"Credit growth is not going to pick up just by reducing rates"

Outlook Business: Is the market glossing over the challenges of implementing GST and the impact on the consumer?

Saluja: No. We don’t have all the answers right now. A lot of work is going on to see who is going to benefit and who is not. Maybe the branded MNCs will benefit the most, logistics costs could come down, and so forth. So, how it all transmits down to the bottom-line is something we will know once GST is implemented. But, for now, the intent of the government to push things through is what has created optimism in the market.

Saha: I think India is never going to see any policy that gets implemented in toto. So, a lot of dilution will happen before the final contours emerge. So, the moot point is that the customer is yet to comprehend how GST is going to change his life. But I think the impact wouldn’t be as harsh as one imagines, because there are always ways to mitigate the higher rates so that it won’t become a burden on consumers. I am hugely positive on GST implementation.

Das: I want to comment on the transmission of interest rates. Let’s look at it this way: a banker has Rs.100, he has to put Rs.4 in CRR, Rs.21 in SLR, and Rs.10 in regulatory capital cost. The balance is Rs.65. Of the Rs.65, 40% is reserved for priority sector lending. That means the banker now has Rs.39 left to lend. Now, how do you price that? So, transmission will take time but it will happen for sure.

Saluja: There is a market outside of banks such as CPs, etc. There is enough money available for anyone who has a good business. Even existing corporates can raise money through CPs and bring their overall costs down.

Mohan: At current rates, AA rated bonds can raise money with a 200 basis points premium. So, there is money that corporates can raise and banks are not necessarily the only option. 

Outlook Business: It’s not the availability of capital, but to assume an earnings trajectory of 15% without bank credit really flowing, seems a bit incredulous 

Singh: True. Credit growth is not going to pick up just by reducing rates. Unless there is demand, there won’t be a pickup in credit. Look at the consumer side; one can see reasonable credit demand with most of the bank’s loan-book growth coming through consumer loans and mortgage loans. In this case, one can clearly see that the transmission has occurred. Mortgage rates have come down from 11% to 9-9.35%. But on the corporate side, we have a demand constraint and without that, credit growth is a very different picture. 

Outlook Business: What’s your take on financial sector stocks, Rajesh? 

Saluja: Within financials, PSU banks are facing far too many challenges. For now, lower interest rates, reclassification of loans, allowing them to restructure some of those bad assets will provide a breather. There will be some sort of a consolidation.

Outlook Business: So, for now, is it a sector to ignore?  

Saluja: At least for the next couple of years.

Outlook Business: Anybody here who has a contrarian stance on stressed banks?

Singh: Even if we assume the NPA story is going to get better from here, from a fundamental standpoint, PSU banks lack the structural pro-activeness needed to compete effectively in the market place. In the last 18 months or so they have actually ceded market share to private sector banks. While banks are a clear proxy for the economy and you cannot really ignore them if you are optimistic about economic growth, most public sector banks are a different story, not because of NPA issues, but owing to their inability to compete.

Bhagat: We also have to look at why these banks got into trouble. There are many factors which includes bad governance. Having said that, there are some very decent assets which can be taken off from the system. But whether the government is keen to do that or not, we don’t know. 

Saluja: But you are seeing a lot of ARC activity because they see it as an opportunity.

Outlook Business: Do you see ARC as an opportunity?

Saluja: No, we don’t but funds with a 10 to 20 years kind of horizon may still see value. But from an investment point of view, it’s always about choices and today there are better choices. For the last 10 years, banks were forced to go and improve penetration in the rural segment. But since most of them were stressed, they didn’t want to spend capital. That was an opportunity which the NBFCs have capitalised upon.

Saha: NBFCs have managed to fill the gap in an operationally feasible manner. So, unlike banks which have restrictions, it becomes easier on the NBFC platform to execute a lot of things at a low cost. So, there is an alternative platform which is doing that at a lower cost and the need is to expand that by investing in technology. Look at Bandhan, they have managed to transform into a growth bank.

Outlook Business: Besides private banks and NBFCs, in which other pockets do you see value?

Bhagat: Pharma offers a good buying opportunity. We also like auto and ancillary stocks.

Singh: All consumer-related sectors whether it is staples or consumer discretionary. We also find value in IT and pharma as these are globally competitive businesses, though there is a little bit of a re-thinking on IT. In the past when IT was written-off saying that labour arbitrage was dead, these companies found their way back. So, we are advising clients to buy good IT services companies.

Das: There are quality stocks in the IT basket, but you have issues around Brexit, you have order cancellations, you have visa fee going up. So, in the next one year IT companies will have to reconfigure themselves. 

Saha: We are very bearish on IT as global financial services are not doing well. IT budgets have been slashed, translating into weaker demand. Second, the sector is witnessing pressure on margins. It hasn’t showed up much due to the rupee depreciation. Also, in our estimate, we don’t think large companies, including TCS and Infosys, are up to speed in reengineering or adding value to command a premium.

Mohan: Our view is that evolution to cloud technology from domestic IT companies has been minimal and that’s where overseas companies have taken a leap. So, our house view is that one needs to wait as far as the IT sector is concerned. 

Outlook Business: So, how are you positioning your clients?

Mohan: I think we are at a very interesting place where both equity and fixed income are looking good. Within fixed income, one can still get decently attractive yields. So, our ideal allocation is half equity and half debt and for sophisticated clients, we are suggesting a 10% play on real estate, PMS and private equity. 

Outlook Business: With most of the rate cut behind us, is there more juice left in fixed income?

Singh: The 10-year yield has come down, but the RBI, in its latest policy, has shifted away from inflation to growth. So we think there is more to come in terms of rate cuts. You could have 25 basis points this year and another 25 basis points in the first quarter of next year. So, the market will shift from playing on duration to accruals. Because accruals will continue to be a critical part of fixed income allocation. Now, within accruals, spreads of AAA papers have collapsed quite significantly and are now below the long-term average. But AA and AA+ papers still have reasonable spreads left. So, I think the action will shift there. 

The other thing to watch out is that the difference between Indian 10-year and US 10-year is about 550-560 basis points, which still is about 70 basis points higher than the long term average. So, on a relative basis, Indian yields are still far more attractive to global investors on an exchange depreciation-expected basis. So, money will keep flowing in, and there will be downward pressure on the 10-year yield as well. In that sense, there is no reason to move away from fixed income.

Bhagat: We could be even more granular in terms of AA or AAA papers of housing finance companies or NBFCs. So there is definitely some juice left.

Outlook Business: Sandeep, are you asking clients to increase their fixed income allocation?

Das: Yes, we are recommending fixed income as there is room to play both duration and accrual gains. We have already seen in September how foreign investors bought Rs.10,000 crore worth of bonds.  

Saluja: A large part of duration is over, now people are chasing yields. The appetite for yield even among MFs and pension funds, too, has increased, especially in the 3-to 5-year duration basket. We, too, are suggesting the same basket as there is still some action left.

This is Part Two of Outlook Business' 5th annual private wealth roundtable, Upper Crest. You can read Part One here and Part Three here.