflation is such that raising interest rates cannot curtail it so, at some point of time, rates will ease off. Effectively, interest rates should start coming down from April onwards, once the government starts spending. However, economic growth is currently under threat. The market is in a downward trend and needs a major fall to bounce back and break the narrow range. Most smart high net worth individuals (HNIs) have already squared off their large positions. The bottom would be somewhere between 5,200 and 5,500 for the Nifty. At these levels, there is enough international interest. This year, the equity market will be flat but commodities will do well. Commodities are becoming the asset class for the year.
How bad is the situation? Are you downgrading corporate earnings?
The situation is not as bad as it was in 2008. Short-term liquidity, which was extremely tight in the past few months, has started easing. The liquidity adjustment facility (LAF), under which all the banks were borrowing, had touched a peak of Rs 1,70,000 crore last year but has come down to Rs 70,000- 80,000 crore. On the inflation front, which is largely driven by food and fuel, we are reaching the highest panic level. Inflation should start coming down in six to eight weeks. We do not see global crude oil prices rising over $100 per barrel in the near term. Crude oil prices between $90 and $100 have been factored in but if they rise beyond this, then even the global recovery will be threatened. But this might not be bad for India since money will flow into the country. What is happening now is that the money is flowing out of the country since the US has started recovering. Higher allocations are being made to the US or Korea and Taiwan, which are dependent on the US.
We have started downgrading corporate earnings. Everybody will downgrade earnings in the fourth quarter and the economic estimates will also come down. In this quarter, GDP growth will be between 7 and 7.5 per cent.
So, are the talks of double-digit growth in India exaggerated?
Double-digit growth may be possible in the longer run. The question is, can the current 8 to 8.5 per cent growth move to 10 to 11 per cent, which is possible considering India’s saving, investment and consumption rates? India’s savings worth $350 billion or 30-34 per cent annually are robust. So there is no way we can fall drastically from an 8 per cent growth rate. But people are making their own estimates about a double-digit growth.
Is the stock broking industry going through a bad phase?
On a three-year basis, the size of the commission pool for stockbrokers has not grown, although operational costs and competition have gone up. From Rs 15,000 crore in 2008, it went down to around Rs 9,000 crore and is limping back. It could be Rs 13,000 crore to Rs 14,000 crore. The same thing happened with the investment banking business. During 2007-08, the commission pool in investment banking was around Rs 4,000 crore and in 2010, which was a good year for the business, the commission pool was around Rs 3,500 crore. The broking industry is facing a dilemma owing to the lack of market growth and pressure on yields since the business volume mix is tilting in favour of derivative options. Options trading, which accounts for nearly 50 per cent of equity derivatives, is a low-yield business for brokers. Currently, brokers are scaling down business since it is becoming hard to sustain costs. Large brokers are surviving on the back of automation in business. Compared to the earlier back office staff of 28 people, we are doing 10 times more business with just 11 people. In the coming years, we would see to it that 50 per cent of our business comes through the retail segment.
Why the thrust on retail?
Unlike wholesale, the retail business is more sustainable. Though the wholesale business is more profitable, banks strive to build a higher current and savings accounts ratio. In the country’s financial services sector, the capital market accounts for an 8 per cent share, while commercial banking constitutes 70 per cent and insurance 22 per cent of the sector. Both wholesale and retail sectors account for 4 per cent each of the capital market. So it was three years ago that we started moving from the wholesale business to the retail sector. Currently, 35 per cent of our revenues come from the retail business and we have a client base of 300,000 customers. Our target is to reach to at least one million customers in the next three years.
Further, to capture a larger pie of the financial services sector, we have decided to diversify from a capital markets company to a full-scale financial services firm. Currently, 70 per cent of our business comes from the equity markets and the rest from other asset classes. Going forward, this mix will also become equal since we are scaling up our commodity, bond, housing finance and life insurance businesses. We will build a Rs 4,000 crore to Rs 5,000 crore asset book in the next three to four years in the housing finance business. Apart from this, we are infusing around Rs 550 crore in the insurance business and our partner Tokio Marine will invest around Rs 1,200 crore.
But the main problem is that the entire capital market sector in the country is struggling for growth. It grew 70 per cent annually from 2004 to 2008 after which it has been stagnant. We see similar growth after three or four years. This is why people want to buy the commercial banking stocks, since the sector has witnessed a sustainable annual rise of 24 per cent for eight years.
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What will be your USP in insurance? How will you approach the housing finance business?
We understand investment and cost management. So far, insurance companies have been stressing on how to sell policies, but we will stress on how we invest the insurance money. The banking and insurance industries in India need more players. Currently, there are around 28 insurance companies but only 17 of them have solid fundamentals. There is huge potential in this business. According to our estimates, India’s household savings will be over $1 trillion by 2020. The only thing is we should be able to build a cost-effective structure — we already have investment expertise. Fortunately, for us, the industry structure has changed in the past few years with the new rules, and they suit us. We have already got R1 approval for insurance. We think a large part of our economic advantage will come when we will be able to sell housing loans and insurance products to our capital market customers and vice-versa. This is cost advantage. So, in India people will have to learn to cross-sell. Why shouldn’t your broker end up being your advisor?
Our approach to the housing finance business will involve a combination of direct selling agents (DSAs) and our own network.