FMCG, pharma & IT to be resilient: Credit Suisse

The gap between the weighted average lending rate in the banking system and the repo rate is at a record high and that needs to be brought down. Just normalising this gap would bring down borrowing rates by up to 150 basis points, says Neelkanth Mishra, MD and India Equity Strategist.What is your reading of the economic data that has been coming out since June? April and May were bad. Where are we headed?The important thing to figure out is at what level the economy will stabilise. Are we stabilising at 85% of normal, or 90% or 95%?Some of the indicators were down meaningfully year-on-year in April and May and the economy was down to 45-50% of normal during the lockdown. May onwards, the indicators started bouncing back sharply, and did so till the middle of June. But since then, they are grinding upwards and some have stagnated. There was a dip in July, but thankfully it was short-lived. This is not entirely unanticipated: we had expected a sharp rebound to 85-90% levels and then a flattening out. Many activities are still barred, and just these would add up to 3-4% of GDP. Schools, restaurants and public transport are not working. International travel is not allowed. Inbound travelers spend nearly 1% of GDP. Offices, especially in the big cities, are working only at a third of capacity. Festival celebrations are likely to be low key.One problem in measurement is that most of the concurrent indicators have their own limitations. Some like mobility indicators have an urban bias – they can only measure where there are smartphones; some like rail freight can be distorted by pricing changes or policy shifts; and others like vehicle registrations may lag sales by an abnormally long period due to lockdowns. My best guess is the economy is back to 90-odd percent of normal. As you would expect, when this happens, some segments will be close to normal, whereas others will lag meaningfully. While power demand is flattish to 2-3% up, e-way bills were down 7% in July. Vehicle registrations are still down by a third. Do you think we need a second round of stimulus and this time a more consumer focused one to take this up from 90% of normal to pre-Covid levels?I do think that there is a need for a substantial stimulus. This 90-odd per cent is likely to keep inching up. But that is not acceptable. There are concerns on both consumption and investment.There is already evidence of a spike in precautionary savings. Bank deposit growth is far in excess of credit growth. It only occurs when people are very uncertain about their future. There is also an income growth problem. Migrant workers are starting to return, but will they have jobs and if so at what wage level? We must always remember that the problem in India is less about unemployment, and more about underemployment, and the incomes the jobs generate. Secondly, on the investment side, in most sectors, businessmen will be cautious. Even those that have managed to preserve their balance sheets and liquidity will be cautious about investing. So, we need significant fiscal intervention. The question is, where should this intervention be? Should the government embark on significant expansion in infrastructure building? That is supposed to have the strongest and highest growth multiplier. My preference, and here I am being prescriptive rather than predictive, is that the centre works with state governments on dramatically improving healthcare infrastructure. This is as good a time as any, given that one of the reasons for caution among citizens is also the lack of medical infrastructure. Supplementing it will reduce fear, not just for Indian citizens but also foreign visitors coming to explore investments as well as expatriates. It will also be widely distributed geographically with 3-5 facilities in every district, and maybe one per block. After all, this may not be the last pandemic we are seeing. I am aware it will not be easy, as healthcare is a state subject. But states have the physical capacity whereas the centre has better access to funds and the responsibility for macroeconomic stability. This has been done in Pradhan Mantri Gram Sadak Yojana and Pradhan Mantri Awas Yojana.The second area can be urban infrastructure and affordable housing. These have to be viewed together. This is again a state subject and will have to be funded by the Centre. One of the reasons why the big cities got into so much trouble was lack of proper housing. If you can address that, in the next pandemic we would be much better prepared. These are areas where you can inject 2-3% of GDP worth of stimulus with substantial multiplier effects for growth. How likely is this? There are signs that there is intent. When the government announced housing for all a few years back, the schemes appeared to assume house ownership for all. One welcome change in the Atmanirbhar Bharat package announced in May was that the government is now also prioritising rental housing. The fiscal numbers though need to be pumped up significantly. Do you think there should be some kind of a cash giveaway? Let’s take a step back for context. Starting in March, I was one of the proponents that during lockdowns fiscal spending should be focused only on making sure that people and enterprises do not die. When you are trying to slow activity down, a growth stimulus would be useless. During lockdowns what will people spend on? You provide people enough so that people have food to eat, and that enterprises have enough liquidity so they don’t fail. If a firm fails, restarting or recreating it requires more time and effort. It is harder to revive supply than demand. But now that we have come out of the lockdown, some demand stimulus is necessary. As we debate the form of demand stimulus, I would be biased towards the government deciding to spend as against income transfers. A cash transfer would have to be substantial to be able to get over the fear of the future, and large transfers can be distortionary. It would take a while for sentiment to revive. In the formal sector those that haven’t already lost their jobs are afraid that the day they join their office, they will, because firms may be uncomfortable firing on Zoom calls. The issue with government spending is the timeline. Schemes take time to design and execute. Take the Pradhan Mantri Awas Yojana, a centre-state collaboration that was executed wonderfully. It required a long time to design, and a few quarters to ramp up. It was announced in November 2016, a few weeks after demonetisation, and truly ramped up about six-seven months later. Do we have that much time to give a stimulus? That is the only concern I would have.This government has also been a bit reluctant to give cash handouts. So if we were predicting that and in the markets you have to predict not prescribe, it is reasonable to assume that that may not be the government's choice. There is a view in certain sections of the central government which says that there is a lot more space on the monetary side than on the fiscal side and it is better to give more monetary stimulus in the form of rate cuts. What would you say to that? There is space for monetary as well as fiscal stimulus. Let’s first look at the monetary space. Lack of clarity on the inflation trajectory was perhaps why the MPC chose not to act this time: they did not give out an inflation forecast too. A number of people in policy-making circles have expressed concerns that inflation is going up even as the economy is clearly slow. Ideally, the MPC should look through this: supply chains are still disrupted, and inflation would be unpredictable for several months. But given that output is substantially below normal, we may need negative real rates for a long time and so these inflation prints do not have analytical value. I think there is scope for more rate cuts at the repo rate level in addition to enormous scope for pushing rate transmission. Why should the Government of India be borrowing at a rate that is 210 bps higher than the repo rate? It should not be more than 60-70 basis points. The gap between the weighted average lending rate in the banking system and the repo rate is at a record high and that needs to be brought down. Just normalising this gap would bring down borrowing rates by up to 150 basis points. Why do you think this gap exists? Is there still fear in the system? This gap exists for two reasons. The first is that there is a shortage of financial system capacity. This problem pre-dates the crisis. The second is caution in banks, as they price loans to adjust for elevated risk of credit default: this is normal and totally expected in such times. Policy needs to act forcefully to counteract both these factors. Though lower rates by themselves may not be sufficient to revive demand, they are necessary. At the margin they will help. Now for the fiscal space. An argument I have often made over the last six months is that the question of who will buy the bonds is less relevant than what happens to inflation and the currency, if the central bank buys the extra bonds issued by the government. If you just consume without producing by printing money, demand goes up more than supply, causing inflation. Your current account also goes out of whack.While these are rational fears, they do not apply now. We are running a massive balance of payment surplus. The pace at which the RBI’s balance sheet is growing is unprecedented, and unlike other central banks globally, who are seeing this because of buying government bonds. The RBI is buying other countries’ bonds to prevent the rupee from appreciation. They are struggling with the ‘Impossible Trinity’. The capital account is relatively open, so if you do not want your currency to appreciate which is what seems to be the policy choice they are making. Then you lose control of monetary policy. The pace at which they are printing money is unprecedented. This problem would have been temporary if rate transmission was happening: more money supply would mean lower cost of funds, which would trigger demand and the dollar surplus would be absorbed naturally. But this is not happening, as we discussed earlier. This problem could intensify further, as the earlier policy of keeping the current account open and then calibrating the capital account to make sure sufficient dollars came in, is changing. For reasons that are less to do with attracting dollars, the capital account is being opened up, and for geostrategic and job-creation reasons, the current account is no longer as open.The only way this can adjust is if the government does fiscal stimulus, boosting domestic demand: this is a lot of scope thus for the government to expand its fiscal deficit at least for this year. Not unlimited, and that too would not be prudent. But substantial. We need to get growth back at any cost. Do you see corporate India picking up the slack? At some point, there will be a vaccine and the lockdown restrictions will be eased and lifted. You are seeing a gradual trending down of the active case growth in India. Corporate behavior is somewhat easier to predict. For anyone who has set up a business, the motivation is to make money. If there is some certainty about the future and they see growth in their sector, they will invest. There will be investments but I do not think in this uncertain environment, it will be sufficient to even think about 4-5% growth in the next year. There appears to be a shift happening in terms of which industry investors are favoring. Are we at the cusp of some kind of a shift where you are going to see a new set of leaders emerging in the rally in the market compared to what was happening a year or so back?Some sector rotation is to be expected as big economies globally have given a much larger fiscal stimulus than the Asian economies. Demand there is likely to be faster. Even though the GDP, which is an output measure, was down very sharply in the June quarter for most economies, by June, the retail sales of goods, had actually gone to pre-crisis levels. In the case of IT, there is a greater focus towards digitisation. For pharma, the year to date increase in PE multiples has been slightly higher than the rest of the market, but the primary driver of pharma outperformance has been that one year forward EPS is up 4% for pharma but down 25% for the BSE 100. The June quarter numbers were likely boosted by some inventory build-up as companies worried about access to inputs. This may not sustain. Structurally it is safe to assume that at least demand growth would not collapse whereas there can be a sustained weakness elsewhere. This is why FMCG and pharma have held up better and there is better resilience of one year forward earnings. I would put IT services firms in the same basket. So it is not really as much a structural break as a reflection of whose business was hurt the least. For banks, with first the moratorium and now the restructuring, the visibility on the balance sheet has gone down, which naturally means lower multiples. Further, due to uncertainty, credit growth has slowed: it used to be 15-18% for the private banks, but not currently. System credit growth is actually at a very low level. So not only is your current business impacted in terms of the fee income generated, there is also greater uncertainty on what lies in your current balance sheet. A few months back, some clients even had this extreme fear that could we see another wave of nationalization as banks needed massive capital injections that only the government could provide? It was hard to explain that this was unlikely, but now, with most large financial firms having raised precautionary capital, such fears have subsided. Given the shortage of financial system capacity in India, the fact that these companies are mostly very professionally run, are very resilient, adapt to changes faster than competition and so continue to gain share. In terms of the robustness of operations and practices, they are comparable to FMCG companies. We remain overweight on the larger private banks. How bad do you think it is going to get for banks in the next six, eight months? With the restructuring announcement, anything dramatic happening over the next six to eight months looks unlikely. The only thing I would worry about is if supply disruptions lead to inflation going up: some of these fears are showing up in the bond yields already. We may see one period of uncertainty starting September when the banks start taking a call on which loans should be restructured and which should not be. One hopes disclosure norms remain high.What about the second tier public sector banks? When we think about those banks, we can think about them on several fronts. Are they an obstacle to growth now? I think they are slowing down the economy, because there is very little incentive to desire growth, design new products, etc. But that concern is not new and I do not think there is a crisis. Will they cause systemic instability wherein they drag down the growth of the economy or drag down the other parts of the financial system? We can discard this risk too as they are government banks. Banks only go under when there is a run I do not think there will be a run on the banks. Will they be able to raise capital? Even if temporarily they go below the RBI prescribed level and are pushed into PCA, there will be some damage done to growth further but I do not think that will be like really problematic for the system. Can some of them be privatised? Newspapers have reported that the government wants to hold on to only five or six PSU banks and privatise the rest. It is a question as to how and in what form and shape these banks can be privatised. Will that be done by raising a lot of equity from the market at much below book and the government’s stake gets diluted down? Will there be a strategic sale where some large foreign bank or some large Indian non-banking finance company is asked to take them over at whatever price after some restructuring? If you are looking at these banks as stocks and whether to own or not, those are the decisions to think about. From a systemic level there is less of a negative surprise that I expect from them.What are your views on the auto sector because that is one crucial aspect of the key indices and plus there is a huge demand play as well? Among the segments of the auto market, tractors clearly have done well and it is not surprising: this is a relatively small market, driven completely by crops requiring extensive farming, extensive government procurement, and which are much more monsoon dependent. For two-wheelers; the prevailing view is that these are the most affordable form of personal mobility, and should benefit from people’s distrust of public transport. That is logical, but the question to ask is will that be sufficient to counteract other factors. The drop in income could hurt what is a large discretionary purchase. The penetration of two-wheelers is already quite significant in India. Among autos, this is the category most exposed to disruption from electric vehicles after buses. The pandemic fears may not last beyond another year. Two-wheelers is a segment that we would, in the stock market at least, rather stay away from. How should investors play the digital theme in India considering that we do not have the kind of companies that exist in the US? We only have the IT services which are now morphing themselves into digital players and a bit of the telecom with RIL and Bharti.I would look at data and technology through a broader prism and not just the e-commerce or social media firms but also companies that can use technology and digitization much better. One of the most remarkable trends from this pandemic has been the acceleration in digitisation.Take banks and NBFCs, go for some of the better ones even though they are not a pure play. But these firms are greatly affected by digitization: the barrier between technology and finance is thinning. In our bank, more than half the workforce is IT. There are digital interfaces, and investing as well as underwriting decisions require data and analysis. These days, in auto loans for example, or even say insurance underwriting, the kind of data that you can tap into with just some keywords is quite substantial. IT services is a sector which we have been pushing June onwards. We thought that it had become really cheap. That call has worked well but I still do not think it is done yet. Ever since the pandemic started, the long dollar theme has been strong. Is there a problem of dollar shortage that is going to come up?Exactly the opposite, in my view. I do not think there is any dollar shortage, at least not for us, though some Emerging Markets like Turkey are struggling. I do not think dollar financing is going to be a problem. A lot depends on the continuing fiscal push in the US, and given the political uncertainty there, some concerns have emerged on the continuation of the stimulus, but it is likely that the Fed balance sheet size will keep rising. They have understood that they are effectively the central bankers to the rest of the world. In India, there is the sudden spurt in retail investors. We are also seeing a bit of a downtrend in equity inflows into equity mutual funds over the last two months. What is the reason according to you?I do not find this surprising at all. It is to be expected when you have unprecedented excess money supply, When economic growth is most likely zero percent, and broad money supply growth is about 12%, the gap between them, which is the excess money supply growth, is at a record high. For individuals or more broadly economic participants, who are increasing savings, either voluntarily due to fear, or because they cannot spend in a lockdown, at a time when excess funds are pushing down interest rates, the temptation to invest the money in stock markets is high.What is the house prediction for how the GDP will end up this year? Are we going to see a bit of a pickup in the second half?Not much of novelty in those forecasts: minus 6 to minus 7%. But everything is uncertain at this stage. If the overall economy remains at 5% below normal from September to the end of the year, the fully year growth could slip to minus 9 to minus 10%. If the economy adjusts even below minus 5% then that goes further lower. The question that really matters is when we cross the FY20 GDP level – somewhere in early FY22, late FY22, or later. There are several natural drivers of growth in India, and there is also policy uncertainty in how the fiscal and monetary levers will be used.

from Economic Times https://ift.tt/2Euk5wL