 "Global factors to drive markets from here on: Tirthankar Patnaik")
The Markets have staged a relief rally after the Union Budget, with most proposals meeting analysts' expectations. Global markets, too, have been supportive. Tirthankar Patnaik, India Strategist at Japan-based Mizuho Bank, tells Puneet Wadhwa that Indian markets are likely to continue to outperform emerging market (EM) peers on a medium to long-term basis, driven by strong, largely internal growth and steady macro fundamentals. Edited excerpts:
What are your key takeaways from the Budget proposals? Do you think that the government has set an unrealistic target as regards non-tax revenues?
We would rate the budget 7/10. That score is driven by the renewed commitment to fiscal consolidation (three per cent by FY18) against difficult odds like the seventh pay commission recommendations, identification of key priorities with focused proposals, and consistency on tax administration. A higher score would have provided greater allocation on PSU Bank capital, and better budget math.
In regards to the non-tax revenues, we believe the disinvestment target can only be met under relatively optimistic market conditions. Over the last 17 years the government has missed its disinvestment target thirteen times, and under current macro conditions, FY17 need not be any different, even as the government seems incrementally more willing on strategic assets like SUUTI (Specified Undertakings of UTI).
Telecom revenues might be partially met through license renewal fees, but the rest imply very high spectrum prices for the 700 MHz band, particularly since first year accruals would only be a fraction of the total.
Do you expect the fiscal deficit target to be revised next year? How would the markets react to this?
We do not believe the fiscal target to be revised next year, as the government is likely to stick to its fiscal prudence path of three per cent by FY18. Along with the fiscal deficit, consistency on market borrowings helps keep a check on yields and the overall cost of funds in the economy, ensuring that fiscal and monetary policies do not work at cross-purposes. The bond market reaction to the budget acknowledges this fact. However, we must keep in mind that the Govt. would appoint a committee to examine medium-term plans for fiscal consolidation in order to replace the FRBM Act.
Depending on market/macro conditions, it is possible that this committee might choose to take a slightly more lenient view on the deficit, a headwind for the markets in our view. India's market performance amongst EM peers has been driven by its stellar performance across both current and fiscal deficits, and the market would consider any deviation negatively.
Has the Budget done enough for the foreign investors (FIIs) and long only funds to look at India as an investment destination given how the macros may shape up?
We believe the Budget has significantly enhanced entry/ease of doing business for foreign investors into the country across multiple channels/sectors, be they ARCs (asset reconstruction companies), NBFCs, insurance companies, asset management companies or securitization trusts.
In addition, clarification on a host of related issues for FIIs, viz., applicability of MAT, long-term capital gain tax on unlisted companies, DDT on international financial centres and tax residency issues have also been address, either partly or full. Lastly, consistency on GAAR (commencement date of April 1st, 2017 remains unchanged) underlines the government's commitment on foreign investment. If anything, continued litigation on international tax arbitration cases like Cairn, Vodafone, etc. is the missing icing on the cake. Even here, the Budget has held out an olive branch of amnesty.
How much upside / downside do you expect in the Sensex, Nifty over the next 12 months?
We believe the Indian markets are likely to continue to outperform emerging market peers on a medium to long-term basis driven by strong, largely internal growth and steady macro fundamentals (CAD, fiscal deficit, inflation), which in turn should allow consistently cheaper domestic cost of funds, even as global interest rates are rationalised to pre-GFC levels.
In addition, the agricultural sector is likely to do well after two years of meagre rains and potential implementation of indirect tax reforms like GST could act as tailwinds for the market. That said, issues like asset quality in the banking space, perceived deceleration in the reform momentum and potential populism before elections in major states could pose headwinds.
Overall performance, therefore would be led by global macro factors that would drive capital inflows, overlaid on a macro recovery, which should track earnings plus an Indian beta. Global macro triggers that we look forward to include growth trajectory in China, rate hike cycle of the US Fedreal Reserve, continued easing by the ECB (European Central Bank) and BoJ (Bank of Japan), trend of crude oil and the overall commodity complex and potential events like Brexit.
Banking sector has been in the limelight given issues like recapitalisation of PSU banks, RBI’s policy initiative on capital adequacy etc. How do you view these developments in light of the NPA overhang?
Though the allocation for recapitalisation of PSU banks in the budget was slightly disappointing, we believe the sector needs a more innovative approach to tackle their asset quality problems rather than just capitalisation. The RBI's latest tweak to the calculation of Tier-1 capital for Scheduled Commercial Banks is a welcome step in that direction.
In our opinion, a holistic approach is needed to address the current stress in the system and it might take a while before the sector (especially PSU banks) are completely out of the woods, and are able to drive credit growth in the economy. We believe solutions to the current PSU capitalisation problems would entail significant dilution for the existing equity holders in these enterprises, and hence would not turn incrementally constructive on these banks till then.
Would you bottom-fish in the metals and capital goods sectors or would the next six months give investors a better opportunity?
Our outlook remains cautious on the metal sector, driven by the uncertain global scenario, despite salient actions by the government Chinese steel capacity continues to be significantly higher than their domestic demand, and would take a while to normalise, given the slow global growth trajectory. Though some of the assets appear cheap on a historical basis we believe it may be a faulty barometer for valuations right now, as it would be extremely low likelihood of these assets to revert to their historical profitability anytime soon.
As for the capital goods sector, we would advise investors to be selective as even though order flow is expected to surge going ahead, many of the erstwhile players' balance sheets are incapable of capitalising on it.
What is your view on the policy-driven sectors like aviation, telecom, infrastructure and real estate?
While the excise duty hike on ATF prices from 8 per cent to 14 per cent would take away some of the crude windfall from the aviation sector, previous gains are large enough to keep earnings momentum intact for now.
The telecom sector is likely to witness a new wave of competition over the next few months that could lead to a further squeeze on their data revenues. Further, the government’s expectation from telecom auction in the ensuing year implies additional pressure on balance sheets. It would be advisable to take a second look after the dust settles in a year's time. Telecom infrastructure plays may be a better choice, however their valuations do not appear attractive.
Announcements pertaining to the real estate sector in the Budget have focused on the affordable housing sector, while overall affordability for consumers was left untouched with no increase in tax concessions for real estate purchase. Measures around REIT would enable listing of these instruments, thereby improving capital availability for the sector.
Which other sectors would you now look to add to your portfolio? Which ones could see a lesser allocation over the next 12 months and why?
Select pharmaceutical companies have a very strong launch pipeline over the next 12-18 months and they look attractive post the recent correction. In addition, a weak currency supports their earnings and provides a cushion in a weak macro environment.
What is the road ahead for corporate earnings for the next 12 months? Where do you see the Sensex, Nifty by December 2016-end?
Corporate earnings are likely to improve only gradually, with FY17 earnings likely to stay around 10% -12% for the Nifty 50 with broad market earnings likely to trail and unlikely to reach double digits, as overall economic growth is unlikely to surprise on the upside for the next six quarters at least. We would expect the Nifty 50 to be nudging 8,100 towards the end of the year. Incremental headwinds on the global macro, a surprise third successive monsoon failure and a Chinese hard landing pose downside risks to our estimate.
