 "Ridham Desai")
India's state-owned enterprises are not known to be favourites of investors. However, Ridham Desai, head of India equity research & the India equity strategist for Morgan Stanley, the New York-headquartered multinational financial services entity, tells Malini Bhupta why he feels these stocks could be winners over the next three to five years. Edited excerpts:
Why do you say investors should shed scepticism on state-owned enterprises (SOEs)?
Our note outlines in detail that this is a bottom-up reform process, with SOE issues being addressed idiosyncratically. It is not a top-down, one-size-fits-all approach. SOE stocks appear inexpensive and under-owned, with strong balance sheets, though opaque profitability. If the government engineers change, as the prime minister's performance with Gujarat SOEs points to, these stocks could be surprising winners in the coming three to five years.
Do you think the government's Indradhanush package will be a game changer?
We view the seven-step plan as a good move, though mostly a repackage of earlier steps. However, it is not enough to stem the bleeding at state-owned banks. The most important need for SOE banks is capital and asset quality. On the latter, statements of intent have been listed, with no concrete steps as of now. For asset quality to improve, we need to see meaningful improvement in the economy.
On capital, the bulk has been allocated to the top six banks (38 basis point additions to common equity tier-1). Weak SOE banks should only see a 25-bps addition to CET-1, on an average in FY16. This is not enough for balance sheet repair.
Depending on whom you speak to, different reasons are cited for the slow uptick in investments. What is keeping back investments?
Investments are up again. We can see that in various data such as new project launches, fall in stalled projects, SOE capital expenditure (capex), capital goods order book and capital goods imports. All point to a neat recovery in capex.
Our view has been that the coming capex cycle will be led by government spending rather than private sector spending, given the indebtedness in private corporate balance sheets. Also, in the previous cycle, half of private corporate spending was in two sectors, materials and energy. It is unlikely that these sectors will drive spending in the coming cycle. In our view, private sector capex is more likely in FY17, after growth recovers.
What is your view on Indian equities, in the face of global and local events?
For the first time in history, Indian equity return correlations are negative or at multi-year lows, with falling commodity and bullion prices. Hitherto, when commodity prices have fallen, correlations have risen, underpinning the historical importance of global risk appetite to India's macro and stock markets. Even the correlation with global equities has fallen to decadal lows.
This decoupling or collapse in correlations is a manifestation of India's improved macro stability. Which, in turn, reflects a hawkish fiscal and monetary policy that is increasing domestic saving and India's growth optionality, relative to a growth-starved world. As a corollary, for India to retain these low correlations, it becomes imperative that its policy makers smoothly transition from caring for macro stability to pursuing growth. If this happens, the equity market will likely retain this newly acquired low-beta characteristic. If it doesn’t, the correlations will mean-revert.
How will India be impacted if a currency war breaks out, following China's move last week?
India’s currency is likely to outperform, given its superior macro stability and growth, even as it loses ground on an absolute basis. Sectors which compete with Chinese imports could be under pressure, though we think the government might respond with anti-dumping tariffs.
Is the logjam in Parliament a serious concern for foreign investors?
The government appears well-intent on taking the GST (goods and services tax) bill forward. Given the size of this reform, for the long run it does not matter much if the bill is delayed by three to six months. However, such delays could cause volatility in the markets. The market is a lot more concerned with growth data at this moment. Regarding the land bill, the market is likely to be focused on what individual states do. In any case, this bill is now for the next session (of Parliament).
