How do you look at the oil & gas sector post the policy announcements on diesel and gas prices
We have seen some progress with the government deregulating diesel prices and raising the natural gas price to $5.61 per mmBTU (on a net calorific value basis). However, the latter may not be sufficient for new investment in the upstream segment unless the premium for development of deep-water fields is high compared to the base price of $5.61 per mmBTU. The government can take certain decisions quickly that are not legislative in nature. A simple thing such as a clear subsidy-sharing formula for oil subsidies should be easy to implement. We cannot have a subsidy-sharing arrangement that is devoid of considerations emerging from the external environment. OIL and ONGC cant be paying $56 a barrel irrespective of what the global crude prices are. The faster it is done, the better it is. It is also relevant because the government wants to carry out divestment in ONGC. But the government has to act on rationalising the subsidy amount of the upstream and downstream companies. What matters for downstream companies is the net under-recoveries, which are at about R2,000 crore. Given the way overall subsidies have come down, there is no reason for downstream companies to be involved in the subsidy-sharing arrangement. The government can exempt BPCL, HPCL, IOC and GAIL from the subsidy-sharing mechanism.
What about OIL and ONGC
The government can give clarity on their net realisations on a sustainable basis. The correct formula could be fixing $60-65 a barrel as a base and have a sharing arrangement with the government over and above that. It is important that domestic companies get the right price for their investments. India is short on oil & gas supply and without investing more, we cannot expect production to increase. Also, reserves are depleting and, thus, if we dont invest, the amount of energy imports would continue to rise.
We have cut our rating on the sector to neutral from overweight. Our expectations that the government will deregulate diesel prices have largely played out. There is some amount of upside left but that may not be sufficient for investors to take an aggressive call on policies.
Is the reforms push strong enough for foreign inflows
So far, the governments focus has been on medium-term measureson external affairs and portraying India as a good investment destination. Whether it is allocation of resources or approvals from government agencies, a lot of such interactions are moving online, which will result in greater transparency. But the government is focusing on domestic reforms as can be seen from the deregulation of diesel prices, increase in natural gas prices and certain labour reforms. The next leg of reforms relate to fixing the investment cycle. For investments, other than capital, you require the approval of government agencies. If India makes the approval processes transparent, the ease of doing business will improve. Acquiring land is a big challenge due to a cumbersome land acquisition policy. This can only be changed by changing the LARR Act, which may not happen soon as the BJP does not have a majority in the Rajya Sabha. Labour laws are again very complicated and need to be changed. These two measures may take at least 3-4 quarters to be addressed.
What are the options we have
One option is that the state governments take more initiatives, as in the case of Rajasthans labour reforms. I hope that more BJP-ruled states and some progressive states start putting in place easier policies related to land acquisition and labour. The last bit is allocation of natural resources, which is in a mess currently, and the only way out is to allocate resources in a transparent manner through auctions.
The interest in India is also being sustained by the sharp improvement in our macro-economic position due to lower commodity prices despite limited progress on economic reforms. Lower crude prices benefit India through a positive impact on inflation, CAD and lower subsidies, assuming they stay below $90 a barrel. Every one dollar fall in crude price will save India about $1.1 billion in terms of CAD and BoP. So, if crude price averages $102.5 a barrel this year, we are looking at a CAD of 1.5% of GDP.
Given that there are concerns related to taxation revenues that are growing at about 5%, lower food subsidies can provide some buffer. If you look at FY16, the subsidy will only be on kerosene and LPG. If one takes average oil prices at $90 a barrel, next years oil subsidy bill could be about R65,000 crore, less than half of the total subsidy amount of R1.40 lakh crore in FY14.
What timeline should we expect for major reforms
It is difficult to draw a timeline. However, some of these are already work-in-progress. There are three key parts to fiscal reforms, the first being the implementation of GST. The GST Bill will be tabled in Parliament in the winter session assuming issues between the states and the Centre on the scope of GST and compensation for states get decided by that time. I assume GST would be implemented on April 1, 2016.
The second is subsidies. The burden has come down with the recent correction in global crude prices and deregulation of diesel prices. But the question is how we tackle kerosene and LPG subsidies. Given that no government is likely to increase prices of kerosene, the only option is to reduce its consumption by moving households towards gas or LPG and by reducing leakages in PDS. LPG prices could be partly raised in the next quarter. The easier thing to do, as in the case of diesel, is to go for small monthly increases, and reduce the number of subsidised cylinders.
This links to the third point: how India distributes subsidies. If India implements direct cash transfer for food and kerosene, as has already been decided for LPG, it could result in meaningful savings in subsidies. It can be done by Aadhaar-enabled or normal bank accounts, which is part of the financial inclusion plan of the government. This will take about 2-4 years to implement fully.
I see a lot of movement on the fiscal side and see a path towards 3.5% gross fiscal deficit by FY17 based on implementation of GST, cash transfer and rationalisation of fuel subsidies. But on the investment side, it will be a slow and gradual recovery.
What is your stance on the banking sector
We like the private banking space but not the PSBs. I am worried about the non-performing loans (NPL). We hoped that some highly-indebted companies would be able to raise capital from the market and sell some assets to survive until a part of their operating challenges got addressed. However, currently, there is low visibility on such short-term measures or even long-term solutions for these companies. This is a matter of concern for the power, steel and telecom sectors.
If you look at power, as of now NPLs are low, as many assets are being built or have just been commissioned. If there is no improvement in coal and gas availability in the next 1-2 years, then some of the assets will become NPAs. The other hope was that some of the power purchase agreements (PPAs) would be renegotiated in line with those of the Mundra-based power plants as decided by CERC. But there is a stay order of the Supreme Court on the same and states are contesting the CERC decision. Even that solution is not available as of now. So the power sector could see more NPAs going forward unless state governments raise tariffs meaningfully.
The steel sector has emerged as a big contributor to restructured loans with many of the smaller steel companies having restructured their loans. But it is not as if the problems are getting solved. The global steel cycle is in a downturn due to huge excess capacity. Imports from China have increased and we have domestic issues on availability of iron-ore. We could see some of the restructured loans slipping into NPLs. Banks exposures per company are large and there are big lumpy loans to certain large steel companies, which could also face tough times.
In the telecom sector, most of the weaker companies are not making any ebitda but have large amount of loans. Thankfully, theres no competition from imports in this sector and the industry as a whole can take price increases to improve its profitability.