Trump Victory A Bigger Worry Than Demonetisation: Vibhav Kapoor
This week on Thank God Its Friday, Vibhav Kapoor, Group Chief Investment Officer of IL&FS identifies and analyses the three big triggers that will drive the market going forward - the demonetisation drive, Donald Trump’s victory in the U.S. presidential elections and the weakness in the rupee.
There are all sorts of numbers being put out there. We are looking at GDP anywhere between 1-3 percent, a lot of analyst are expecting the recovery in growth to be delayed by 2-3 quarters. What is your assessment of the impact of demonetisation on our markets?
So short term, it is going to have a major impact. So this quarter is almost washed out in terms of expectations and earnings growth etc. Anyway we did not have much earnings growth over the last 2-3 years. So in that sense it is pretty big disappointment. The next quarter is going to be much slower than it would have otherwise been. So I think for financial year 2016-17 it will probably end up with may be 4 percent, 5 percent earnings growth instead of 12-14 percent that people were looking for. But beyond that I think financial year 2017-18 it should bounce back and probably earnings as well as GDP growth should come back to normal statics. So I think it is a short-term influence rather than the longer-term thing and I think in the longer term probably we will have a lot more positive influences rather than negative.
Trump Victory Vs Demonetisation
I believe that you had previously said that you expected the Nifty to correct levels of 8,100-8,200 in the event of a Trump win. It is already getting close to 7,900 sort of levels. Do you see further downside and what is the worst case scenario you are looking for? At what levels do you think correction-based buying will come back?
These two events have happened simultaneously – demonetisation and the Trump victory on the same day. I think very naturally in India people have been more concerned and concentrated their attention on demonetisation because it is a major event, it is a local event and a layman can understand what is happening. But as I said earlier, I think that is a relatively short-term thing so the impact will last for two quarters, or in the worst case, three quarters, but not more than that. The Trump victory which is a global factor is of much more consequence than the demonetisation for the market over the medium term, say for the next 12-18 months.
When I said earlier that a Trump victory would cause a correction to 8,100....at that time the consequences of a Trump victory or the way the markets globally have behaved after Trump victory has exactly been the opposite of what people had thought. So nobody had anticipated the dollar to run up, the U.S. markets to run up. The morning Trump won, all markets were down badly. Dow was down 1,000 points but then it recovered and it has not looked back from there. So now you have to revalue what is happening.
I think the Indian analysts and investors are not giving that event much importance but its going to have a huge influence on the market. If Trump lives up even to half his promises of cutting corporate tax in the U.S. from 35 percent to 15 percent, allowing money to go back from outside at 10 percent (corporates have kept money outside), fiscal spending, fiscal deficit...if he does that, I think a lot of money is going to go back to the U.S. It has already started. We can see emerging markets have sort of big drain of funds, both from bonds as well as equities, and that is only going to continue, maybe accelerate if all this happens over the next 12-15 months and that is going to have a detrimental impact on all emerging markets. It has already started, we can see that. It will happen in terms of currency depreciation, it will happen in terms of outflows of FPI money and so on. Combined with the demonetisation impact for the next 6 months or so, I think the markets will have a very tough time going forward.
Further Weakness In Rupee?
You just said that it is looking like the dollar is going to strengthen from here on and of course that is going to have implications for the rupee. Do you see the falling rupee playing a spoilsport to the 50 or 100 basis points repo rate cut that you were expecting from the RBI in the event of demonetisation?
Yes. Because too sharp a cut in the repo is going to accelerate the decline in the rupee. Already, the differential between U.S. yields and the Indian yields is narrowing very sharply. So we are down up to 6.2 and they are down 2.4 or something. So the differential is 3.75 which is just enough to cover rupee depreciation. So if you have another 100 bps cut here and there they go up another 30-40 bps, there is really going to be an outflow of funds from bond funds etc. and therefore the rupee is going to come under more pressure. So yes definitely I think that is going to form a sort of a major point in the decision making process of the RBI as to how much they can cut. So RBI will probably not cut by 100 bps because of that.
What Will Bring Flows Back Into India?
You mentioned that markets face the risk of outflows accelerating in the near future. But what will it take for global events or what will it take for variables to change domestically which could bring back FPIs and how long do you think that will take.
In the short term, nothing. Because when such things happen, FPIs tend to allocate money towards markets and economies where the currency is appreciating and the market is appreciating. What is likely to happen is that money is not going to flow out from here but money is also going to flow out from bonds even in the U.S., into equities. That is already happening. So there is very little you can do about it in the short term. And anyway you cannot start to grow suddenly at 10 percent, 12 percent so as to stop that flow of funds. So in the short term, I don’t think you can do anything. Over a medium term, of course, you can do a lot of things in terms of reforms and growth pick-up etc. which then will have an impact and money will start to come back. But it is more of an emerging market issue than a sole India issue.
Silver Lining: Retail Flows
Do you believe that increasing retail flows into mutual funds via Systematic Investment Plans will in any way offset the dearth of foreign flows?
That is very good thing happening in the last two years. We have seen a lot of domestic money coming into mutual funds. We have seen a permanent shift, to some extent, of savings going into equity and mutual funds. If fixed deposit rates come down further as they are likely to, that should keep the flow of money going into the equity mutual funds at a strong pace. That is good. If the markets start coming down continuously over a period time then investors get a little bit hesitant and that can reduce the flows to some extent. But hopefully they will still keep on investing.
Fed’s Future Trajectory
Markets have already started pricing a Fed rate hike in December. How important do you think the commentary will be, this time around, in terms of pace of hikes in 2017? Is that something markets will focus on?
Markets will focus on that because the Fed hike in December is almost 100 percent priced in. So the commentary will be important but I’m not sure the Fed will give you some very specific commentary in December given that the new president will come in January. They would like to see what policies he follows, what deficit financing he does, what type of spending he does. I think you will see some very ambivalent commentary from the Fed. saying ‘we’re going to be data dependent, see what the president’s policies are’ etc. So they are likely going to leave the market in an uncertain mood.
Budget 2017 Expectations
We are also looking at the Union Budget in a couple of months. What are your expectations from the Budget? What roles will the demonetisation and implementation of the GST have on the Budget?
The Union Budget is going to be very important this time again, especially because of this demonetisation event. There are still unclear issues. If the Reserve Bank of India (RBI) does save that money – Rs 3 lakh crore or Rs 4 lakh crore whatever the final amount is – and whether that can be transferred to the government. There have been conflicting articles, some saying it is possible, some saying it’s not possible, some saying the law has to be amended etc. So if they can do that then it will be a plus since they will have a much more to spend. The government can recapitalise banks, they can spend more on infrastructure, they can give some sops to the public. I think the sops are coming, definitely. They also perceive politically that the people have had a hard time and therefore you need to give them some positive vibes so that they can start spending again in a big way. So I would expect some fiscal stimulus of some kind or the other, either through reduced taxes or through increased spending or a combination of both, some recapitalisation for banks but a lot will depend on the final arithmetic and legal leeway that they get to transfer some of this money to the consumer.
Any estimates you’re working with right now?
It is too early because December 31 is still far off. Unfortunately, we hear so many things off the record that people are still managing to convert their black money to white. We don’t know how much of the amount is not going to come back. We have had estimates of Rs 3-5 lakh crore earlier. But what we hear off the record is that people are managing to convert it. So let see what the final figure is.
Global Versus Domestic Themes
So given the current situation...we know what’s happened globally, we know what’s happened in India and the GDP growth cuts that we have seen..Where would you put your money now? In global or domestic themes? Because it is a double-edged sword right now..
I would keep a fair amount in cash to be honest. You could put some money in global themes as they have underperformed earlier like information technology (IT) and pharma. But IT is suffering from a lot of its own problems which have nothing to do with demonetisation or the domestic situation. The new business model with cloud and digital computing is something Indian companies are finding very difficult to adapt to. It will take them at least three years to adapt to them and then some of them will fall out of the way, some will do well. Secondly, now you have the Trump problem because he has promised that he is going to look at the H1-B program. The rupee depreciation will help a little bit but that is a temporary thing. Pharma is okay, maybe a little better. Stocks have come down so you can put a little bit of money there. Domestics, as I have said, I do not know yet. It is too early to say. The impact of demonetisation as well as the dollar and the yields going up leads to a pretty uncertain situation right now.
FMCG: GST Boost
Which are those areas which are exposed to large informal or unorganised sectors and stand to benefit from the demonetisation move?
I think fast moving consumer goods (FMCG) is one such sector. The unorganised sector plays a big part there. Some segments of FMGC at least, if not all of them. The GST, as and when is gets passed and implemented will be extremely beneficial for the organised companies in these sectors. The advantage of not paying tax which the disorganised sector has will go away and they will also have to come into the chain. So FMCG is one sector which is going to gain substantially from that.