Dhananjay Sinha, JM Financial Institutional Securities
Budget 2022 should focus on providing more support to the demand rather than the supply side. Reviving the damaged informal sector and small businesses, which create jobs, will be crucial, says the MD and Chief Strategist of JM Financial Institutional Securities.
He believes there are several factors that could impact India’s growth in the coming quarters, and the government should ensure fiscal support to keep growth intact. Despite the recent correction in the market, he says we are not at “cheap value” yet.
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Here are edited excerpts from his interview with Moneycontrol.com.
Do you think India’s GDP growth is on a strong footing?
Despite the expected rebound in real GDP growth to 9 percent in FY22 from a contraction of 7.8 percent in FY21, the big picture is that India’s GDP trajectory remains fairly muted. The GDP trend after the Covid shock, including the Q2 print, is flat (0.3 percent YoY) compared to the pre-Covid trend of 4.5 percent. Thus, if one extends the pre-Covid real GDP, which was already weak (4.3 percent), the post-Covid trajectory so far is 11.3 percent lower, widening from -10.4 percent in Q1. This GDP gap is due to lower domestic absorption: private consumption is 15.6 percent lower than the pre-Covid trend and fixed capital formation is 9 percent lower.
The incremental factors beyond Q2FY22 are not very favourable given the steep slowdown in China and the potential spread of the Omicron variant, which will slow global trade activities. Given its prominence in India’s post-Covid recovery, flattening of global trade will have a significant impact on India’s growth in the coming quarters.
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What do you think the government should do in the upcoming Budget to support growth?
We believe fiscal support will be very crucial in deciding India’s growth trajectory if private consumption and private investments remain on a modest recovery path. Therefore, the Budget should focus more on providing support on the demand side compared to the supply side. Revival in the damaged informal sector and small businesses that create more jobs will be crucial.
High domestic inflation despite sub-trend GDP is a concern, which hints at supply bottlenecks at the individual industry level. Offsetting this may require incentives to promote greater domestic supply, without undertaking protectionist measures.
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Which sectors do you think will be in focus in the Budget?
Support to the real estate and allied sectors by way of tax measures can revive demand. Improved demand support through sustained fiscal measures can eventually crowd in private capex. Given the deleveraged balance sheets of large corporate and manufacturing sectors, and capital with banks, sustained improvement in demand conditions can trigger a domestic up-cycle.
We believe residential real estate, infrastructure, textile, fertilisers, and autos will benefit the most from the Budget.
However, the Budget has little impact on the way markets turn out since, in recent years, many policy announcements are done outside of the Budget.
Do you believe the market will correct further or has the recent fall created cheap value?
The 7 percent correction from the recent peak in Indian benchmark indices and 12 percent decline in the Bank Nifty is in line with our concerns on India’s rich valuation both on historical and global comparisons. There has been some correction in market valuations across sectors, but that is still fairly shallow.
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In terms of trailing price earning multiple, the Nifty 50, at 23x, has declined substantially from the peak of 40x in March 2021 and is now 10 percent lower than the 5-year average of 27.4x. However, given the volatile nature of earnings in the aftermath of the pandemic, we think it will be premature to consider this correction as having created cheap value.
Considering a less volatile measure of valuation, namely price/book, Indian markets are still fairly expensive. At 4.1x price to book, the market valuation is only marginally lower than the recent 13-year peak of 4.3x and 20 percent higher than the 5-year average. Further, a global comparison of major indices shows that Indian benchmarks, at 3.3x 1-year forward price to book, are still the second-most expensive in the world after the US (4.3x); they are substantially higher than the global average of 1.9x.
Where do you see the Nifty headed?
A comparison of domestic indices shows most sectors are at 30-100 percent higher valuations compared to the past 5-year average. This, along with the possibility of lower post-Covid structural growth, as opposed to volatile YoY comparison, and prospects of narrowing global and domestic liquidity, makes us believe that value creation is still afar. Hence, it is possible that benchmark multiples may moderate further.
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Since the healthcare segment is expected to stay in focus, do you like anything in this space?
During the Covid crisis, governments took various measures to enhance the healthcare sector. This may continue to be reflected in the upcoming Budget. We have seen the listed hospital space doing well in this evolving situation.
What about the banking sector? When do you see it putting NPA woes behind?
Banking sector balance sheets have improved significantly over the past 12-18 months due to several measures to ward off the solvency risk on banks emanating from the Covid crisis. Thus, the gross non-performing asset ratio of the banking system declined to 7.5 percent in March from 8.5 percent a year ago, and it has improved further in Q2FY22. Likewise, the capital position of the banking sector has also improved with the capital adequacy ratio for large banks rising by 100-200 bps.
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The key factor holding back banks is an anaemic recovery in credit demand and the ability to deliver strong core return ratios. In the absence of an adequate pick-up in leveraging runs the risk of NPA resurgence as the regulatory forbearances lapse. So, more than bad loans, the banking sector requires a sustained recovery in the economy, in which revival of private demand is very crucial. Hence, the prospects of the banking sector and banking stocks are crucially dependent on the efficacy of fiscal measures to revive the demand side.
Would you bet on any plays in this space?
We are underweight on banking and the financial sector at the moment. However, we favour large banks endowed with growth buffers, long-duration deposits and shorter duration assets, which should ensure relatively better margin and return ratios.
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Notwithstanding the recent outperformance of PSBs in 2021, largely driven by the steep decline in NPA ratios, we continue to favour private banks due to their larger capital buffer and structural ability to gain market share.
FIIs have largely been sellers in 2021, do you see the trend reversing?
Even before the advent of Fed rate hikes, India has seen a net outflow of $ 7.8 billion since the end of March. The direction of the US rate cycle and the Fed’s quantitative easing explains a substantial portion of the portfolio flows into emerging markets; domestic growth has much less explanatory power. Hence, monetary policy tightening by the US Fed and, subsequently, by other central banks, will have an impact on flows.
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