The finance minister will unveil the Union Budget for 2013 on Thursday, which will have a direct bearing on the country's economic landscape. Gautam Chhaochharia, executive director -" India strategy & midcaps, UBS Securities India tells Puneet Wadhwa in an interview that since the growth-inflation dynamics are very different this time; there is political, and not just economic logic in being fiscally prudent. Edited excerpts:
There were concerns the US bond-buying programme may be coming to an end. How do you read into this development and what is the likely impact on the markets?
Our house view is that Federal Open Market Committee's (FOMC) uncertainty about its quantitative easing (QE) programme was not a surprise. Indeed, we continue to expect that growth will be strong and inflation high enough to push the US Federal Reserve to slow the pace of asset purchases by the end of this year.
Did the pause in the market rally in 2013 surprise you, especially after the upmove seen in the second half of 2012?
Not really, markets never move in a straight line. Also, fiscal consolidation measures do have immediate negative impact on economic activity -" something which took the markets by surprise. But this pain is necessary for ensuring economic cycle recovery, especially the investment cycle.
How do you see the markets panning out?
The markets have been demanding fiscal consolidation to create room for investment cycle recovery. The government has played ball and is cutting its spending. The flipside, however, is that it implies weaker economic activity in the interim.
Volume growth has been slowing for many consumer-facing companies. Steel, cement, power, auto, cargo numbers are not encouraging. The January-March quarter may see even further weakening.
The markets may react adversely to weak interim data points, given that there is still largely a lack of belief in the government's efforts, including fiscal consolidation, and hopes even for a pre-election stimulus to consumption. We would view such corrections as a buying opportunity and remain positive given our expectations of continued Government efforts to revive the economy, along with fiscal consolidation -" a medium-term positive.
Have the markets lowered their expectations from the coming Budget given the overall macro-economic situation? What are your expectations?
Some market participants believe that this may be a populist Budget given that it is a pre-election year. However, we don't think so. The growth-inflation dynamics are very different this time; hence there is political, and not just economic, logic to be prudent fiscally. We expect fiscal consolidation and a credible one.
What are the key positive and negative announcements that the markets are likely to react to?
The markets will likely follow the macro level measures, rather than sector specific policy changes, which may be limited anyway. A few things to watch out are GST (goods and services tax) road map; tax increases.
As regards the Food Security Bill, the government may make noises, but actual allocation may take some of the punch away from fiscal consolidation efforts and be a negative.
Domestic investors seem to lack conviction about the markets given the persistent net outflows and redemptions seen in the mutual funds' equities segment. Could this change in 2013?
The outflows have not been a surprise to us given weak performance of the markets over the last five years. Unlike developed markets, alternate investments here have yielded reasonably attractive returns -" bank deposits, bonds, gold and real estate. It will change only with steady, sustained market performance.
How do you see the government's divestment process panning out? Do you think there is enough appetite for such issues? Which ones, in your opinion, will sail through easily?
Government's targets are not that aggressive, given the scale of inflows and potential support from LIC. There is appetite for quality companies at reasonable valuations. The recent NTPC issue is a good example.
How has the results season panned out for companies in the mid-cap space as compared to their larger peers? Are there any key things/trends that you would like to highlight?
Nifty companies reported weak Q3 results-"earnings growth (ex global commodities) of 2.6 per cent, below muted expectations of 4.8 per cent.
Top line growth moderated further (weak economy and fiscal consolidation), but overall margins were flattish.
Of the companies under our coverage, 59.4 per cent have either beaten or met our expectations versus 62.7 per cent last quarter. Sectors that have posted strong earnings growth are consumers (Asian Paints), banks (ICICI, HDFC Bank), and IT services.
Sectors that led earnings upwards were banking (led by ICICI, HDFC Bank and Axis Bank), petrochemicals (Reliance Industries), IT (TCS, HCL Tech), and consumers (ITC), while oil & gas (BPCL), materials, telecom (Bharti Airtel), and power (Tata Power) were a drag on earnings.
Mid-caps in general are more geared operationally and financially.
So, their weaker performance is not surprising given a weak macro environment. But market leaders in midcaps have still managed to hold on to their profitability, which is a good sign.
Do you think that the worst is over for India Inc as regards earnings? Do you expect better days ahead? What is your investment strategy, especially for the banking space?
Consensus earnings estimates seem to have bottomed. We remain positive given our expectation of continued government efforts to revive the economy, along with fiscal consolidation.
The latter could dampen economic activity near term, so there might not be a seasonal uptick in Q4. Weak earnings and macro data points are adversely impacting markets. We would view corrections as a buying opportunity.
We are overweight on banks, infrastructure, petrochem, telecom and media and underweight on autos, consumers, pharmaceuticals and power. We are neutral on IT services, metals and mining, oil & gas and real estate.