 "Gautam Chhaochharia")
Gautam Chhaochharia, executive director and head of India research at UBS Securities India, talks to Vishal Chhabria on the forthcoming Budget, global and local risks, concerns over bad debt and earnings outlook. Edited excerpts of an interview.
What’s your take on the relentless selling by FIIs?
There are multiple reasons for markets to appear weak to all of us. It starts off with what is happening globally, including China, which hurts India and in that context it is relevant to highlight that India is a very over-owned market for the last couple of years and that is working against India. When global risk-aversion happens, fund managers are forced to sell to manage exposure risks. Locally, there has been an issue of heightened over optimistic expectations about how quickly and sharply growth recovery can happen. Reset of these misplaced expectations is also hurting.
FII buying is unlikely to pick up in a hurry. So, now for India to keep getting positive inflows in the equity markets, it has to deliver on the high growth expectations and even surprise positively.
How much more pain do you see in the markets before things improve?
Absolute market levels now are reasonable. Our NIFTY downside scenario for December 2016 was 7,000, so it is near that level. Valuation is not dirt cheap where you just jump in. It is still at 14 times, which is in line with historical averages, and not below. But in the context of what is happening globally it will remain vulnerable to the global risks in the near-term. We still do not see growth surprise to be positive; market needs growth surprises to be positive or hope to move up.
What direction will market take before and after Budget?
Budget will not matter so much going by last few years. Into the budget and post budget market moves have not been that dramatic. Yes, you always focus a lot on the budget, it is a big event for the entire market, but not necessarily a near-term market driver. Having said that, we do look at this budget as a lot more important event than what we have seen historically and for the simple reason that there is potential change in policy stance by the government. The last 3 years government has been sticking to bringing deficit and inflation down.
Now, the government may want to reflate the demand side. There are 2 issues there. One is limited fiscal space, can they actually do it without hurting all the parameters they have laid down and second is the adverse impact on the macro side.
The fiscal space is the biggest challenge in the context of pay commission not just for the central government but even more for states. The central government has the benefit of oil bounty and it can still show some level of fiscal consolidation. But pay commission is a much bigger issue for the states – roughly (an increase in fiscal deficit by) 0.4-0.5% for Centre and 1.2% for states and states are anyway running near fiscal limits. This is actually a much tougher environment as to how to implement that because if you go ahead and implement and stick to fiscal consolidation it can hurt quality of spending, we move back from capital spending which is great for long-term growth to revenue spending which gives you at best next two quarters of growth. If they expand fiscally then it hurts the macro parameters…inflation, currency, etc.
What would you want from the government, should they go beyond the fiscal limits?
Definitely not! India’s macro parameters are not at a level where they can afford to give up fiscal consolidation. Just to put things in perceptive, consolidated fiscal deficit for India is around 7% which is comparable to where Brazil is today. It has improved for India since September’13 but it has still not improved to a comfortable level. Last time India did fiscal expansion and implemented pay commission in 2008-09. That time consolidated fiscal deficit for India was 4.5% which gave room for fiscal expansion. We are not even talking about power reforms, bank recapitalisation, etc. Those pressures are there and above holds only if oil stays at $30 levels. So our view and advice would be to stick to fiscal consolidation.
What are your expectations from the budget?
Beyond the fiscal deficit number, road map on corporate tax reforms will be key. The FM has talked about bringing in a clearer road map of how it will play out in the next 3 years, year by year and what incentives he will take away to fund that. We are also looking at clarity from the government on the subsidy side specifically on fertilisers and food, which is a big subsidy area with lot of room to plug leakages.
So, you are saying they should use saving and subsidy cuts to lower the deficit and push growth?
Exactly! RBI Governor has been saying for last couple of years that ‘best framework for economy to grow at a good rate and sustainably is to have a lower inflation environment’. If 2008-10 is repeated (merely pushing consumption through various programmes) then experience suggests it comes back and hurts. Broadly, stick to fiscal consolidation but improve quality of spending. But we are talking about 1.7% of GDP extra spending on pay commission. That is a big challenge given where Indian macro is right now.
But from where will the revenues come giving that the markets are in a bad shape?
Divestment may not be easy given the market conditions and the assets they have. It will be tough, but Central government has scope in terms of oil benefits. Just by annualising the increase in oil excise duty this year, they will get around 0.33% of GDP extra next year (FY17). So, they do have a lot more levers, they still can cut spending on the subsidy part because fertiliser prices have come down. It is not difficult for the central government to show some kind of fiscal consolidation and still implement pay commission even though quality will then get hurt, but is it still feasible.
But what happens to the states?
Maybe states can manage by cutting down other expenses or by increasing taxes. But, all these have implications for the macro environment.
Nowadays, the hot topic is PSU banks. Even SBI chairman said that more bad debts are expected this quarter. How do you see this PSU space, do you see value or is there more pain out there?
It is a mix of both. There seems value, but obviously we don’t know the exact underlying asset quality. The relevant point is that new stressed assets are not happening. So actual stress assets creation has probably bottomed out a year back, reporting is what is still left. Once the reporting is done, which is what the RBI is trying to push, and when the investors know that this book is clean and this is the book value, then the overhang can go and bank stocks can do well. Bank of Baroda is a clear example here.
What is your take, how much more reporting of bad assets is left?
It is tough to say, there are some estimates which our bank analysts also have but in terms of reporting there is still a lot left. We have done our report last year when we attempted to estimate the stress by looking at Registrar of Companies' data, identifying basket of leveraged companies and see where they are and looked at what banks are reporting and we still see a gap in terms of what the banks have reported and what those stress assets would be.
Do you think banks are under-playing reporting of NPAs?
Definitely banks are under pressure to report bad assets. It is not a small number where you say the worst is behind us, not yet, but once they actually acknowledge that then that could be where you get an idea of the problem size. So what the government has to ensure is that, one, this acknowledgement happens faster and simultaneously give out very clear road map on capital infusion. Now they have given a capital infusion plan over the next 2-3 years but the markets are worried that that might not be enough because a lot of capital requirements are based on fund raising in the market and is that enough on the context of the number which is much bigger. If they accelerate the capital infusion plan in the Budget, it will be positive.
On the earnings front, Q3 has again disappointed. How do you see earnings actually planning out in FY17?
We will see more cuts in earnings estimates. We have seen cuts happen, we have seen a reset of expectations around investors but it is not yet at a level which we would say is realistic, in terms of both economic recovery as well as earnings recovery. There is still optimism for FY17. We still see a leg down. Consensus is expecting FY17 earnings to grow 19%. If things turn out well, and recovery happens, maybe we could see 13-14% earnings growth. So, at least 6-7 per cent EPS estimate cut is likely.
What would you advise to investors in respect to 2016 and how should one position their portfolio?
The long term growth story is still intact for India; unless the government adopts a riskier policy framework. Whatever growth we are seeing right now is high quality growth, it is happening despite fiscal consolidation, despite the reasonably tight monetary policy, and despite the credit cycle being weak. It is not as good as the expectations were high after the new government but still a reasonable growth. So we will still advise the investors, from a longer term perceptive, to stay invested.
We have been writing since late last year, that there is a risk to small mid-cap stocks, and we remain underweight small mid-caps. This is primarily because valuations are expensive and we see risks to local retail flows. There is a lot of optimism built in about how the local retail investor will invest more in equities, given how gold and property have done. I don’t think this is a structural trend, because historical returns influence retail investors' decisions. The one year return turned negative late last year and if the markets remain where they are I think 2 year returns will turn negative very soon.
China is also facing slowing growth and many people doubt its data itself. How do you see these things?
Our house view is that hard landing is unlikely there, we will have slower growth; our growth forecast is lower than the street’s. The policy managers there should be able to manage the transition to slower growth. Global crisis is not our house view.
When do you see capex cycle recover?
Not in a hurry. Some pockets are improving, like roads, railways, but broad corporate capex will take time. At the earliest, capex cycle, if at all, will pick up in 2017. It is not that the capex is not happening, capex is happening but the base is high because it includes a lot of capex in commodities, power, etc. So there won’t be a commodity capex, also India is now power surplus. So capex from a macro point of view will take time, at a micro level we are seeing recovery in roads, railways hopefully, even corporates which are growing will keep investing.
Bond yields have remained elevated for quite some time despite RBI’s rate cuts. What is your take?
There are obviously technical issues about demand supply in the bond market, but I would argue that it also reflects something which the equity markets are complacent about, the point which we discussed in the beginning about any potential change in the fiscal stance, specifically that the state governments are not in a position to implement pay commission. So, bond markets have been early to realise that and that’s why you have seen state government yields actually going up much more than you see at the central government level. So maybe the bond markets are telling you something which the equity markets are not.
Any other upside or downside threats you see?
In all our discussions with investors, the broad assumption is that oil is not going to go up sharply. If it does, it will hurt India in 2 ways, one the macro stability gets impacted (current account, fiscal, etc) and secondly, some of the markets where investors have become very, very underweight they will be forced to increase their weights there, emerging markets for example, if oil moves up.
Upside is just stick to what the government is doing and look for a way to delay, dilute, stagger pay commission, have a much more stable macro environment and in that scenario we will get much more rate cuts than what the market is looking at which will help the banks, which will help recovery, make the macro more stable, lead to a low cost economy, etc.
