GST To Improve Fiscal Outlook, Not Make It Worse: Credit Suisse

Fiscal outlook for the next year should be better not worse, Credit Suisse’s Neelkanth Mishra says.

(Source: BloombergQuint)
(Source: BloombergQuint)

The government’s revenue collection under the Goods and Services Tax may be better than the mop-up in the previous tax regime, if the first four months of data are anything to go by. That’s the word from Neelkanth Mishra, managing director and India equity strategist at Credit Suisse.

From that perspective, fiscal outlook for the next year should be better not worse, he told BloombergQuint on the weekly series Thank God It’s Friday.

“I don’t see any scope for fiscal slippage. But the fact that yields have moved up by 50-60 basis point shows that if there is a slippage, then it is priced in,” Mishra said.

Here are edited excerpts from the interview.

How has economic growth panned out in 2017? One a score of 1 to 100, where would you rate it? Also, how would you evaluate the government reform process and earnings growth?

I would rate economic growth at 40, government reform process at 80, and earnings growth at around 50.

Key Themes For 2018

Demonetisation, GST, bank recapitalisation were the recurring themes in 2017. What you think people will talk about the most in 2018?

Most of the big reforms are done. As any good doctor knows, once you have done the major treatments you let the body rest for a while. Especially with the national elections looming in early 2019, more structural and meaningful reforms are unlikely. But we can see good momentum building on power distribution and fertilizers. In November, the volume of fertilisers sold through DBT in the states where pilots where going on, was four times that of previous months. So, in Rajasthan and Maharashtra, every district now is active. 50-60 percent of all retailers, we are talking about 20,000 retailers in Maharashtra itself and 50,000-60,000 in Rajasthan are active doing DBT transactions. The rollout from Jan.1, 2018 will also be meaningful, not directly for the markets, but for the economy. Other than these two, I don’t expect anything new. There is a lot that will happen on GST, insolvency as time goes by.

Trigger For Further Earnings Downgrades

One of your reports suggests that we are likely to see further earnings downgrades. What will lead to these downgrades?

There is a natural inclination to associate the markets with the economy. That if the economy is doing well, then earnings should do well. I don’t think there is direct linkage. In every quarterly result, if Aug.15 is the deadline, till Aug. 9 or Aug. 10 based on one or two companies, earnings can change for the index massively. So you have to be very nuanced. You can’t project the basis of the economic outlook. There is a large part of earning’s growth in FY19, wherein almost 38-40 percent is expected to come from private banks. And that is predicated on a certain loan growth which I think they should deliver as they are still gaining share. But in terms of net interest margin projections, there is scope for disappointment. With the recapitalisation of PSU banks, you will see more margin pressure emerging in the banking system. The single line uptrend that we saw in private sector margin expansion is something that has stalled this year because of weak demand. With additional supply from PSU banks, you will see disappointment. The credit cost estimates that people have built in since 2014, every year people think that this is the worst year for credit cost and next year will be better and the same is expected in FY19. Our sense is you should see credit cost being elevated at least for another year and who knows about FY20.

On staples and discretionary, demand growth may not be as strong as is being currently projected. We are not saying we end up at 5 percent in FY19, but I don’t think the 22 percent consensus will last. By the time FY19 is done, it should be more like 12-13 percent. But by the time we get into FY19, the projection for FY20 will be 20 percent growth. From a forward-looking estimate, we should not worry too much about the cuts, but we should just worry about the pace of cuts.

Election Impact

What about the political impact on markets?

For any event, even if you are 100 percent sure of what is going to happen, as you start getting closer to that event, there are butterflies in the stomach and some uncertainty. As the state elections proceed - Karnataka in April-May and then semi-final elections of Rajasthan, Madhya Pradesh, and Chhattisgarh in November. As these start to play out, the attention of the market will be very much on reading the tea leaves and how to extrapolate from this on what is likely to happen in 2019. After the UP elections, everyone assumed that 2019 should not see any regime change at the center. Let’s see what results say. Results could go either way but market interest in some of these developments could be quite strong.

I don’t expect state elections to drive lasting volatility. But you will see media attention, market attention being paid to this. Beyond the Budget, the direct economic implications of this will be quite limited.

What sort of influence can 2019 elections can have on the upcoming Union Budget?

That’s the question on top of everyone’s mind. Everyone is eager to understand what the government will do in the last Budget of this tenure.

The big question is will the government turn profligate. Will the government will start relaxing the fiscal targets for consumption-stimulating expenditure? 

In a sense, if the fiscal deficit moves up because the government has decided to budget for PSU bank recapitalisation, even if recap bonds need to be treated like regular fiscal deficit, I don’t think the market should be that worried. If they start increasing the allocation for direct transfer of cash into people’s hands, expansion of some inefficient schemes by the own sense is that appears unlikely. This is the last year before elections and governments do tend to become profligate. My sense is that we won’t see any major deviations from the policies seen in the last four years.

Fiscal Slippage Concerns

Would a fiscal slippage of 20-30 basis points in the current or next financial year from what was set under FRBM is something which the market will readily absorb?

Bond yields have moved up, and it is because of the inflation spike. If you talk to traders, there is a lot of concern on the fiscal side because oil prices have gone up. People think that government will lose excise revenue and they will keep cutting excise per litre.

The big elephant in the room is GST. GST, put together, is 40 percent of the country’s tax stake, and you cannot have any fiscal discussion without bringing in GST.

Sadly, even the people who think that there is the possibility of a big fiscal slippage don’t seem to be very confident of what number is the revenue neutral number for GST. People say GST revenue is running short. But running short against what? The government, given that it has only four months of data to work with, is not clear on how to project this into FY19. Those are the interesting aspects rather than whether the government will start becoming wasteful suddenly in the final year.

The big picture for us on GST is that, despite all the distortions that we have seen in the first four months, our sense is that GST is delivering revenues ahead of the tax which it subsumed. From that perspective, the fiscal outlook should be better and not worse.

Finally, it is the choice of the senior people in the government who take a call on fiscal deficit. From a productive investment perspective, like spending on roads and railways, they have now shown, and the markets have taken it very nicely, that extra-budgetary funding is great. So they will keep supporting through extra-budgetary borrowings. Even in urban transport like Mumbai Metro most of the funding is extra-budgetary. The necessity for the government to expand its fiscal deficit meaningfully is not that high. But projecting GST revenue is a challenge, and you don’t know what consensus will emerge within the government. Other than that, I don’t see any scope for fiscal slippage. But the fact that yields have moved up by 50-60 basis points shows that if there is a slippage, it is priced in.

RBI To Move On Rates?

What’s your outlook on interest rate trajectory in 2018? Are you expecting a long pause before RBI eventually moves on rates?

Given vegetable prices, I think tomatoes have already started to correct. The onion crop hits in the next two to three months. So the bulk of the food price spike that we have seen should be behind us by March or April. On the housing side, the big spike is the the House Rent Allowance which peaks in December. Ideally, we should be looking through some of these distortions since they are so predictable. There is no stickiness in the inflation numbers that I see. Almost 54 basis points of overall inflation is coming from LPG and kerosene because the government is withdrawing subsidy. It is not something that monetary policy should act against.

So long as the headline inflation number is where it is, it will be hard for the monetary policy committee to act and it could be at least four months before the MPC sees a window of opportunity. 

There is also a growth aspect. Growth is not doing well and the MPC has started to create policy room so that if growth disappoints, they may act. But they are still neutral. If you ask me, in the next seven to eight months, rates should be much lower than they are.

When do you see the likelihood of a rate hike in India?

There are people who are already projecting that. There are some of my peers who are talking about a late 2018 calendar year hike. My sense is a rate hike is unlikely to come in 2018 but it might come in 2020-2021. It will be far out.

Investment Cycle Revival

When can we see the investment cycle revival happening?

It is a very important aspect of the economy. As of now, hings are abnormally weak. New project launches are the lowest since 2004. This year, gross fixed capital formation as a percentage of GDP could be 24 percent, the lowest since 2004. We can see some improvement in the calendar year 2018, but I don’t think it will be very meaningful. The classic problem is that the sectors where private players are allowed, there is significant overcapacity and broad-based demand growth is not that strong. And sectors where we need more investment, we don’t have private sector involvement. Look at power distribution and see what has happened in Agra. The reduction in AT&C losses is phenomenal. You would wonder why we are not seeing an aggressive expansion of private sector in distribution, to improve metering. Our utilities team today put up a useful note showing that even after two years of UDAY, there has been no meaningful improvement in all the operational metrics yet.

The private sector is not allowed in power distribution more or less, or drinking water, sanitation and urban transport. We are restricted to the government doing all of this. Therefore, we don’t expect meaningful recovery. The government is trying its best. In railways and roadside, there is some pickup in momentum but much lower than the government itself will like it to be.

The critical factor is affordable housing, which the government is trying to push. There are capacity issues in urban governments in terms of the pace at which they can clear projects, the pace at which land can be freed up. It could take a couple of years for the system to start responding.

Therefore, my sense is the revival in investments is not going to be meaningful in 2018. It could happen in 2019 or thereafter.

Portfolio Approach

You are betting more on global-linked plays rather than the domestic consumption story which would be a contrarian call at the moment?

Yes, and it surprises me how different it is from what I was recommending two years ago or even at the beginning of this year. The problem is if agricultural income growth is weak then broad-based consumption will not do well. There are company specific stories about beneficiaries of GST rate cuts and what it does to companies’ margins, those we can still like. There are companies which are getting into new project areas. In the agriculture sector too, there are attractive stories. But by and large, demand growth will disappoint in the sector. Same with cement.

Non-banking financial companies have had a dream run. We have been recommending them since 2014. Within NBFCs also there are names which can thwart or at least are not in sectors where PSU banks can go. The fact that PSU banks are getting capital, their margin pressures could be meaningful, their price-to-earnings are high. As someone put it nicely, so far it was okay to be in structural sectors in India – sectors that have a sufficient headroom for growth for many years at profitability levels which are consistent with what they are doing now. Therefore, it was okay to give them high multiples. Some of these are very good quality companies with excellent management but are over-owned and will not deliver upside. They may not fall meaningfully because there are so many people lining up to buy them. But I don’t think there is a meaningful upside. The upside will come where expectations are quite low.

Look at the second quarter earnings. It is the first quarter in three years where we saw no index level EPS cuts. But that happened because energy and metal estimates where raised higher and estimates for everything else came down. Those are the sectors I would rather be in because we will see comfort in those earnings coming through.

Watch the full interview here.