‘Earnings growth biggest concern; a correction in market is due’

CALENDAR 2017 has started on a strong note with the Sensex and the Nifty hitting all-time highs on the back of strong investment from both domestic and foreign institutional investors. MANISHI RAYCHAUDHURI, managing director, Asia Equity Strategist, BNP Paribas, told SANDEEP SINGH that while foreign portfolio investors (FPIS) continue to remain upbeat on India following the election results in Uttar Pradesh, the earnings growth and, therefore, the valuations remain a concern. He said that a correction in the markets would make investment proposition attractive for investors. Edited excerpts:

How do you read the political developments in India?

If I look at the equity markets in India, there were earlier some concerns like how the global variables would pan out, how the protection measures in the US will impact, political uncertainties in the European region and, of course, domestic political outcomes. Now, the way the election results have come, it has lifted one big piece of the puzzle — the one about domestic politics — and put it in a silo of irrelevance. From the kind of interactions that we now have with FPI and domestic investors, the opinion seems to be that the ruling party is on a very strong wicket and the resulting political capital could be a significant tailwind for decision making. The General Elections are more than two years away, and FPIS and DIIS (domestic institutional investors) don’t seem to be concerned about its outcome at present.

Also, it’s encouraging that the government has been bold enough to implement reformist steps (such as demonetisation), which could be unpopular with a section of the electorate in the near term. The clear opinion of FPIS now is that such reformist steps would continue as the government has demonstrated its willingness to execute reforms for the longer-term benefit of the economy.

How are investors seeing the choice of the Chief Minister in Uttar Pradesh?

There have been some concerns whether the new administration will stick to the core agenda of economic growth and development. However, most investors feel the best course of action now is to wait and watch. Clearly, at this point of time, the ruling regime has a benefit of doubt both from DII and FPIS.

Did the 7 per cent gross domestic product (GDP) growth number come as a reassurance?

I don’t look at aggregate GDP or IIP (Index of Industrial Production) numbers for forecasting purposes. Much better variables are high frequency on the ground numbers that we regularly get. We look at how many million tonnes of cement were consumed, number of cars sold, two wheelers sold, freight

The FPIS have strongly invested into India in March. What is their view on Prime Minister Narendra Modi as he is nearing three years of his government?

The mood among FPIS is clearly upbeat and a significant part of that upbeat mood among FPIS is contributed to by the present government. After the recent state election outcomes, it has only got reinforced as they believe that it could provide the necessary political capital for the administration to engage in more reforms. Even though demonetisation had a short-term dampening impact on economic growth, most of the long-term investors are convinced that this is the right step in the long run to formalise a much larger segment of the economy.

What could derail this inflow of funds?

There are some global events that could trigger that, the first is an appreciation of US dollar. While that has never been good news for flows into emerging markets, we think that it may not turn out to be as bad as it was during taper tantrum episode. On that occasion, it was the emerging market currencies that depreciated. This time around, the appreciation of the dollar is being predicated more against the developed market currencies. Our forecast shows that the emerging market currencies are likely to remain flattish on account of better fundamentals, as most of them have repaired their current accounts remarkably over past 2-3 years.

Other than that, protectionism and restrictive trade practices in the US could potentially hurt the emerging markets. I, however, feel that even in those circumstances, India would be relatively less affected as Indian exports to the US are not significant in proportion to its GDP compared to many other emerging markets.

Are there any concerns on domestic front?

There are a few, such as job creation, which is a corollary of private investment, and also the health of the banks especially the public sector banks (PSBS). I think this trio of concerns is possibly the biggest impediment to stronger growth trajectory for India right now. The hopeful sign is that the NPA (non-performing asset) accretion for PSBS which till September 2016 was accruing at a rapid pace, seems to have decelerated in the December quarter. Having said that, the PSBS’ credit cost could continue to increase over next 2-3 quarters.

The issue of private sector investment is low capacity utilisation which stands at 7072 per cent. No one will look to invest until it rises to 80-85 per cent. I don’t know when that could happen but it needs significant consumption demand pick-up and utilisation of the existing idle capacities could take anywhere in 12-15 months.

However, in the long run, India looks fine especially in comparison to its Asian market peers as the growth is fine, political stability is there which in turn is likely to aid reforms. Implementation of some of the reforms such as the GST, the Bankruptcy Bill could significantly accelerate the economy over the longer term and increase efficiency in various sectors.

What are the concerns on valuations of market and earnings growth in India?

It has been an unending wait for earnings revival. I have been saying for the last one month that the Indian markets should correct but the markets have a mind of their own and the recent election results were a shot in the arm for sentiments. But, a correction is due, it should happen now to make the investment proposition attractive for investors.

My biggest concern is earnings and if that revives, a lot of things will fall in place and valuation concerns will abate. In the near term, we are not seeing much improvement in the earnings growth. While India has historically traded at a 25-30 per cent premium in P/E (price-to-earning) terms to Asia Ex-japan, it is currently trading at a 50 per cent premium. Normally, I would not have been concerned about valuations if the earnings estimates have been going up but in case of India, that is not so. MSCI India EPS (earning per share) estimates have been drifting down and in this respect, India is in a different league compared to Asia Ex-japan because Asia Ex-japan EPS has revived nicely over the last three months, led predominantly by North Asian markets. Even China has stabilised growth and currency and that is the biggest support factor for Asian equities this year.

For India’s earnings, while most of the factors such as export revival, governmentled investment and consumption look fine, the only piece of the puzzle left out is private investment and I don’t have much hope there for the next 12-15 months. So, if I put all this together, the 7-7.5 per cent GDP growth seems to be in the bag.

“Protectionism and restrictive trade practices in the US could potentially hurt the emerging markets. I, however, feel that even in those circumstances, India would be relatively less affected”