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The markets have reacted negatively to global developments like Cyprus' bailout. On the domestic front, Dravida Munnetra Kazhagam's (DMK) withdrawal from the government and the Reserve Bank of India's (RBI) outlook on interest rates while reviewing the Monetary Policy saw the key indices tumble. Nick Paulson-Ellis, country head (India), Espírito Santo Securities tells Puneet Wadhwa in an interview that he doesn't see general elections in India getting advanced, which will be a major headwind for the markets. Year 2013 is likely to see a modest acceleration in growth in both developed and emerging economies, he adds. Edited excerpts:
Given the political uncertainty after DMK's withdrawal from the government, do you foresee an early election? How do you see the development impacting the markets?
Whilst the DMK news is unhelpful, I still don't expect an early election. Nevertheless, if the prospect becomes more real then it will be a major headwind for the markets. Investors will be forced to reflect on an unusually wide range of possible outcomes.
With two weak national parties facing strong regional parties, you could even see a Third Front, which is not a recipe for stability. We aren't saying elections should be a dominant theme now, but later in 2013 investors will have to face up to the fact that the outcome is unusually uncertain and potentially unstable. And a cliché it may be, but markets hate uncertainty.
How do you see the reform process panning out now, especially big ticket plans like divestment, spectrum sale, etc?
I think the banking plans are on track, but divestment and spectrum sale assumptions are clearly aggressive. A disinvestment budget at more than double FY13 looks a struggle to me. My sense is the risk isn't to the CAD (current account deficit) and fiscal side, it is to growth.
The risk is that if the revenue side - primarily divestments - isn't tracking in line with expectations, then fiscal consolidation to 4.8 per cent is such a public 'red line' policy for Chidambaram, that plan expenditure will get cut to offset weaker revenue, robbing the recovery of a key booster in terms of capex. If that happens then we face a risk of pro-cyclical fiscal policies accentuating the economic slowdown.
What is your interpretation of the statements by the RBI and the outlook for interest rates?
We expect CAD to improve somewhat, from an expected 4.8 per cent of GDP (gross domestic product) in FY13 to below four per cent in FY14, with measures to address gold demand and align domestic fuel prices, and as CAD concerns recede we expect the rupee to strengthen to 53 by March 2014.
In terms of rates, with core inflation under control and growth still a major worry, combined with progress on the fiscal front from the government, we expect some more scope for monetary easing and look at a further 50-75 basis points (bps) of repo rate cut by April 2014.
How are you positioning yourself with respect to emerging markets (EM), and India given all this?
With respect to positioning, we expect the outlook for risk assets to continue to improve, with global policy forcing investors up the yield curve. EM benefits in the hunt for yield, hence EM flows generally, and India flows specifically, should continue, both into equities and higher yielding EM sovereign and corporate credit.
But the economic performance of the major EM economies is lacklustre, and EM performance is likely to be less correlated than it was in the 'risk on/ risk off' trades of recent years, with more divergent trends and probably not a broad-based EM equity rally. And India fits into that framework - our positioning is cautiously optimistic, and we expect the market to rise in-line with low teens earnings growth, but like others we are still struggling to find firm evidence of a bottoming out in growth and the green shoots of recovery.
Do you think Indian policymakers have failed to deliver on their promise of reviving the economy?
I don't think policymakers have failed per se. I just don't think we can yet point to the results. I think the RBI has been a little too cautious and backward looking, whilst Chidambaram has performed extremely well in the face of many political constraints. Serious macroeconomic imbalances had built up over several years, and reversing this is going to take time. It will be a slow grind to a recovery.
So, as a result, do you see the foreign institutional investors (FIIs) losing interest in India?
The FIIs aren't losing interest. But they will if the fundamentals don't improve shortly. The rally has been predicted on policy action, but sustaining it depends on policy steps yielding real economic improvements.
Despite the flows seen 2013, the markets haven't moved much. Where is the money going then? What is your outlook for the mid-cap space?
The problem is the FIIs buy and the DIIs sell, as the latter continues to face monthly outflows. The mid-cap space has suffered badly this year for a number of reasons; margin calls, weaker earnings due to less pricing power and FII flows disproportionately flowing into and supporting large-caps.
But as long as the quality filter is applied we see no reason to shy away from good mid-cap names, with a number of stocks in our coverage universe looking attractive, like LIC Housing Finance, KPIT Cummins, Rallis and Federal Bank.
What is your estimate of Q4 earnings given the advance tax numbers? Is more pain in store for India Inc over the next few quarters?
We take a longer-term view, so avoid obsessing about the quarterly earnings numbers. But for calendar 2013, we expect earnings growth to recover to low teens levels.
Are there any specific sectors where you expect a significant outperformance?
We still see good opportunities across banks and financials in a rate cycle, as well as information technology (IT), pharmaceuticals, and increasingly metals and mining stocks as investors once again look at the sector.
In banks, we like smaller private sector banks, like ING Vysya Bank, then wholesale funded NBFCs which haven't rallied yet due to risk perception, such as PFC. In IT, we like Wipro in the large-caps, and several mid-caps like Persistent Systems. Lupin and Cadila Healthcare are our preferred pharma plays, whilst Jindal Steel and Power Limited (JSPL) is our preferred play on metals and mining pack.
What is your opinion of the US economy in the light of the recent economic data and the sequester that kicked-in on March 1?
I'm upbeat on the US. It shows clear and growing signs of recovery, with a rebound in housing, a financial system back on a more stable footing, and a significant boost to competitiveness through reduced energy costs due to shale oil and gas. And we expect extended monetary support from the Fed. Clearly, the headwind for the US is how the federal budget deficit is dealt with. The risk of a one-off shock has been averted, but the debate and measures agreed between Democrats and Republicans will be key to the US getting back to over two per cent GDP growth over 2013-14.
What is the likely impact of this on the other developed and EM economies over the next 12-18 months?
A recovering US is important to global growth, and to investor confidence, especially when combined with a more benign view on the two other key risks for investors (namely China hard landing and Euro zone implosion).
Year 2013 is likely to see a modest acceleration in growth in both developed and emerging economies; with pro-cyclical Euro zone austerity policies still the biggest drag on recovery. EMs have underperformed in Q1, and global investors are showing a preference to play the recovery in the liquid, less distressed developed markets, and this trend may well continue.
