The Indian equity market may extend its strong momentum in 2015 even as fund flow from sovereign wealth funds slows down, says Neelkanth Mishra, managing director and head of India Equity Strategy, Credit Suisse. In an interaction with Devangi Gandhi, Mishra points out that the FY16 downgrade in Sensex earnings will be led by financials, given that stock prices are not reflecting risks associated with lending to sectors like metals and steel producers.
Why do you think India may emerge as the ‘island of stability’?
Over the past six months, deflationary concerns have risen in several markets. Some of the decline in commodity prices is being ascribed to a supply response, but there is clearly a demand issue as well. Chinese growth is significantly over-reported; so, if one adjusts for this factor, the global growth looks worse. Real global GDP growth in CY14 stayed anaemic, and 2015 is expected to be only marginally better. India, however, stands out as a rare economy with relatively strong growth — the growth gap between India and the world is expected to widen.
What about the impact of global slowdown and sharp fall in commodity prices, including that of crude oil?
The consensus view of lower commodity prices being a boon for India is perhaps directionally appropriate, but it overstates the advantages as the economic impact is likely to be only neutral-to-slightly-positive. We believe balance of payments surplus is unlikely to be higher than the $40-45 billion as weaker exports and capital flows would offset the gains from cheap oil. First-order impact on inflation would be insignificant given that imported commodities are an insignificant part of CPI inflation — petrol and diesel together have a 2% weight in the index. Even second-order effects could get muted by the recovering economy. The markets are much more linked to the world than the economy, given that 56% of Nifty revenues are not in INR, and of the rest, a large proportion comes from banks that lend to the first set.
Can it impact FII flows?
Given that a number of oil producing countries are big exporters of capital, these flows to India may slow down. We estimate that sovereign wealth funds backed by such countries have been investing $8-10 billion into India each year. The overall FII flows into the Indian market could come down from an average $20 billion in the last three years to about $10 billion next year.
This slowdown could be countered by investors exiting emerging market funds to put in money in India funds, which is a trend that has already started. Currently, though India’s weight in the emerging market basket has increased, it is more performance-linked — India has done well, but others have not. But the re-allocation from the funds that are under-invested — the eventual savers like pension funds, insurance funds, and Sovereign Wealth Funds — is unlikely to be rapid. They are much more considered in allocations, and even after they have committed, it would take them time to deploy the capital. They don’t move just because the market’s done well for one year. So, at least in the near term, the moderation of savings in commodity exporters will likely hurt equity flows into India.
What about the expected monetary easing by Japan and the euro zone?
If the Japanese central bank was to print more money, is it necessary that flows in India will go up? I don’t think so, because a lot of it can possibly go into de-leveraging. Even if a country doubles the quantitative easing — the primary money supply — if the money multiplier shrinks, then the eventual money available may not be that much. There are also multiple decision-points in between, at which funds can be diverted to various assets and countries. Therefore, it is wrong to correlate money printing directly to fund flows to India. But I think what it does impact is valuations: You can assume lower interest rates for a considerable time period while QE is happening. As a result, the propensity to still be invested in equities that are seemingly expensive but have higher growth opportunity would improve during QE. I am not correlating it to flows, but pricing expectations. Moreover, FII flows are not very strongly correlated with equity returns. So, I wouldn’t stress too much on flows.
The expectations on interest cuts are mounting.
What impact could, say a 50 bps cut, have on the financial health of Indian companies?
Even if there is a cut of 50 bps, on a base of 8% this translates into a 6% reduction in interest cost, assuming that this reduction is passed on. The interest coverage ratio of companies that account for one-third of loans in the system, is less than one, this decline will not make much difference, except for a handful. This is also because there are changes happening even at the Ebit level, i.e., their profits are shrinking as well. In case of metal producers, there has been a steep fall in metal prices globally, and a lot of steel companies are going to face stress, given that all of them have debt-to-Ebit ratio of five to six times. Even for smaller ones, the loans have just been restructured — very few have had loans written-off. In power plants, the restructuring can continue till the time the plants are not viable, given that there is a growing demand. However, in case of metal companies, the supply at such prices may not be viable.
These risks are not reflected in valuations of some the banks as people expect credit costs to come down, which I doubt. Earnings downgrades are likely because the consensus numbers for FY16 for financials are too high. So, most part of earnings cut (3-4%) on Sensex EPS will come from financials, materials and industrials, in our view.