Stock market has rallied in the last few weeks, but the momentum has remained limited to select heavyweight stocks. For now, strong Q1 earnings may determine the momentum in the share market, Anuj Kapoor, Managing Director, Head of Investment Banking, UBS India, says. As far as bond market is concerned, considering the latest spike in yields, the domestic debt issuers need to adjust to the existing rate scenario which looks to be on an upward trend as of now.
Further, in the currency market, Indian rupee may further weaken against the US dollar unless the FDI inflows increase and oil prices cool down. In a wide-ranging interview with Ashish Pandey of FE Online, Anuj Kapoor talks about various concerns before Indian capital markets. Here are the edited excerpts:
Q1. Lately, the rupee has remained volatile for a variety of reasons. Where is it headed now?
Recently, the INR stands out as an underperformer even though the CNY remains the focus of attention. An approximate 10% rise in oil prices on expectations of sustained supply-demand imbalances, compounded by President Trump’s bid to cut off all Iranian purchases, had pushed the USDINR close to all-time highs recently. With oil prices having cooled off a bit in the past 10 days, we have seen the pressure on INR ease off a bit.
While a hawkish RBI and stabilizing US rates augur well, escalation of trade tensions has kept Asian currencies on the back foot. So even though the INR may continue to outperform cyclical Asian FX (like in the past month) amidst ongoing China growth (and CNY) worries, any sharp recovery in USD/INR looks increasingly unlikely.
Over the next six to twelve months, the INR may continue to suffer due to an adverse current account balance. India needs approximately 20 billion USD/annum of extra inflows vis-à-vis 2017 to see a meaningful return to appreciation—this would be a stark reversal of the current trend. Unless FDI inflows accelerate and oil prices ease, the INR may remain under pressure. RBI has been on the lookout for FX interventions in recent days, hoping for a defense during all-time lows.
Q2. How are India’s stock and bond markets placed at this moment?
Indian stock markets have held up compared to weaker global exchanges, especially in Asia (Nifty +5% vs. Hang Seng -6% YTD). Trade wars and geopolitical tensions have led to recent volatility in the markets.
The rally in Indian equities has been narrow and investors remain selective. It has been primarily restricted to blue chips while most small and mid-cap stocks have suffered. (More than 70% of the top 500 Nifty stocks are in the red this year).
Domestic institutional inflows have been strong, shielding the market from FII selling pressure. However, it’s important to note that inflows into domestic MFs have tapered off by more than 50% from the highs of last year.
For equities, the key trigger remains an earnings rebound in Q1 (y-o-y growth over a small base last year). While the market remains open for quality issuers in this environment, issuer prudence is well advised.
In the global bond markets, we have seen an increase in yields due to a combination of higher US treasuries and wider credit spreads. This has led to repricing of cross border corporate bond issuances from India (75-200 bps wider YTD), reflected in there being virtually no issuance from Indian corporates over the last four months. Investors are sitting on mark-to-market losses and are extremely cautious and sensitive to the yields on offer.
On the domestic front, yields have widened and RBI’s tone continues to be hawkish after the recent rate hike, given inflationary pressures. The recent changes in FPI regulations have not been very helpful and we have seen FII outflows despite an increase in bond limits for foreign investors. Indian issuers will have to get readjusted to the prevailing rate environment which looks on the upward trend.
Q3. How do you see 2018 shaping up for IPOs?
Last year was a record year for IPOs with issuance of around $12 billion. While the beginning of this year was fairly busy for the IPO market, overall ECM volumes are down over the first six months by about 20% over the same period last year.
Several big-ticket issuances have been lined up for the latter half of 2018 such as Lodha, HDFC AMC and Renew. But I don’t see this year’s IPO volumes surpassing last year’s, especially given the current market environment and upcoming elections. We could also see some differentiated offerings such as REITs coming up later this year.
Q4. According to the recent RBI Fiscal Stability Report, NPAs are likely to worsen notably in the current fiscal year. Will India’s bad loan problem last much longer and dent the economy much more than expected?
Earlier this year in February, RBI had done away with the earlier restructuring schemes such as CDR, SDR, S4A and JLF restructuring, and stipulated that all non-performing loan resolutions must be as per the Insolvency and Bankruptcy Code (IBC). In addition, it has provided a more stringent timeline for bad loan restructuring after which they will be referred for insolvency proceedings. As a result, public sector banks and corporate-focused lenders saw record high slippages in the March quarter.
Our estimates suggest that 16% of system lending is stressed, of which 3.2% is yet to be recognized as NPLs. We expect new Gross NPL formation to decline in FY19, but provisions may remain elevated due to the current low Provision Coverage Ratio (PCR). Expected resolutions of large steel cases would support an increased PCR in the coming quarters, in our view.
Q1FY19 earnings for banks are likely to be aided by the decline in NPL formation and recoveries from a few NCLT accounts largely in the steel sector. However, they may be offset by MTM losses on the bond portfolio and higher provisions.
Loan book growth picked up in the quarter and over the long run, and I expect the IBC to have a far reaching impact on the Indian Banking system. It’s true that some of the first few resolutions are taking time, but one has to remember that this is a new law and there is absence of precedents which can aid quick resolution of these complicated situations. Moreover, the IBC has indirectly also benefited resolving some of the delays in payments by Indian corporates to the banking system.
Q5. Do you think the government is finding it hard to deal with the recent volatility in global crude oil prices? Will oil prices keep pinching the government in the year to come?
The increase in crude oil prices is clearly having several impacts on the economy like currency depreciation, higher inflation and adverse balance of payments. Headline WPI inflation of 5.77% is well above RBI’s inflation target band of 4% (+/-2%). Building in higher global crude oil prices and an ongoing modest recovery in investment demand, we estimate the current account deficit to widen to 2.5% of GDP in FY19.
Balance of payments mismatch is not helping India. Unless the FDI inflows accelerate meaningfully, the INR may remain under pressure.
While the Government has shown a commitment to fiscal discipline by passing on increases in crude oil prices to retail consumers, incrementally passing this on may not be straight forward due to inflationary pressures and the perceived political impact.
Q6. Will the Indian government be able to cap the fiscal and current account deficits safely ahead of 2019 elections?
There is concern that the central government could miss its fiscal deficit target of 3.3% of GDP for FY19. The fiscal situation may continue to remain stretched due to the risk of populist spending ahead of the 2019 elections, farm loan waivers by some states and rising oil prices.
A pick-up in GST collections over upcoming months could provide some comfort.The Government is also exploring options to optimize fiscal/inflation dynamics such as tax cuts. Higher global crude oil prices have been passed through to retail gasoline and diesel prices, suggesting a commitment to fiscal discipline.
However, if external stress continues to rise, the government has an option it has used in the past: raising dollar deposits (FCNR (B)) to ensure external stability.
Q7. How is India performing on the inflation front?
Headline CPI inflation stood at 5% as of June 2018, while the latest print on WPI inflation has been 5.77%, beyond RBI’s target band.
Going forward, we expect monthly CPI inflation to average around 5% YoY in FY19 (versus the RBI’s forecasts of 4.8-4.9% YoY in H1 and 4.7% YoY in H2). These forecasts assume Brent crude oil prices average US$75/bbl in 2019 (UBS’s global oil forecast). We expect refined core inflation (CPI excluding food, fuel group, petrol & diesel) to average around 5.5-6% in FY19, indicating demand-push inflation and rising input price pressure.
The dynamic between inflation and corresponding domestic interest rates will boil down to a few factors including revision in minimum support prices for crops, global oil price movements, monsoons and the risk of fiscal slippages.
Q8. When do you next see the Reserve Bank of India (RBI) hiking interest rates?
Tightening external financial conditions imply that it is not appropriate for the RBI to keep pursuing monetary easing to support growth. The key is to ensure macroeconomic stability so that recovery in growth can be sustained over the medium term and is not compromised to meet short-term growth/inflation dynamics. We believe a rate hike now will avoid the risk of steeper tightening in the future. The government also needs to keep a lid on fiscal spending, which could be tricky in the run-up to the 2019 elections.
Our current forecast is for MPC to hike policy rates by another 25 bps in FY19 (likely in August 2018 after the 25 bps hike executed in June) before engaging in a pause. However, the risk of a 100bp tightening cycle is now very much alive vis-à-vis our base case expectation of 50 bps in the event (a) global crude oil prices (Brent) continue to rise from here (towards US$100/bbl) and/or (b) the US dollar (USD) continues to strengthen.