'While GST and demonetisation are likely to cause disruption for longer than the market currently expects, they can have meaningful positive impact over the medium-term.'
Illustration: Uttam Ghosh/Rediff.com
A Credit Suisse India Market Strategy report, Outlook 2017: Uncertainty seems certain, authored by Neelkanth Mishra , below, left, Managing Director and India Equity Strategist, and analysts Prateek Singh and Ravi Shankar talks about 12 to 15 months of disruption ahead under the shadow of 'momentous changes' in India and globally.
The same report predicts that once this disruptive phase is over the 'medium term outlook is better' even as it warns that though the equity markets have 'already corrected, it is not enough.'
Mishra spoke with Rediff.com's Prasanna D Zore about his expectations from the Budget, market valuations and the sectors that are under-valued and over-valued.
What are your Budget expectations? Do you think this will be a populist Budget?
This is going to be a very complex Budget to analyse. There are so many moving parts this year for the Budget preparers, that is, the government, and analysts like me, who need to understand what it means.
The merger of Plan and non-Plan (expenditure); the merger of the Railways Budget (with the Union Budget); the mid-year start of GST; the intention to simplify tax structures and yet give industries specific incentives are some of the things that will make this a complex Budget.
Also, the economic resilience of the economy or the lack of it that the government will rely on is far from clear.
The CSO data (on economic growth) for FY17 was for data till October and before demonetisation happened.
There is also issue of tax buoyancy and how much surge in November vis-a-vis tax data is reliable and sustainable are all the issues that make this Budget difficult and complex to analyse.
That makes me think that the government may not try to disrupt it (the economy) even more by attempting very complex and revolutionary moves.
I think the government will stick to the basics.
The consensus is that the fiscal deficit will be lower than 3.5 (per cent of GDP) and I don't see any reason why it should be any different.
In the past few years we have seen the trend of usage of high extra budgetary resources to fund infrastructure and capex (capital expenditure)... that trend may again continue.
We have already seen, for example, the Pradhan Mantri Awas Yojana line up debt of Rs 20,000 crore (Rs 200 billion) from NABARD.
The expectation, which the government has been talking about for some time now, and may happen this year is to see that the headline corporate tax rate is lowered to 25 per cent in a graded manner along with parallel removal of exemptions.
Most of the moves will be tax neutral.
It is about their ability to identify and implement which exemptions to remove first; so there will be some corporates which get more affected than others.
That choice has to be made.
So far they have not been able to do it, but hopefully this year something like that (lowering of corporate tax to 25 per cent) will happen.
Given the consensus on lower fiscal deficit, do you think the government will have adequate room to spend more money on infrastructure?
It is not a question about room to spend, but the ability to execute.
Your report talks about lot of disruptions going ahead in the next 12 to 15 months. Where would you see value amid this disruption?
There is a temptation when writing reports, especially, to talk only about one issue. While it is simpler to talk about one issue in a 1,000-word article, but the economy, as I mentioned earlier, has many moving parts.
While GST and demonetisation are likely to cause disruption for longer than the market currently expects, they can have meaningful positive impact over the medium-term.
Further, a lot of phenomenal work is happening on the state government side.
Take, for example, some significant projects in Mumbai -- The Trans Harbour Link, the MUTP 3, -- and there are metro rail projects in UP, Bihar, housing projects in Odisha... there is also technology-driven change that is happening even within the government like usage of data across departments, moving to a system where you have an income tax assessees not knowing who the assessor is dents corrupt practices; you may have noticed that in Mumbai, a lot of traffic violations nowadays are penalised online.
This brings down corruption, brings (in) funds to the government.
So the medium-term prospects for India still seem bright.
Where do you see value in this market?
Value is in sectors which have low PE (price earnings) and which are beneficiaries of low interest rates.
Now, all the uncertainty both global and in India is really bad for PEs.
So, the bond to equity valuation arbitrage works adversely: If bond yields start to rise automatically, there will be pressure on price to earnings multiples of equities, so we think high PE (sectors) are exposed to time correction risk before they come to more reasonable valuation levels.
That risk is not there in sectors like IT where in the last five years we have seen a de-rating.
What are the sectors you are looking at?
We are looking at housing finance companies, Indian IT, private sector banks because despite the fact we expect the banking system to come under pressure this year in the markets we have some very well-managed private sector banks.
Even globally, there are very few sectors that provide such medium-term visibility on share gains in a substantial sector.
We think that the government is unlikely to let the PSU banks grow or at least some of the smaller PSU banks to grow and so there is lot of market share up for grabs.
While the new banks will provide competition they will take some time to scale up and attain critical mass.
In the interim, the growth rates of listed private sector banks will be quite decent... there may not be 30 per cent profit growth, but quite decent and so despite relatively high multiples it's (private sector banks) a good place to be.
What are the sectors that are over valued?
We don't like cement; consumer discretionary; many NBFCs because they have very high multiples and their earnings expectations for FY18 are not great in our view.
Why do you think the government having limited ability to stimulate the economy?
The sectors where the government could do capex are limited and the reason why NHAI (the National Highways Authority of India) is not able to build more roads is not lack of funds.
To address the pace of construction of national highways, what is needed is not more budgetary allocation but some structural changes in NHAI.
That is more critical than providing more budgetary allocations.
The same is true about the (Indian) Railways.
The NHAI hasn't issued even a single tax free bond -- recall that they have approvals to issue up to Rs 70,000 crore (Rs 700 billion).
Talking about the markets, do you think they are reasonably priced at these levels and where will the PE contraction/expansion come from?
Some of the high PE sectors I mentioned are egregiously priced given that (earnings) growth will be not that exciting.
Could you elaborate on the part of the report that says that government's intent doesn't seem to be to give growth capital to PSU banks. What makes you read the government's intent?
The formulae used to calculate the capital allocation quantum two years ago when the system credit growth was relatively robust, showed that the government did not expect or maybe want the PSU banks to grow faster.
Since then you have seen PSU banks grow almost nothing, their loan books haven't grown at all.
This has meant that despite heavier than expected losses their capital needs haven't grown.
My sense is that the government is deliberately not increasing allocation of capital to them and it is not about they cannot find Rs 5,000 crore to Rs 10,000 crore (Rs 50 billion to Rs 100 billion).
Three things you are looking forward to in the Union Budget 2017-18?
Extensive use of extra-budgetary resources to spend on capex and the reason I said capex is because those extra budgetary resources should be project based.
I think they will not breach the 3.5 per cent mark on the fiscal deficit front.
I would look for much higher allocation for rural housing: The uncertainty is that it is a subsidy and intrinsically this government is uncomfortable giving subsidy.
But I do think that this should be a big job creator because at the bottom of the pyramid there is likely to be continued stress.
48 per cent of our work force is in agriculture; most people are excited this year that volume growth will lead to revenue growth, but my fear is volume growth is accompanied by price declines, which means there is low income growth and if agriculture starts shedding people it creates a lot of stress.
So, low end job creation is very important: Rural housing can provide a huge stimulus on this front.
