Credit Suisse’s Neelkanth Mishra suggested that, with a lower disinvestment targets, the government may be pacing itself and managing expectations. (Illustration: Suneesh Kalarickal)
It is far from clear how long the conflict sparked by Russia’s invasion of neighboring Ukraine will last and how energy prices will readjust — factors that are key to determining how risk assets are priced — and the prevailing environment means market volatility is likely to remain elevated, Neelkanth Mishra, managing director, co-head of Asian equity strategy, and India equity strategist at Credit Suisse, said in an exclusive interview with CNBC TV 18 on March 21.
There is a lot of difference between what the markets have been used to in the last 10-15 years and what is happening presently, Mishra said. Of course, the fact that inflation had been under control in the last 15 years offered countries a lot of policy space, he added.
How does the prevailing situation affect Indian markets?
The RBI (Reserve Bank of India) is in a bit of a different situation right now, the balance of payments situation is perhaps the one thing that RBI should be most worried about. How it wants to handle higher energy prices is another concern, Mishra said.
The (foreign exchange) reserves have fallen and if energy prices are going to stay elevated for more than a year and the fiscal deficit increases, then it would make more sense for the RBI to let the rupee depreciate further. Once that starts to happen, the monetary policy becomes even more challenging, he said.
“When you start intervening on the currency side, it sucks away the liquidity that allows you to buy bonds and that should be supportive of bond yields… at the same time another tool of attracting capital and slowing down the economy is to raise rates and that is very tricky and markets don’t like uncertainty; in case energy prices remain elevated, the market upside becomes limited,” Mishra added.
What will be the impact of a rising interest-rate environment on valuations of Indian companies?
Mishra thinks the headwinds from rising energy prices may not be as negative as feared from the perspective of company earnings because a large part of earnings per share is linked to global pricing. A very large part of the earnings of companies linked to the Nifty index is not related to what happens in India. Companies in the information technology, pharmaceutical and automotive sectors are cushioned by exports, Mishra noted.
“Therefore, if rupee weakens, the earnings are supported (by exports)… from the earnings perspective, there is less of a risk”, he said.
Obviously there will be some risks and some companies will have to take a margin hit, some will see their consumption and volume growth suffer. This trend has been evident in the last 3-4 months and may persist longer. At an aggregate level, however, the earnings risk is likely to be lower.
Mishra says the real challenge is on the price-to-earnings multiple, but expect the markets to trade on a flat line and earnings growth to support valuations.
What will be the impact of the Rs 25/litre hike in diesel price on bulk users?
India needs to adjust to the fact that it has to import nearly half of its energy needs, Mishra said. Excluding biomass, which is still about 25 percent of India’s energy consumption, India requires to import energy resources equivalent to 4 percent of gross domestic product (GDP).
“If energy prices are going to be 50 percent higher, there needs to be an adjustment. And, that happens by raising prices which brings down demand, or you let the rupee to depreciate, which again leads prices to go up… either way your demand needs to fall; otherwise this becomes unsustainable because the balance of payments which was in surplus of $ 15-20 billion till December trade data is now at a deficit of $ 40-50 billion; if oil is at $ 120/barrel and coal, gas, fertilizer all get marked up, then that deficit could easily rise to $ 100 billion, so there is no other solution and you have to led the prices go up and let demand come down,” Mishra explained.
He believes that the challenge for policy makers is in deciding how long this situation will last. If this lasts for, say three months, then letting the USD-INR exchange rate and retail fuel prices remain unchanged is the right decision. If this lasts longer, the adjustment process has to start. “And given the rise in diesel prices for bulk users, I think that adjustment has started now,” Mishra added.
Given what other governments are doing, it doesn’t look like higher energy costs, essential for demand destruction to happen, will be fully passed on to consumers. “The countries with a significant balance of payments need to adjust the most. So some kind of adjustment is inevitable, and we can only hope that the energy prices don’t remain (elevated) for very long,” Mishra said.
What is your take on the financial sector, given that some big banks are seeing a de-rating?
Mishra remains overweight on banks; he thinks India is still at the cusp of a multi-year economic recovery. Higher energy costs are a headwind that prompted a sharp correction of banks.
The strategist says loan growth will depend on how quickly the economy recovery rebounds from a medium-term perspective. The fact that the banking system is well capitalized, most borrowers have low leverage, and personal consumption and personal loans aside, corporate borrowings have been quite muted in the past couple of years, helps banks offset risks from a likely global slowdown and perhaps some adjustments that need to happen in India, Mishra added.
He believes that there are many variables that are still supportive of the financial system. The sectors hasn’t many unknown problems and valuations are inexpensive so he continues to repose confidence in the sector.
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