India Inc has ample reasons to be cautious about its earnings estimates in the next financial year, says Ajay Bagga, head, private wealth management, and managing director, Deutsche Bank India, as sustenance of oil at higher levels (Brent above $120), poor monsoons and geopolitical risks may affect earnings. Edited excerpts from an interview with Puneet Wadhwa:
Were you surprised that most banks in the US made it through the stress test? What are the chances of crude oil prices derailing the fragile economic recovery in the US and other emerging markets?
The stress tests results were almost in-line with expectations. The test had modelled for a sharp decline in home prices, and hence was likely to have greater impact on banks with higher proportion of mortgage in overall portfolio.
Emerging economies are likely to see their growth under pressure with Brent crude sustaining above $120 levels. The impact is more on countries like India, which run a high current account deficit and are also dependent upon imported crude for substantial portion of their oil requirements. The advanced economies are undergoing a fragile economic recovery led by consumption. High crude prices can seriously impact recovery in these countries.
In the Indian context, what are your key takeaways from the recent statements by the Reserve Bank of India (RBI)?
As expected, the RBI has kept all key policy rates unchanged in the recent monetary policy review. The central bank highlighted its inability to provide a clear monetary easing signal, noting persistence of inflation risks due to rising global crude oil price, weak domestic fiscal position and a vulnerable exchange rate. The RBI has been keen to cut rates since the January policy meeting, but with both global and local economic indicators bottoming out and inflation not easing sufficiently, its room for cutting rates has arguably shrunk.
How do you rate the Union Budget proposals?
We found the Union Budget to be realistic. It targets to reduce the revised fiscal deficit from 5.9 per cent of GDP for FY11-12 to 5.1 per cent in FY12-13. However, we expect the deficit to be about 5.3 per cent of GDP. Our main difference with the official forecast is that we don’t think fuel subsidies can be brought down a great deal given the constraints of coalition dynamics in India. While the increase in excise / service tax is positive for fiscal consolidation, the absence of credible subsidy rationalisation is disappointing.
An increase of 19 per cent to 27 per cent in plan expenditure on industry, infrastructure and agriculture are standout features of the Budget. These underscore the government’s urgency in addressing the issue of decelerating capital formation in India. Extension of viability gap funding to newer sectors, doubling of tax-free infra bonds and elimination of the import tariff on imported coal for fuel-starved power plants are the other positives.
What is the mood among FIIs right now? Could they perhaps realign their investment strategy with respect to India given the state of the economy and the compulsions of coalition politics that have somewhat derailed the economic reform process?
Their mood can be gauged from the fact that they have poured in nearly $8.9 billion in India in CY2012, second only to South Korea, among the emerging economies in the region. However, the high fiscal deficit and current account deficit are key negatives, further punctuated by compulsions of coalition politics delaying the economic reform process. The government, though, has made its intentions clear of focusing on growth by targeting a reduction in fiscal deficit, decrease in subsidies and higher allocation for infrastructure and agriculture.
Does RBI have enough room to tinker with key rates?
The fiscal deficit target looks fairly difficult and factors in too many positives. Lower-than-expected growth in tax collections and failure to achieve disinvestment target are potential negatives. The rise in bond yields post Union Budget reflects market scepticism.
There is a definite gap between bond market’s demand for government paper and supply of the same from RBI. Our analysis estimates almost Rs 1,20,000 crore of OMO by the RBI to be conducted in FY13 to manage the borrowing programme without disrupting the markets.
RBI cannot afford to be aggressive and any moves on rates have to be calibrated. Any meaningful correction in oil prices or fall in core inflation will give it some legroom and market participants would be watching out for these cues. If a decision on raising fuel prices is pushed all the way to July, RBI would comfortably cut by rates by 25 bps each in April and June, in our view.
What are your earnings estimates for India Inc in the next financial year, and is there any reason to be cautious?
We expect the Sensex EPS to grow over 15 per cent in FY13 to Rs 1,307. Sustenance of oil at higher levels (Brent above $120), poor monsoons and geopolitical risks are likely to be key factors that may affect earnings.
How has the investment trend moved over the last six months in the private wealth management segment? What are you advising your clients at the current juncture?
We haven’t seen any major changes in allocation towards equity. Global liquidity flows have been strong since beginning of the year, and the upmove did catch the domestic investors by surprise. However, volatility in the markets has kept them away.
Given our neutral stance on equities, we are advising clients to maintain their equity allocations to strategic levels. In fixed income, we are bullish on the short end of the curve and hence are in favour of instruments with one- to two-year duration like fixed maturity plans (FMPs) and short-term debt funds, among others.