Demand Revival Key to Strong Earnings Growth
Investors are discounting a quarter point interest rate cut from the Reserve Bank of India on Tuesday. S Gopalakrishnan, chief investment officer at ICICI Lombard, tells Shilpy Sinha that there is room to double that given the slow growth and the need to revive the banking sector suffering due to stressed assets. Edited excerpts:
All eyes are on RBI Governor Raghuram Rajan on interest rates. What’s your expectation? Markets are discounting a 25 basis points cut. One can argue for a surprise for more. There is room for 50 basis points (rate cut) given the slow growth and stressed assets in the banking sector. The other point is if you cut 50 basis points, expectations will get over. The third is if RBI cuts by 25 basis points and the policy stance is accommodative, I think it will be anywhere between 25-50 basis points. Within Asia, we have the highest inflation. It is a question of what is the priority — do you want growth without being mindful of inflation? We are correcting. Financial savings have come down to 6% of the GDP. If it is not giving real return, why will people put their money in financial assets. They will rather buy gold or physical assets. That has been the trend so far. Whenever inflation is high people have gone for gold or physical assets. Now, we need to
strengthen our financial savings.
The market has rallied after the recent Fed statement. Has the threat from the US rate hike has receded? In the recent past, we saw markets reacting to the reported core inflation number of 2.2%, we saw the dollar weakening and commodities rallying. I am sure (Fed chief Janet) Yellen knows the underlying economic conditions better than we all know. The issue is that one does not want dollar to appreciate much, nor an asset price bubble, nor deflation and return of pessimism either. So, it is a delicate balancing act which is being done. Our assumption is that there will be no rate hike for the rest of the year.
What does it mean for fixed income securities? If the stance is positive, the 10-year G-sec can come to around 7.35%. Markets will follow how inflation moves and how global factors pan out. The overall spread has always been between 4.5-4.8%. Now, we are sitting between 5.8-6%. There is a huge gap. If you look at US rates and our rates, there is a huge difference. If you look at most developed markets they are experiencing deflation. The only risk to the whole interest rate cycle is the fear that monetary policy has done its bit and the only way to boost economy is fiscal. What has happened in dollar market is a balance sheet issue and that overleveraging has to come down.
Oil has been a saving grace for India. But it has rallied recently. Is that a cause of worry? The recent spike in the commodity is not fundamentally driven. It may again correct back. Companies are not sure of where this commodity correction will settle.
Corporate earnings have been a drag for India. Does that change in the new fiscal year? You have to look at how nominal GDP performs. A lot of companies did not pass on benefit of lower costs. If the demand strongly revives, we will see a strong corporate earnings growth. Otherwise, it will be a repeat of 2015-16. Best case scenario is low growth in the range of 8%-10%.
There is a complaint about overall economic growth? Is there a scope for acceleration? Growth will come from capex investment from government and a lot of FDI is coming into India. We are on a slow recovery path. We are clearly seeing a slow correction in numbers. The GDP growth could be 7.5-8%, largely driven by domestic consumption. FDI flows should be more than FII flows. We don’t see exports recovering. The demand has to come from domestic consumers. Rural demand should come back. We had two bad monsoons. This year should be (one with) a normal monsoon. For private sector, as long as they don’t see potential demand, they won’t come in.