Crude above $70-75 a barrel is a negative for the Indian market as every

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$10 a barrel rise in crude prices adds 1.7-2 per cent to inflation, says Saurabh Nanavati, chief executive officer of Religare Mutual Fund. In an interview with Bijoy Sankar Saikia, he says India Inc’s earnings for the next year may be downgraded by up to 3 per cent because of margin pressures. Excerpts:

What would you attribute the spurt in the market over the past few sessions? Is this euphoria sustainable?

Global investors were expecting populist measures in the budget to compensate for the high inflation, especially high food prices. Large populist measures would have meant further strain on fiscal deficit next year, with no additional benefit of a 3G-type bounty being visible. In the absence of such populist measures and a lower target for fiscal deficit at 4.6 per cent, investors were definitely relieved and they returned to the market. The budget rally is over for now, and the market will now be focused on global cues and crude prices as these are the dominant factors affecting inflows to our market.

The FM’s deficit target appears to have made a lot of people breathe easier. However, some others find the figure doubtful. Your opinion?

While the headline number of 4.6 per cent looks very good, the math is not adding up. Firstly, there will be no 3G bounty this year. Last year’s fiscal deficit was 5.1 per cent with over Rs 38,000 crore in fuel subsidies. This year the budgeted amount is Rs 23,000 crore. Given the high oil prices, it could possibly fall short in the first half itself. The finance minister is banking on buoyant tax collections for next year. I personally feel the deficit could exceed 5-5.5 per cent given the high oil and commodity prices.

Do you find the FM's confident utterances and the current market valuations attractive enough to bring back FIIs into our market?

There is no path-breaking reform announcement by the FM in this budget for FIIs to return to the market in a hurry. However, India continues to remain a hotspot for FIIs, given its 8 per cent GDP growth trajectory over the next five years, which is much higher than developed economies. Money will continue to come in over longer periods. But we need to take a step back for the immediate future as growth in developed economies has surprised on the positive side — both in the US as well as Europe. Investors were fearing the worst last year and positive surprises have forced FIIs to re-allocate some money back to those economies at the cost of emerging markets. It is natural for fund managers to do this. Price correction and time correction for the Indian market will again make it attractive for FIIs to come back in the second half of the year.

Barring the crude price rise, what could be the other downsides for the market from here on, if any? If at all there is another correction, how much of a fall would you expect?

Crude price anywhere over $70-75 a barrel is a negative for the Indian market. For every $10 a barrel increase, inflation rise by 1.7-2 per cent in India and fiscal deficit increases too. A positive thing for India is local oil and gas production is rising and it has reached 15 per cent of imports. A rise in local production will improve Indian market’s prospects substantially. The downside for our market will emerge from high inflation, any crisis in Europe, high crude prices and higher fiscal deficit and any earnings downgrade. We feel earnings for next year may be downgraded by another 2-3 per cent from 18 per cent at present because of a rise in crude prices and lower margins. If the market corrects 10-12 per cent from present levels, which is a 30-40 per cent probability, it will be a phenomenal opportunity for retail investors and FIIs to enter the market with a large margin of safety for the upside.

Reading from budget fineprint, which sectors do you think are main beneficiaries?

The government’s decision to leave most direct and indirect taxes unchanged is neutral for most sectors and positive for certain sectors such as automobiles and cigarette manufacturers. A higher income tax exemption limit for individuals will put more money in their pockets, leading to higher consumption. However, this has to be weighed against high inflation, which will eat into spending power.

We have had interest rates at near peak and inflation at its high throughout February. Yet auto sales numbers have come better than expected.

This is a common phenomenon not just with automobiles, but with the entire basket of consumer discretionaries. It has two elements working in its favour — cyclical (pent-up demand) as well as structural (given the rise in per-capita disposable income and the wallet share of discretionary expenditure, which rises when the wallet share of needs falls).

Do you foresee any deterioration in earnings growth in the March quarter? If yes, which will be the sectors to watch out?

There could be a minor deterioration in the March quarter, but it will be definitely visible in the June and September quarters, given the high crude and commodity prices.

Given the fact that the government has lowered its borrowing targets for both FY11 as well as FY12 and that inflation numbers are stabilising somewhat, will interest rates peak around these levels? Or will rising crude prices send all calculations haywire?

We expect the government’s net borrowings to exceed its budgeted estimate of Rs 3,58,000 crore and fiscal deficit to exceed its target of 4.6 per cent without any severe correction in the prices of fertiliser and crude. The government’s estimates of revenues are realistic, but expenditure, particularly on fuel subsidies, is woefully inadequate.

How would you comment on the budget move to allow foreign investors to invest in domestic mutual funds?

Allowing foreign investors to invest directly in domestic mutual funds is a great reformist step. While the fineprint and the modus operandi will be known over the next two quarters, we need to understand the broader picture. There are two categories of foreign investors — institutional investors including FIIs, insurance companies, pension and endowment funds and retail investors, including HNIs. Institutional investors will not invest directly into local mutual funds because they get 30-60 basis points fee structures globally and will not pay the 200-250 basis points fees that local mutual funds charge. They would much rather contract a separate account for their large investments, with local mutual fund houses, and get it managed separately from the retail tranche. The move is clearly targeted at foreign retail investors, including HNIs, where the opportunity is large. It will materialise only over a longer period, say two to five years. Foreign retail investors already have global funds offering the India strategy to them in their local jurisdiction. They would buy domestic mutual funds over global funds with an India strategy only if local funds outperform handsomely. This has certainly been the case over the past many years and will need to be highlighted to the foreign retail investors.

Which are the sectors you have been playing at this moment and which are the ones you have been avoiding? Why?

We are currently overweight on consumer staples and discretionary, utilities and healthcare sectors and are underweight on materials, real estate and financials sectors.

bijoysankar@mydigitalfc.com