Ridham Desai is head of research and equity strategist at Morgan Stanley India. Desai joined Morgan Stanley in 1997 and has since become one of the most important voices in the Indian finacial market. Desai said India's growth is picking up and the setbacks due to demonetisation, higher oil prices or weaker currency have mostly played out. He said domestic companies and corporate banks will lead solid earnings growth in coming quarters.
“Emerging market currencies, bonds, equities, are all looking good and in that context India also should be doing quite well over the course of the next few months,” said Desai.
In an exclusive interview to CNBCTV18, Desai talks about the banking sector, NBFC crisis, and upcoming election, among a raft of other topics.
Watch the full interview : here Edited Excerpts: The last time you told us that from a global top-down perspective you were waiting for your emerging market (em) global strategists to come out with their view for 2019 and we have that view now. The view is that in 2019 the developed markets may underperform emerging markets and they will be the outperformers. Does this tie-in with what you are picking up locally?
Growth in India was picking up and we have seen that now for several quarters the revenue growth is putting successive highs. We are at a 4-year high on revenue growth for the quarter that just ended and I think the revenue growth will accelerate further in this quarter.
Corporate margins have been all over the place for various reasons, we got setback from demonetisation, GST implementation, some idiosyncratic factors, then from oil and rupee. A lot of that is settled and our view is that we are heading into the start of a new earnings cycle.
I have been saying this for a while but it has not borne fruition but I think we have now come to the moment where the headline earnings growth for the Nifty or the Sensex will show robust numbers led largely by domestic companies and corporate banks.
We should be ready for some solid earnings growth in the coming quarters. That is really the story behind our EM call as well, which is that relative growth in emerging markets will exceed that of developed markets. Valuations in the emerging world are far more supportive than they have been in a while and we also see a rise in the dollar.
So, emerging market currencies, bonds, equities, all looking good and in that context, India also should be doing quite well over the course of the next few months.
Your thoughts in terms of the India specific risks, which would come in from the elections? How much of a risk would it pose to your outperformance thesis?
Elections are always a binary thing, very hard to judge ahead and we know we have seen a lot of surprises in expected outcomes, so very difficult to tell in advance but it will clearly be a source of volatility. Had they not been around, we would have had a very strong 2019 but given that we are going to have elections, I think what investors should expect a fair bit of volatility depending on how the electorate decides to vote in the next government.
The key risk for the Indian market is that we get a minority government and the market gives off some of its gain. However, a minority government is not necessarily a risk to the economy but does present risk to stock prices.
That is how I would view elections. To my mind, equities being a longer duration asset class, people need to look beyond these events which generate volatility and at these current levels valuations are offering an opportunity for investors to do long-term investing and that is what I would remain focused on.
Due to the problems in the debt market some people are extrapolating it to in terms of growth for consumer goods, growth in real estate, construction – do you think that can have a negative impact? Are you rolling back any of the EPS (earnings per share) numbers because of that?
There is a temporary issue around that. I think the market is behaving quite well contrary to expectations. Last month, when a lot of people thought there would be a lot of problems in November but it went through smoothly. I don’t think we are still out of woods. I think the next couple of months are still tentative and it is an opportunity for large banks to grab share from non-banking financial companies (NBFC), which is already happening. You can see credit growth posting multiyear highs and I think that trend may persist over the next few months.
So, I did not see any meaningful impact on credit growth. Idiosyncratically, in certain sectors where there was heavy risk-taking, there may be some temporary impact. The overall theme here is that maybe the NBFCs will give up some share to large banks. And Large banks are further supported by our view that the NPL (nonperforming loan ) cycle has ended.
So, this is quite a sweet moment for large banks – they are collecting deposits, they are collecting assets and they are seeing worst of NPL behind them. So, you can expect, especially the corporate banks to report very strong earnings progression over the next few quarters. The impact on consumption and construction is temporary and probably will get over in the next couple of months.
So what you are saying is that the providers of finance will not be NBFCs but banks and basically growth is not going to be stymied because of that?
Not to a great extent, a few basis points here and there. We have trimmed our GDP growth number by 10 basis points, so that is our view on the impact.
One basis point is a hundredth of a percentage point.
We have taken down our earnings growth estimate by about 1 percentage point. So, that is the impact in our view, it is not a very large impact in my view.
Just to go back to global growth versus local growth and earnings growth, not GDP growth. For the last couple of years we were seeing global earnings growth, especially in the US at multiyear highs, margins have been very strong but that has failed to reflect in our numbers, in Indian companies, Indian corporates. Now if we are heading into 2019 and we are saying that global growth, earnings growth is going to start to come off, it is peaked off and may trail off, is there no implication to how well earnings may pick up because you said we will expect solid earnings growth going forward, is there no correlation or you think it is sort of overblown?
No, there is a correlation. There are two things about earnings, there is revenue growth and there are margins. So, the correlation is much higher at the revenue growth level than at margins; margins are far more idiosyncratic, far more country specific.
Just to take your example forward, corporate earnings in the US have hit all-time highs. We represent that by share of profits in GDP which are close to 12 percent. In contrast, in India, it is at all-time lows, share of profits in GDP are at 3 percent. So we have seen contrasting trends between the US and India with respect to margins.
However, there is certainly some linkage between revenue growth, and if the US economy would slow down perceptibly next year, then it will have an impact on revenue growth everywhere in the world including India. So there will be an impact on GDP growth. So, the correlation does not break down at the revenue level, but it is very different at the margin level because idiosyncratic factors drive in.
There is some amount of decoupling that has happened because I think India has achieved a lot on the macro front. You can see that in the rate cycle. India has not necessarily synchronised itself with the Fed in this rate cycle. So in all likelihood, for example, the Reserve Bank of India (RBI) may pause in this December, the Fed may continue to hike. Now when did you last see that because ever since India opened its doors to foreign capital in 1993, we have been very synchronised with the Fed rate cycle. However, not this time around.
There has been some breakdown because of India’s own macro achievements, but the topline, headline growth on revenue is pretty correlated, the margins are not.
There is a fear which is emerging in the real estate space in India, there could be a possible default, tier-II, tier-III companies could be more impacted, bond yields are spiking. How worried are you that we are going to see a structural slowdown within the real estate space and that is probably going to augment going into next year?
As I mentioned earlier, some temporary slowdown is in the offing but I do not see a sustained slowdown. I think some stronger real estate companies will step in, some projects may get sold, some valuation opportunities emerge out of such funding issues. There are some pretty good balance sheets around which are capable of taking over these projects.So, there will be some slowdown, but not a whole lot, not in the mode of a crisis as you are trying to highlight. I do not think that is what I am sensing. I am sensing more of a temporary slowdown rather than a crisis.