By Abhirup Roy and Euan Rocha
MUMBAI (Reuters) - India's largest mutual fund manager ICICI Prudential is betting on banks to drive a much-awaited recovery in corporate earnings in 2018, as additions to their record pile of sour loans slow after surging in the past two years.
Banks will also benefit from an expected revival in economic activity likely to drive capital expenditure by companies and hasten lending growth that has hit multi-decade lows, Chief Investment Officer Sankaran Naren said at the Reuters Global Investment 2018 Outlook Summit.
"Everything you're looking at is working positively for the corporate banks in the next two years," Naren, who manages about $44 billion of assets, said referring to those banks that are more focused on lending to companies and which have been hit harder as large borrowers defaulted.
India's soured loans hit a record $145 billion at the end of June, with state-run banks accounting for the majority of the bad debt. However, the latest quarterly results show increases in bad loans slowing sharply at many banks.
"The biggest area of earning growth over the next two years is going to be the fact that provisioning peaks this year and slowly comes down," Naren said, adding he was boosting exposure in the sector.
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India last month announced a far higher-than-expected $32 billion plan to recapitalise state lenders to help resolve bad loans and kick-start lending growth, spurring a rally in bank stocks.
Naren - a market veteran with over 23 years of experience - said he is also getting more positive on the information technology and pharmaceutical sectors, which have struggled for several quarters.
India's information technology sector has grappled with cuts in client spending in United States, the biggest market, while regulatory concerns and pricing pressures have hit drugmakers.
HIGHER OIL PRICES
Naren sees higher oil prices in 2018, which would increase India's trade deficit and lead to a weaker rupee - in turn benefiting export-oriented sectors such as IT and pharma.
The mutual fund house, part of a joint venture between India's ICICI Bank and UK's Prudential Plc, has about 55 percent of its assets invested in debt.
It has brought down the average maturity in one of its key bond funds, Naren said, as a three-year bond rally in India comes to a halt over concerns on inflation, fiscal slippage and hawkish monetary policy.
On the other hand, India's share markets have hit a string of record highs amid strong retail inflows, despite an elusive earnings recovery and uncertainty stemming from the rollout of a major tax overhaul.
That has stretched valuations in several sectors, raising concerns of a potential correction.
Naren said he is confident an earnings recovery will materialize, but warns retail investors should focus on allocating investments in a wide array of funds to hedge risks.
In the absence of a major market correction since 2011, investors are "getting lulled into believing that equity is a low risk asset class," Naren said.
"That is our biggest worry right now."
($1 = 65.4825 Indian rupees)
(Reporting by Abhirup Roy and Euan Rocha; Additional reporting by Devidutta Tripathy; Editing by Richard Borsuk)