Credit Suisse on Monday said trade wars and hike in US interest rates by Federal Reserve is a concern for emerging markets.
In an interview to CNBC-TV18, Neelkanth Mishra, managing director and India Economist & Strategist, said that Credit Suisse is very positive on construction companies as lot of government funds are coming in to this sector.
Watch: Markets in midst of serious global risk aversion, says Credit Suisse
Mishra said he is worried about balance of payment deficit even after a remarkable growth in the economy.
Edited excerpts: Q: I read both your tax note as well as your gross domestic product (GDP) note. But for the benefit of viewers, you are not terribly impressed by the 8.2 percent GDP number?
A: It’s a strong sign that the disruptions are now firmly behind us but the number itself shouldn’t be. We shouldn’t take that as a very strong indicator of growth and this is something that we said, when we analysed the Q1, that is June quarter results for companies and there was very weak base.
So the period at the start of GST (Goods and Services Tax), there was a significant inventory reduction in the economy and therefore, if you combine mining, manufacturing and construction, so the industrial growth was only 0.1 percent in the June quarter last year. So the fact that it grew at 10.3 percent this year is therefore not surprising. On a two-year compound annual growth rate (CAGR) basis, the growth is average on the industrial side, below average.
On overall GDP, what is remarkable is that in the last five quarters, we have seen first disruption and then a stronger growth on that disrupted base. The two-year CAGR is between 6.8 percent and 7 percent. It's almost like flat line. So, trend growth is continuing. Our 25-year CAGR is also seven percent. So we are very much at trend growth. We are definitely not overheating from consumer price index (CPI) perspective, but what worries me quite a bit is that even at this growth, we are now running balance of payment deficit and therefore, even this appears unsustainable and has to slowdown.
Q: There is a bit of a dichotomy here. There is a growth issue, crude close to $80 per barrel, rupee at where it's, still the market is at new all-time high and in fact keeps making new highs. Your thoughts on whether we are perhaps creating some risk there?
A: Not really. We have to understand that the economy and the market have very different constituents. As we have often said, more than half of the revenues in the the Nifty and the BSE 100 are not denominated in rupees. In fact, if the USD/INR assumptions for the overall market move from 64 per dollar, that may have been about six-seven months back to 71-72-73 per dollar going forward, that by itself could drive the Nifty peers high by 8-10 percent. There are refiners,metal, IT, other companies with foreign businesses and assets and therefore the weakness of the rupee, in fact, we have done quite a detailed analysis on this.
So, other than the fact around rupee weakness, some foreign investors may try to preempt and sell out and hope that they will come in when the rupee has weakened to prevent the losses. Once you ignore that aspect – actually a year from a very meaningful rupee fall, the Nifty is generally meaningfully higher. So, I do not think the external balance by itself is something that or rather the rupee itself should be a concern on overall Nifty. For the foreign investors, even other emerging markets have had much weaker currencies and this is not necessarily a bad market to persist with.
In terms of balance of payment deficit, though that is something that worries me. It is almost like household that is consuming Rs 130, but has income of only Rs 100, which is Rs 30 of current account deficit and now even foreign lending is not available. That means foreign capital inflows are short of Rs 30 and therefore, only Rs 20 and therefore, you have to cut consumption by Rs 10, which is the process that now has started.
As the rupee weakens and it translates into higher prices of autos and higher prices of consumer staples, you will see demand starting to slowdown. We have started to see some signs of that. It's still distorted by seasonality or festivals and some other factors. But I think as that correction starts to happen, you may see that some of the more overvalued stocks, especially in sectors where the consumption growth will slow, may get negatively impacted but overall Nifty, I don’t see a concern.
Q: What is your analysis suggesting in terms of lead indicators, because what we hear from companies is that construction activity has picked up, infrastructure execution has picked up compared to what we have seen before? Now, the commercial vehicle sales indicate that the tipper segment is doing very well, directly related to construction activity.
A: Construction is a sector that we have been positive on for almost two years now. We think there is a lot of government money going in there, especially on the road side, we have seen some remarkable pace of activity. It was surprising to us how rapidly the Mumbai-Nagpur prosperity corridor expressway got ordered out and construction started. There is more than Rs 2 trillion of projects happening in Mumbai itself. There are 15 plus cities doing Metro rail. A lot of this has extra budgetary funding. So, it's not necessarily state and central government budgets. Beware, the spending growth is not that meaningful. So, there is a lot of work that has been kicked off and therefore, it's not surprising. We are very positive on construction companies.
The challenge of course is on the consumption side. So, we are looking at overall GDP growth that is where our worry should be and especially, because of valuations that we have seen in some of the sectors.
Q: I remember your previous note, where you said that the best growth is behind us. So what are you looking at? The rupee depreciation has a positive impact on the Nifty as you pointed out and on many Nifty company earnings. So how are you looking at the earnings in FY19 and 20 now with the renewed parameters?
A: The consensus numbers for FY19 are at about 31. The last I saw and FY20 was about 24. So FY20 over FY18 growth is about 57 percent. So, it looks quite high, but we have to understand that FY18 saw very large provisions made by banks and therefore, the earnings at the headline level were subdued and they were negative 4-5 percent. So, once you adjust for that, these numbers are achievable. There are segments, as we discussed, where growth will slow and in particular on that release – the concurrent indicators have been very strong. In fact, if you see corporate commentary even after the Q1 results, the commentary is very positive. So I do not think there is anything wrong with what is happening right now. As market participants, what we have to worry about is what happens going forward.
Q: As a house, Credit Suisse got bottom on metal stocks bang on. What is the call now? Where are we in terms of cycle? If you look at stock prices; while they have moved up from recent lows, they are still way off their highs.
A: We are in the midst of very significant global risk aversion so our Credit Suisse global risk appetite index is still in panic territory. There is a lack of certainty around all the issues around trade war, what will happen with US fiscal boosting up yields and forcing the Fed to raise rates and therefore, creating more pressure on emerging markets, which were heavily benefiting from the inflows because of the zero interest rate policy and QE policies of the Fed over the past seven-eight years. So as the reversal happens, how badly will the growth slowdown. Will there be crisis? What is happening in China? When Chinese growth going to revival well? There is a meaningful amount of uncertainty there and therefore, metals is a sector, which is greatly determined by what is happening in China.Our view is that there was a growth dip and since then, there is also a revival. Last month’s data was somewhat encouraging and as the policy starts to support growth again that some of the fear of sharp slowdown will abate, we have seen the stocks bounce back a bit. What is also happening is that as the evidence of undersupply, especially in sectors like steel is now becoming stronger. So, now we are in 16th-17th month of very elevated spreads between steel prices, iron ore and coking coal prices. So that is the profitability that all these steel companies operate and that has been so strong and yet, there has not been enough of a supply response outside of China, which suggests that this number needs to rise higher. There are some steel stocks in India, which on current profitability are at 20 percent free cash flow yield. So, as the profitability grows, the PE multiple and the earnings before interest, taxes, depreciation, and amortisation (EBITDA) multiples correct. So, that correction is also happening and we are also cutting down our target, but that profit improvement, the cash flow generation is still tremendous. So, as the comfort comes around, these stocks would do well.