With the general elections barely six months away, the outcome of the legislative Assembly polls indicates the baton could pass to a Narendra Modi-led Bharatiya Janata Party (BJP) at the Centre. Jyotivardhan Jaipuria, managing director and head of research, Bank of America-Merrill Lynch, tells Puneet Wadhwa the market is hopeful the 2014 elections will throw up a stable government but it will still be wary of political developments over the next six months. Edited excerpts:
What is your interpretation of the outcome of the Assembly polls and how are you extrapolating this to the general elections scheduled for 2014? How are the markets and foreign institutional investors interpreting these?
The key issue for investors is if the elections in 2014 throw up a stable government that can undertake reforms. The assembly polls provided an indication of the mood but (these states) account for only 13 per cent of the seats in Parliament and, hence, are not necessarily a reliable indicator of where the national elections would go.
The Bharatiya Janata Party (BJP) had done well in the assembly elections in late 2003 but lost the general elections in 2004. The market is hopeful that the trend in the assembly polls seems to indicate the 2014 elections will throw up a stable government but will be wary of political developments over the next six months.
Some market participants expect that formation of a stable government at the Centre will see a policy push for key sectors. What's your view? What policies do you think will see the light of day?
A stable government at the Centre will find it easier to push through reforms. Some of the key measures include the Goods and Services Tax Bill, increasing the foreign direct investment limit in insurance and the Direct Taxes Code. More significant is probably easing of project clearances, which the current government has done through the Cabinet Committee on Investment. The power sector is the main area the government should focus on.
In that context, will you recommend investing in infrastructure, telecom, sugar and other policy-related sectors?
A stable government in the May 2014 elections would find it easier to undertake reforms. We are overweight on telecom, since the structure of the industry has improved and pricing power is returning. The other sectors offer attractive valuations but are high risk-high reward sectors, given the current uncertainty on the nature and shape of the new government.
How far are we from the actual bond buying tapering by the US Federal Reserve? There are reports suggesting tapering of the stimulus in China could be a bigger threat to global markets. What is your reading?
Our US economist, Ethan Harris, expects the Fed to begin tapering in March. Our Chinese economist expects China's tapering of stimulus to be gradual. Policy in China is turning neutral but there is no room for tightening. In addition, China's was a mini-stimulus to start with.
What is your broad call on the emerging market (EM) pack, especially India, given the recent macroeconomic data and the political landscape? Is it a good time to buy?
EMs are likely to start recovering in 2014 from a weak 2013. As that happens, inflation will gradually edge higher. More, less accommodative US monetary policy will probably pressurise domestic interest rates in certain EMs with high current account deficits. A lot of EMs are going to elections in 2014. So, political uncertainty is going to be key. Countries going to the polls include India and Indonesia in Asia; Turkey, South Africa, Hungary, Egypt and Iraq in EEMEA (Easter Europe, Middle East & Africa); Brazil and Colombia in LatAm. So we are longer-term bullish on emerging markets but prefer developed markets near-term.
Flows to the EMs, especially India, have been fairly strong since September. Is there an argument for valuation premium for Indian equities or do you think the flows could alter direction soon?
Indian markets traditionally have been at a premium to the global EMs and in line with Asia-Pacific, ex-Japan. However, currently they are at a higher premium as compared to historical averages. To further increase the premiums, India would need to show seriousness to kick-start the reform process and restart the capex cycle. However, the good news is that unlike in the recent past, India is no longer the most expensive among the regional peers. Valuations are not going to be the driver for flows changing: near-term tapering is a risk to flows.
Will the government contain the fiscal deficit by cutting the revenue deficit as promised or will it wield the axe on crucial increases in plan expenditure, nixing hopes of a revival in the capex cycle? What is your interpretation of recent economic data? Is the recovery sustainable?
This will be achieved by a mix of cuts in revenue deficit and in plan expenditure relative to the Budget. The target would be
achieved only notionally, as some of the non-plan spending is likely to be pushed forward like last year, especially oil subsidies.
The CAD (current account deficit) had shrunk to $5.2 billion from $22 billion in June, on account of gold import curbs. The July measures reversed the rate cut cycle and led to a rise in lending rates just before the busy October-March season. We now expect lending rates to ease in the first quarter of FY15. However any meaningful recovery is only expected after the general elections, once political uncertainty is cleared.
What's the big story in terms of sectors for 2014? Should one stick to consumer discretionary and defensive stocks or is the time ripe to shift to high-beta names?
Till the elections, there will be uncertainty on the new political environment. In this environment we recommend a mix of rupee- sensitive exporters and domestic names. We are overweight on software and pharmaceuticals but are underweight on consumer staples. We are also overweight on telecom and automobiles and like select banks.
