Oil At $70 Will Challenge India’s Conviction For Reforms, Ambit Capital CEO Says

Crude oil reaching the level of $70 per barrel will challenge the Indian government’s conviction for reforms, Ambit Capital’s Chief Executive Officer Saurabh Mukherjea told BloombergQuint. In particular, it will raise one question whether the government still wants deregulated oil going forward, he said.

The government deregulated petrol prices in 2010 and diesel prices in 2014 to align these closer to that of international crude prices. At the same time in 2014, the price of crude oil tumbled close to $50 per barrel from near $100 a barrel. India being a crude importing country benefited from the fall in crude prices.

Some economists, such as Sajjid Chinoy of JPMorgan, argue that the crude oil slump was one of the primary reasons that took India’s GDP growth to 8 percent over that stretch of time. However, it is now 2017 and benchmark WTI crude is making a dash towards $60. This could have an adverse effect on India’s already slowing economy and a fairly overstretched market, said Mukherjea. If oil prices continue to rise close to $70 per barrel, the government may have to consider subsidising fuel once more, he said.

On India’s Record Stock Market Rally

Mukherjea said that the quality of money coming into the market was less than ideal, especially on the qualified institutional placement front. While the government’s Rs 2.11 lakh crore push in the form of public sector bank recapitalisation has improved the earnings and growth outlook for next year, the markets still seem overstretched, he said.

Barring a miraculous pick up in earnings next year, you’ve got an overstretched market.
Saurabh Mukherjea, Chief Executive Officer, Ambit Capital
On Monetary Policy

Mukherjea said that the “conservative investor should take this as broadly the bottom of the rate cycle” as commodity prices and fiscal spending could go up, pushing inflation close to 5 percent. “I think the odds are going towards rate hikes rather than rate cuts over 2018.”

Here are the edited excerpts from the entire conversation:

Q: What are the signs that are leading you to believe that the market could be tiring out?

A: Whenever you see a big surge of qualified institutional placements after long upward rally in the market, especially those from less than ideal companies, it raises some questions about quality of the rally and quality of the paper coming to the market. So, it could be that we will have earnings turnaround around the corner. But at this juncture, we feel like we have an overstretched market on the valuations front.

As we are saying since the banking recapitalisation was announced, there is reason to believe that in the next year gross domestic product growth will pick up to around 7 percent and earnings growth will, may be the first year in five years, be in the double-digit earnings growth. Even considering 15 percent earnings growth next year, you could have market more than fully valued and hence, from a fundamental perspective, we will have overstretched market. Over the quality of paper coming to the market, especially on the QIP front, it has smelly stuff hitting the market.

Q: Are you worried about the quality in the primary market and on the IPO front?

A: The IPO activity has been mixed. You have a few good companies mixed with several ordinary ones. What is noticeable is the lack of high quality business to consumer and high quality manufacturing companies. We haven’t seen many since that memorable DMart initial public offer. Not many names come to my mind who are really front-line plays on the manufacturing or business-to-business segment.

Good news is on the life insurance front that several stellar champions of the life insurance come through. IPO is mixture of mediocre and some high-class names. But the QIP names do look worrying. This are companies which was trying to raise money for a while. The fact that they have got a window to raise the money, so they are printing the dollars as quickly as they can, it does raise question on the quality of paper hitting the market.

Alongside that you got overstretched valuations. It was little less overstretched before the PSU recapitalisation. But even barring remarkable earnings next year, you will have overstretched market. Alongside that for the reasons that India can’t control, oil is picking up and going through $60 is a concern for us because of the impact that oil has on our economy given that we import all of the oil.

Q: At what level crude will start concerning you? What facets will be at risk? How will the political game play a part in market mood?

A: The last time I was speaking to you, the government had cut excise in order to compensate for the rise in the oil price. Fuel is still deregulated in our country which means dollar for dollar, the rise in crude with a two-month lag will hit our economy. We have 14 elections in the next 17 months and it will be a big test of the governments conviction on the reform front whether to regulate oil. If oil and crude go to $70 and this government doesn’t bring subsidy back, then it could be a huge sign of the commitment for the reform. That’s the big test coming up with the potential price going to $70 and India has to ask the question if you still want the deregulated oil going.

If you see in the last couple of years, we have pulled of something which is miraculous. We had GDP growth falling for six quarters, falling interest rates and in spite of that on the bond and equity front, foreign institution investment money is coming into India.

That’s never happened. The reason we pulled that off was that the inflation was low. It was low because the commodity was cheap, and the fiscal deficit was under control. Both of these factors, commodity and fiscal deficit could go the other way now in next couple of years as we approach the 2019 elections. Hence, it is worth being circumspect in the overall market positioning.

I do agree that the recapitalisation of public sector banks does give chance to play cyclicals, excluding the banking, financial, services and insurance sector. Cyclicals will have a decent run as global commodities rally. But on the overall market level, I continue to believe that we have a fully valued market.

Q: Do you think it will be significant enough for RBI think of rate hike going forward? There has been talk about a rate cut, but none of the economist seem to be looking out for a rate hike.

A: When people don’t talk about something and consensus is blindsided to risk, that’s when you should be focused on the risk. The reason we are being able to keep inflation at 3-4 percent is because we have been helped by the commodity cycle and we have been helped by the government which has been fiscally prudent. So a lot of credit to the National Democratic Alliance. The first three budgets were fiscally conservative, prudent budgets.

Now, the fiscal is under a degree of pressure, Goods and Services Tax collections are below par, the PSU banks recapitalisation bill – unless the RBI picks it up – will stretch the fiscal and this could be the normal definition of the budget deficit. If you look at the stretched fiscal plus the PSU bank recapitalisation, plus the rising commodities, it will be absolutely miraculous if consumer price inflation didn’t start pushing towards 5 percent.

The cautious investor should start seeing this broadly as the bottom of the rate cycle. In the positive exceptional circumstance, we could have one more rate cut but the odds are growing in the favor of rate hikes rather than cuts over the course of 2018.

Q: Whether the valuations are stretched or not in the NBFCs?

A: If you take market as a whole or even brokerage stocks, it’s unquestionable that on a one year view or even a one and half year view, we are fully valued at the moment in this country…I do worry about the brokers who are also trying to become NBFCs. I don’t think they have business doing it but that’s their prerogative.

But if I look at brokers who don’t have big NBFCs housing finance books, the reason I like them is that real estate in India is heading for major correction. We have already seen a correction in real estate prices across the big cities in the last three years.

But with growing evidence that land price deals are being struck at cut price rates and anywhere between the 4,000-7,000 companies in the NCLT process, we can look forward to a major correction in the land prices next year. So, given the increasingly grim outlook for putting money in property and land, Indians will shift to putting money in the financial system wherein the brokers will benefit.

Does that mean a stock price rally for market? I am not sure. Lenders do account for 35 percent of the Nifty weight. No sector has accounted for this 35 percent of Nifty weight. The rally in lending stock is overdone. But the brokerage and wealth management companies in India have long growth runway ahead of them as Indians stop saving through physical like land, real estate and increasingly save through financial assets like bond, equities, mutual funds and so on.

Q: What is your take on consumption story?

A: For consumption the big unknown that we are trying to access is, has there been in effect the stealth GST cut. In the sense that in the lower end of the spectrum, i.e, Rs 1.5 crore and below turnover companies, are they paying GST or are they operating in broadly tax-free regime – not the tax free de jure but the tax free de facto.

For the small trader with SME below Rs 1.5 crore and less of turnover if the GST regimes lacks, then I think winter consumption could pick up. It is hard to gauge because every weekend the GST rules change. So, the business community and chartered accountants do not known fully what’s happening. But given the eminence of 14 elections, the fiscal decides to take it easy on GST collections then small and medium enterprises might will be able to drive consumption through the winter as they realise that GST is not that much of horror show that they and we thought it would be.
Source: Bloomberg