There is a need to restore macroeconomic stability considering inflation has been rising, as have crude oil prices, with both the current account deficit and fiscal deficit coming under pressure, according to Sudhakar Shanbhag , chief investment officer, Kotak Mahidra Life Insurance Co. Limited. Excerpts from an interview:
What is your outlook for financial year (FY) 2019?
The last three years have been a story of macro improvements. This has been confirmed by Moody’s upgrade of Indian government bonds to Baa2 from Baa3, while changing the outlook to stable from positive. However, it seems that apart from a cyclical recovery in GDP, all other macro parameters would either be static or would deteriorate. A GVA growth of 7.1% in FY2019 is expected, rising from 6.5% in FY2018.
Economic growth is likely to recover as the negative effects of demonetisation and GST recede. Government expenditure on the rural economy and the investment cycle will pick up from the second half of calender 2018.
However, we see headwinds from domestic and external factors, such as rising inflation trajectory, hardening global interest rate cycle, lower fiscal space, and normalisation of monetary policies by developed market central banks.
CAD is expected to remain in the negative 2% range and CPI average is expected to move up by about 100 basis points due to unfavourable base effect and the global commodity cycle. Higher than expected crude price and lower than expected GST collections will add to the risks. On the external front our current foreign exchange reserves are reasonable. However, we do expect to see a depreciating bias on the rupee.
How do you view markets as 2019 is to be an election year?
India has a heavy election calendar in CY2018/2019 with several BJP-ruled States holding elections in late CY2018/early-2019. The market’s high valuations reflect the fact that it does not expect any negative political developments over the next two years.
The market is clearly not prepared for any unfavourable political development, such as the inability of the BJP to win elections in its traditional strongholds of Chhattisgarh, Madhya Pradesh and Rajasthan. Also, general elections are expected around April / May 2019. Expectations and results of these elections will add to the volatility in markets.
How will the impact of monetary policy play out?
Less accommodative monetary policy of global banks will put the onus of market performance on earnings. We can expect high double-digit growth in the net profits of the Nifty-50 companies in FY19 and FY20.
This will be led by improved operating conditions in many sectors, such as banking, pharmaceuticals and telecom that saw a sharp deterioration in their operating conditions over FY16-18.
We can expect strong earnings growth in the global commodity sectors although their performance will depend largely on the strength of the Chinese economy. Earning risks also exist across sectors from various global and domestic factors and high profitability in case of several consumptions sectors. The Nifty-50 trades at about 17.2 times FY2019 EPS on a free float basis and is already discounting a sharp recovery in FY2019 net profits.
It offers reasonable valuations on a FY2020 basis. However, we can also expect high double-digit CAGR in net profits for Nifty-50 companies between FY18 and FY20. This compares with 7% CAGR between FY14 and FY18 on a like-to-like basis. There is potential risk of de-rating of multiples in several sectors from policy, regulatory and technological changes.
The market appears to be quite sanguine about the BAU investment case for many sectors, as is implied in the rich valuations.
The high valuations for several sectors that face challenges suggests that the market is not worried about forthcoming disruptions even over the medium term, which is quite remarkable in an era of rapid technological advancements.
Having said that, on a price-to-book ratio basis, if we look at the last 15 years’ average, the market seems to be in a reasonable band at this stage.
There is no reason to believe that the Indian investor will not continue to shift focus from gold and real estate to banks and equity markets during the next couple of years. Foreigners being overweight on India is also relatively lesser compared with the past and hence can be expected to support flows. However, the negative flows in February 2018 needs to be closely watched over next few months.
On the global front, growth is expected to improve with employment and inflation coming back to normalcy. India may not be a major beneficiary since we are not an export-oriented economy. Also, we are not a major producer of commodities and in fact are vulnerable to higher crude prices.
Normalisation of monetary policy by global central banks may weaken the valuation support for global and Indian markets.India’s attractiveness in emerging markets continues to be on account of favourable demographics and the large market it offers for various goods and services.
How do you read Budget 2018?
The finance minister has been able to address the stress in rural and farm sectors by making enough allocations as also taking structural decisions like making minimum support prices at 1.5 times the cost of produce.
The health insurance scheme of ₹5 lakh cover per family for 10 crore families, focus on education, infrastructure, housing and senior citizens in particular are steps to bridge the urban-rural as well as the rich-poor divide in the country. Tax revenue growth of 16.6% would be possible if the higher tax base and implementation issues are resolved.Non-tax revenue and divestment targets seem achievable. The FY18 expense shift from capital to revenue is projected to reverse in FY19 which needs to be achieved for sustained growth. The gross and net market borrowing figures at Rs.6.06 lakh crores and Rs.4.62 lakh crores is more or less flat compared to FY18.
The fiscal deficit number for FY18 at 3.5% was a bit higher than expected while the target of 3.3% for FY19 is on expected line of some consolidation over FY18. The introduction of long term capital gains tax at 10% as also a distribution tax on equity mutual funds is negative at the margin but the grandfathering of gains up to January 31, 2018 is a good measure to ensure no panic sales are done to realize gains.
The equity markets will move back to their focus on earnings which are expected to be in the mid-teens for FY19 and FY20. Debt markets over the next year will face the brunt of macro deterioration at a margin compared to FY18.
How will the bond markets play out?
For the last 6-9 months, the bond markets have been in a bear market grip. As discussed earlier the macros for FY2019 are at a deteriorating trend compared to FY2018. CPI is expected to be about 100 basis points (bps) higher than what has been realized for FY 2018, though the second half is expected to be lower than the first half. Brent prices have seen a movement to an average of about $57 with a low of $47 and a high of $70 in FY18 adding to volatility in bonds and the range is expected be between $60 and $70 in the next 12 months.
One of the biggest variables will be the level of GST collections with an expectation of better compliance leading to achievement of budgeted collections.
A surprise on either side can lead to more volatility. In the recent past, we have observed less participation from public sector banks that control about 40% of the G-Sec market, impacting prices. All variables as observed are currently leading to a high uncertainty premium in bonds. The current 10 year for example is about 165bps above the overnight rates whereas the historic average is about 85bps. Even if we see from a real rates perspective the yields offer a good spread of over 3% compared to realize CPI range of 4 to 5%. From an investor’s point of view, the current yields are in an attractive zone.
What would be your advice to investors?
Most difficult things have to be expressed simply and executed. For all investors whether retail or corporate, the mantra is to stick to risk based allocations across events and market cycles and stick to goals set on that basis. Some tactical allocations changes envisaging or post events is fine but majority of the wealth is created by sticking to asset allocations.
