How are you looking at the overall valuation for the Indian equity markets?
Sonal Varma: Globally, a few factors have surprised us. One, the pace of recovery has been much stronger than expected across-the-board, notwithstanding the more recent virus-led wobbles in some of the developed economies.
Two, particularly for India, the containment of Covid-19 has been a positive surprise and that has enabled continued normalisation in activity because that is something that other economies have actually not seen as much. There have been cases of virus picking up.
Third, clearly the overall policy stimulus, monetary and fiscal have been quite substantial. It is a positive global environment and particularly for India, given the virus containment. Our view is that the lag effects of easy policy of India are yet to reflect in the growth numbers. We think India’s growth is going to outperform other countries in Asia this year. So in calendar year 2021, we are expecting close to 12.8% growth which is partly base effects driven but from a fundamental standpoint, is a fairly solid growth number.
What is the outlook and also how have you looked at India stacking up vis-à-vis some of the other emerging markets when it comes to the big themes to play?
Saion Mukherjee: We have seen a significant rally in the Indian market. The recovery has been strong and besides the liquidity that we have seen coming into India, we have corporate earnings. There was a fair bit of pessimism at the start of the fiscal year as the pandemic was unfolding. The corporate earnings, particularly from the second quarter and now, into the third quarter, we are seeing resilience in corporate earnings and consensus estimates are going up. Therefore, to that extent the stocks have done well.
When I look at the numbers for the next couple of years because as we go through this year, the markets will start factoring in what is going to happen in FY23, we find the consensus is factoring in almost 20% earnings growth on a CAGR basis between FY20 and FY23 and in that context, it appears to be pretty optimistic given what we have seen in the last four-five years.
Our concern is essentially about the rise in commodity prices which can put pressure on margins for various companies. If we look at the non-oil and gas, non-financial space, the EBITDA margin is actually at a decade high. There can be some potential risks there. We would like to be cautious and more selective in equities currently. The key themes that we are looking at is essentially deep cyclical recovery and we are positive on specific banks where we see good valuation support. We are positive on infra construction space and that is one theme that should start playing out. Also we remain constructive on IT and the pharmaceuticals, where there are structural growth stories from a medium term perspective. In the backdrop of the current liquidity environment, we would see valuation multiples in these sectors go higher from the current level.
The dollar weakness is leading to foreign money finding its way into emerging markets like India. When in 2021 will we see the RBI rate trajectory moving upwards or the interest rate trajectory stalling?
Sonal Varma: As we navigate 2021, our view is we need to differentiate between the liquidity policy versus the rates policy of RBI because the rates policy is guided more where the output gap is, inflation relative to target and even though we are seeing a recovery, right now the output gap is likely to be negative. So on the repo rate side, the rates will be on hold through this year. It is only in early 2022 that we can expect the repo rates to go up but the process of normalisation of liquidity is likely to begin very soon. The variable rate, the reverse repo option does not really tamper the durable liquidity but going forward, from a macro standpoint, as growth picks up and cost push pressures are picking up, there is a need to reduce the size of durable excess liquidity that is there in the banking system.
That process will start with the CRR hike and reset which happens at the end of March but post that, the process of gradually reducing liquidity to a lower surplus will begin which implies that the effective policy rate which has been below reverse repo and are closer to reverse repo gets closer to repo rate as the year progresses. Liquidity normalisation will begin very shortly this year but the actual repo rate hike is still some time away.
How are you expecting earnings to shape up within the financial space and where do your preferences lie?
Saion Mukherjee: We do see opportunities in the financial space particularly in terms of valuations. Post the pandemic, there were lot of concerns on the asset quality side but we see essentially things are a lot better than what was earlier anticipated and companies have already made enough provisions for that. The credit cost is under-shooting and that would probably continue in the near term.
Of course, we have to watch out what happens from a slightly medium-term perspective but in the near term, it looks pretty good. Also, we are seeing growth coming back in some of the banks which are well capitalised. They are gaining market share and therefore the well run, well capitalised banks are likely to surprise on the upside as far as earnings are concerned in the near term. Overall, we are positive and overweight in the financial space.
How have you read into the top-tier IT companies’ commentaries as well as earnings growth? Ddoes Infosys continue to remain a favourite?
Saion Mukherjee: Yes, we have been positive on IT through last year but as the stocks had rallied, we reduced our weight gradually. The quarterly results have been better than expected on the revenue front on a sequential basis. Margins were 100 bps better. We are aware of large deal wins which give visibility to growth over the medium term. This structural change in growth can potentially surprise on the upside. There is some expectation which is already there in the stock prices but as that plays out, there is scope for multiples to expand in the sector, particularly in the context of the current liquidity environment.
Do you believe that RBI will maintain a fairly accommodative stance going into this year as well?
Sonal Varma: This year of course has a long way to go. But what the market policy committee committed to back in October last year is to maintain an accommodative stance at least into the next financial year. That implies at least for the February policy and most likely even for the April policy, the accommodative monetary policy stance will be maintained.
From a 6-12 months’ perspective, the macro dynamics are changing and our view is growth is likely to surprise positively. For Financial Year 2022 (FY22) we are looking at a growth number which is above 13% from here. This is partly base effects driven, not entirely. On the private sector side, we think there will be a faster pick up, particularly as vaccinations pick up both in the developed world as well as in India.
On the inflation side, we have seen headline inflation impact come down to close to 4.5%, thanks to collapse in vegetable prices. But the underlying price pressures have surely picked up with the pickup in global commodity prices and as demand is picking up in India. There is a risk that because of pricing power, we could see a greater pass through in the coming quarters. So, from the central bank’s perspective, we think they are going to adopt certain hierarchy in terms of how they manage their policy.
The first step is more in terms of allowing some of the regulatory dispensations which inspire. The liquidity side has been gradually normalised and the starting point from a durable liquidity perspective is the CRR hike that happens at the end of March. But even beyond that, the banking system’s liquidity cannot stay at these levels because the economy is no longer in crisis level.
Third, we think the policy stance will stay neutral going into April. Sometime after June-July, there is a chance that the stance also should go to neutral from accommodative and the final step will be an actual hike in the repo rate. But we think that is more likely in the first half of CY2022 when we are expecting a 50 bps hike.