‘Mar­kets are likely to find re­lief in a sta­ble govern­ment’

Business Standard - - THE SMART INVESTOR - In­dia eq­uity strategist, Bank of Amer­ica Mer­rill Lynch SAN­JAY MOOKIM

With two key events — the in­terim Bud­get and the Re­serve Bank of In­dia’s mone­tary pol­icy re­view — over, in­vestors are now eye­ing the out­come of the up­com­ing gen­eral elec­tion. SAN­JAY MOOKIM, In­dia eq­uity strategist, Bank of Amer­ica Mer­rill Lynch, tells Puneet Wad­hwa that the mid- and small-caps are likely to de-rate, es­pe­cially as in­vestors take a step back in the run-up to the elec­tion. Edited ex­cerpts: What are your in­ter­pre­ta­tions of the in­terim Bud­get pro­pos­als and the out­come of the Re­serve Bank of In­dia’s (RBI’s) MPC meet?

The in­terim Bud­get has in­tro­duced the farmer in­come sup­port scheme and re­duced taxes for lower in­come in­di­vid­u­als with­out in­creas­ing the fis­cal deficit. The im­ple­men­ta­tion of the Prad­han Mantri Kisan Sam­pada Yo­jana is crit­i­cal. Eco­nomic the­ory sug­gests that long-term in­vest­ments in in­fra­struc­ture-re­lated ar­eas are es­sen­tial for sus­tained growth.

Even as the in­terim Bud­get deem­pha­sises these into the elec­tion, there is hope that govern­ment agen­cies can con­tinue capex-re­lated spend­ing through ex­tra bud­getary bor­row­ing. It is pos­si­ble that elec­toral and po­lit­i­cal in­cen­tives con­tinue to di­rect pol­icy to­wards re­dis­tri­bu­tion. Yet it is im­por­tant that the govern­ment re­tains fo­cus on ‘grow­ing the pie’ while ‘dis­tribut­ing the pie’. The rate cut an­nounced by the RBI last week sup­ports our long-term view of con­sump­tion

over in­vest­ments for eco­nomic re­cov­ery.

How are the mar­kets likely to re­act to a coali­tion govern­ment at the Cen­tre?

The cen­tral govern­ment does con­trol crit­i­cal pol­icy ar­eas. Yet, it could be ar­gued that the im­pact of any po­lit­i­cal sur­prises in Delhi on the econ­omy is grad­u­ally re­duc­ing. Eq­uity mar­kets are likely to nonethe­less re­spond to elec­toral out­comes. The mar­kets are likely to find re­lief in a sta­ble govern­ment, which can be ex­pected to last its full five-year term and have fewer con­straints from coali­tion part­ners. Eq­uity in­vestors are likely to view a frac­tured coali­tion in Delhi with some dis­may. That could lead to some down­side to In­dian eq­uity prices.

Are the mar­kets pre­pared for a higher fis­cal deficit?

As long as in­ter­est rates do not re­spond ad­versely, we be­lieve eq­uity mar­kets are likely to view fis­cal ex­pan­sions pos­i­tively in the short term. Some rev­enue fore­casts for FY20 (2019-20) may be termed ag­gres­sive. GST (goods and ser­vices tax) col­lec­tions are ex­pected to grow close to 18 per cent year-on-year, and the govern­ment is re­ly­ing on ~90,000 crore in dis­in­vest­ment rev­enue. These, at the mo­ment, do not drive any sig­nif­i­cant con­cern on fis­cal deficit. It may be pos­si­ble for the govern­ment to stay close to the 3.4 per cent (fis­cal deficit to GDP) fore­cast through some ex­pen­di­ture man­age­ment. Any sig­nif­i­cant in­crease in oil prices could hurt the fis­cal math in FY20.

How are for­eign in­vestors now view­ing In­dia as an in­vest­ment des­ti­na­tion?

We be­lieve a ma­jor­ity of in­vestors, rightly or wrongly, are cur­rently fo­cused on the up­com­ing elec­tion and the po­ten­tial volatil­ity in stock prices around the event. The stock mar­ket also of­fers a lim­ited set of large-cap ideas, as stocks that are de­liv­er­ing on growth have be­come very ex­pen­sive on mul­ti­ples. The dif­fer­ence in P/E mul­ti­ples be­tween the top 10 per­centile of MSCI In­dia stocks and the bot­tom 10 per­centile is at an all-time high and con­tin­ues to rise, while the gap be­tween the growth of the top 10 per­centile and the bot­tom 10 is fall­ing, and is close to lows. This in­creas­ing dis­per­sion has likely been driven by fall­ing global cost of cap­i­tal, as cen­tral banks in­jected liq­uid­ity. As that tide has turned, there is a risk that el­e­vated In­dian stock val­u­a­tions could come un­der pres­sure.

Your views on non-bank­ing fi­nan­cial com­pa­nies (NBFCs) and banks?

Banks in In­dia seem to have largely recog­nised the bad as­sets on their bal­ance sheets. Gross NPA ad­di­tions should slow down as loan growth im­proves. Many banks are still close to their his­tor­i­cal P/B (price-to-book) av­er­ages and there has not been any sig­nif­i­cant re-rat­ing. This cre­ates a strong in­vest­ing case — es­pe­cially on a rel­a­tive ba­sis — for In­dian banks. Some NBFCs have seen con­cerns about the qual­ity of their as­sets, but we be­lieve the size of the po­ten­tial prob­lem should be rel­a­tively small when com­pared to to­tal sys­tem as­sets. Liq­uid­ity in the sys­tem is likely to re­main suf­fi­cient, es­pe­cially with the RBI step­ping up its Open Mar­ket Op­er­a­tions (OMOs).

What are your pref­ered sec­tors?

We are over­weight on fi­nan­cials and stocks that are linked to ru­ral de­mand (such as the two-wheeler sec­tor). We have re­cently re­duced our un­der­weight on in­for­ma­tion tech­nol­ogy com­pa­nies, as the de­mand en­vi­ron­ment has started to im­prove.

Do you rec­om­mend in­vest­ing in mi­dand small-caps?

As a bas­ket, mid-cap com­pa­nies still trade at a premium to large-caps even as they have not de­liv­ered bet­ter growth. These stocks are likely to de­r­ate, es­pe­cially as lo­cal in­vestors take a step back into the elec­tion. This is hap­pen­ing al­ready. The head­line in­dex has been sup­ported through 2018 and Jan­uary 2019 by a hand­ful of large-cap stocks. The broader mar­ket has been sig­nif­i­cantly weaker. Close to 30 per cent of the BSE500 was down 10 per cent or more in Jan­uary 2019, even as the Nifty was flat.


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