If policy prods demand, growth could recover faster: UBS Securities

In Q2 headline earnings growth in the Nifty, earnings was in double digits.

corporate tax rate, global manufacturing base, China, Nifty, Nifty earnings, PSU stocks, financial markets
Gautam Chhaochharia, Head of India research, UBS

The recent cut in the corporate tax rate has created an opportunity for India to benefit from the potential shift of global manufacturing base from China, Gautam Chhaochharia, head of India research, UBS Securities, tells Yoosef KP and Bhavik Nair. Edited Excerpts:

Is it correct that the corporate tax rate cut does not have that kind of impact on profitability beyond the initial point, because it has to be driven by growth? How do you see Indian companies responding to the rate cut?

Let me offer a three-part answer: what happened in the US; how we compare India to the US; and identify the target of the corporate tax cut. First, in the US, the tax cut did impact headline earnings which helped markets. It did not have an immediate impact on the economic cycle per se. The Indian economy is very different to that of the US in terms of structure, development, etc.

In India too, the impact on headline earnings is already evident. In Q2 headline earnings growth in the Nifty, earnings was in double digits. It happened after many years, and after a long time we haven’t seen headline EPS revision downwards for Nifty. India’s headline Nifty earnings this year is clearly being helped by that. However, it should be viewed as a one-time adjustment, and does not necessarily imply that year-on-year growth will improve sustainably.

Third, in our view, the tax rate cut is not designed to boost the capex cycle over the next two quarters, but is rather a structural reform for the medium-term. And that context is very interesting. Against a backdrop of rising costs and escalation in trade tensions between the US and China, it represents a golden opportunity for India to benefit from the potential shift of global manufacturing base from China.

Which sectors do you think to turn around in one year so?

The time frames are relevant. For the next two to four quarters, we are bullish on financials, oil & gas, telecom and property. We remain cautious on auto, IT services and small and mid-caps because we have yet to see policy measures with the potential to drive a sharp economic recovery.

Do you think the financial markets are shifting towards the ESG framework?

Globally, this is an unarguable fact. Ultimately, a part of the global money pool comes from HNIs via family offices and pension funds, as well as from retail investors. The first two segments are more conscious about where their money is deployed than they were previously. It is a clear trend, but it is too early to predict how it will manifest itself in terms of stock picking.

PSU stocks have been biggest value destroyers. Do you see anything changing?

Absolutely. PSU stocks are trading at material discounts to their underlying value. Until recently, there was skepticism that the government would opt for privatisation. However, it has made piecemeal divestments over the last few years. Typically, piecemeal divestments come at a discount. However, a privatisation programme offers strategic value and India has sufficient assets for the programme to last for between 15 and 20 years. And then there are loss-making entities like Air India, which, once sold, serve to reduce fiscal stress every year.

What is you outlook on PSU banks? Is the worst over?

The worst is over. One of the problems was that stressed assets in the system were not getting resolved. The recent stress on the system is, to some degree, the collateral impact of the prolonged NPA cycle. If things normalise and liquidity improves, we will be at the bottom in the next quarter or two.

Going forward, do you think NPA numbers will come down?

If the NBFC and property sector stress is left unresolved, it will be a drag on growth and also prolong the NPA cycle.

Do you see a systemic crisis brewing in the financial system?

Over the last five-six years, the Indian banking system has digested 17% of loans as NPAs. We did not have a systemic crisis. It dragged down growth because the system still did not have a mechanism to resolve the issues quickly. A systemic crisis implies inter-bank lending to be curtailed or run on the deposits and we don’t see any such possibility in India.

What is your outlook for 2020?

Globally, we expect a further dip in growth. In our view, global markets are significantly underestimating the negative fallout of trade wars.

What is your Nifty target?

Our Nifty target for June 2020 is 12,300.

What is your outlook on growth?

The key factor over the next year is the progress of the reform agenda: Will we see more of privatisation and labour reform that have the potential to help market multiples? Will we see evidence of a manufacturing shift? That will matter. It is not yet priced in and no one believes it right now. Finally, will there be policy measures that will help growth recover in short-term? If you don’t see short-term policy measures, then the recovery will be gradual. If policy stimulates demand, then the recovery in growth could be faster.

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