Revival in exports a big positive, rates should soften now
Sep 15 2013 , New Delhi
its easy money measures. Excertps:
How do you look at the latest round of euphoria in the market? We have very little in terms of fundamental change, yet stocks rallied? How does one explain this?
In the last couple of months, the sharp rupee depreciation, exacerbated by a weak current account position, triggered a sharp increase in short-term interest rates by RBI. This effectively worsened the GDP growth outlook and held to ransom a key catalyst for revival. But finally, the sharp 15 per cent rupee depreciation even in REER (real effective exchange rate) terms, not to mention the substantial nominal depreciation of 40 per cent vis-à-vis our major competitors like China over the past couple of years, seems to be bearing fruit in terms of a sharp improvement in our exports and curtailing of imports, especially gold.
Even adjusting for normalised gold imports, the CAD run rate seems to have reduced to a much more manageable 2.6 per cent of GDP. This is likely to give substantial comfort to RBI to start rolling back its onerous increase in short-term rates as well. After all, domestically, major drivers of inflation such as incessant food-grain MSP increases are no longer present, while core demand and GDP growth are at decadal lows, creating a case for lowering of rates. In our view, this hope that RBI could once again reduce short-term rates is aiding the current rally.
But frankly, do you have confidence in the strength of the market? One doesn’t see much that can help companies’ balance sheets. In fact, till the other day we were seeing earnings downgrades?
True, there are concerns regarding our low investment rate and missing catalysts for GDP revival due to inadequate policy reform. But we should not underestimate the power of exports as a growth catalyst. It has been seen in China and other Southeast Asian countries, and considering our sharp rupee depreciation, it can prove to be a major catalyst for India in the coming months. The recent decline in trade deficit is not just about lower gold imports. More importantly, it is backed by a 13 per cent growth in exports in dollar terms for two months in a row. This is a very healthy growth and it is real growth as it is in dollar terms and not just rupee terms. At this run rate, if exports continue to grow, it can potentially add a whopping 200bps to overall GDP growth. This could in turn trigger a virtuous GDP upgrade cycle as investments also start picking up.
While the relief on the Syria and rupee fronts is understandable, with regard to the QE measures in the US, the fact is Fed is going to go ahead with it, even if it happens at a slower pace.
Well, that is a funding issue and capital goes to where there are returns. So, if our GDP revives, then money will come to India irrespective of Fed tightening. Moreover, in any case the interest rate differential that India is offering is at decadal highs of more than 6.5 per cent in real terms, which is a huge differential to incentivise capital to remain in the country and attract more capital (including from NRIs).
And then we hear about a plan to hold up a huge amount of plan expenditure in order to meet the CAD target. That should be a negative in terms of investment.
Yes, investments are clearly the missing trigger so far. Like I explained above, with cooling CAD, growing exports and normalising inflation, ultimately investments will also pick up. But that will be a more gradual process. In the near-term, exports and RBI lowering rates are likely to be more immediate triggers. As for the fiscal side, it is very important that the government at least bites the bullet and hikes diesel price, which I believe it will do, due to the threat of a sovereign downgrade.
What was your yearend Sensex target at the beginning of August, say, and what is it now?
Earlier, before the positive trade data numbers came in, we were circumspect and cautious in our portfolio stance and the overall market, expecting a range-bound situation. On Sensex, we were and continue to be ahead of consensus as we believe Sensex with its high weightage of IT, defensives and private banks will remain resilient. It is the broader market, where we were more cautious. But with the recent changes, we believe we may see another 10 per cent upside on the Sensex in the next few months and even 20-30 per cent upside in beaten-down high-beta stocks if RBI indeed rolls back the MSF rates. Beyond that, for the rally to sustain we will have to wait and watch if exports continue to pick up sustainably, and if investments also start picking up.
However, things have begun to look up for certain specific sectors, ain’t it? Telecom for instance? Where else do you see the so-called green shoots?
In the short-term, if RBI indeed starts rolling back its rate hikes (for which as explained, we believe the odds have improved), it would give a strong signal for kicktarting domestic revival and is likely to result in a sharp immediate rally in beaten-down cyclical stocks, including banks and other rate-sensitives, irrespective of weak near-term earnings outlook.
Hence, from the point-of-view of a potential positive trigger from RBI and beaten-down valuations, we believe sectors like banking, auto, capital goods and other high-beta cyclicals can be invested in the near term. Subsequently, if indeed the broader GDP revival also starts to pan out on the expected lines, further re-rating potential can be re-assessed.
Weaker domestic fundamentals (exhibited in tepid 3 per cent volume growth in steel) had prevented us from turning positive on metals earlier. However, continued rupee depreciation has improved the competitiveness of Indian metals, both ferrous and non-ferrous. Considering recent capacity additions and meaningful underutilised capacity in the sector, we believe the same is likely to be utilised for sharp increase in exports going forward, aided by improving global fundamentals as well. Additionally, considering that beaten-down valuations are building in the worst case for domestic GDP, improvement on that front would lead to further positives. As a result, we have also upgraded several of the larger high quality names in ferrous and non-ferrous sectors.
What, according to you, will drive our markets from here on?
Initially, one can look at exports, trade data and interest rates as near term triggers. Of course global events would continue to have a bearing too, and need to monitored closely. Beyond that, it is elections and investment environment that will ultimately guide markets.
Post RBI measures, the projections for the rupee have turned very bullish. People are even talking about 60-61 levels. What are your views on this?
Consistent with the above discussions, I do expect the rupee to stabilise at around 62-64 in the near term.
How have you been advising your clients to play in the market at this stage? Is it the right time to go bottom fishing? If so, what should be the criteria?
Unlike a couple of months back, we have a positive outlook on several more sectors currently, including not just IT and Pharma, but also Metals. Also, at least from a near-term perspective we believe the odds are in favor of a rally in Banks (especially private banks) and other rate sensitives, cyclicals and high beta sectors as well, due to reasons mentioned above.