Foreign investors will return to Indian capital market, says Angel Broking chief

The normal fizz that one witnesses before the Central budget is missing this time. The Sensex is down by about 10 per cent from the beginning of this year and shows little sign of rebounding. To that extent, any downward spiral post budget may be limited.

While the budget may address fiscal concerns of the market, many of the unfavourable developments like the on-going unease in the Middle East that can result in a flare up of crude oil prices, the selling spree indulged in by FIIs, concerns over the several scams that have rocked the Central Government, the probable outcome of the assembly elections in some of the key states etc are all beyond the fiscal domain.

Even inflation and the commodity prices have remained stubbornly high and fears over continued increase in interest rates have made the investors wary of investing in capital markets due to fears over markets correcting further.

In an interview to Business Line, Mr. Dinesh Thakkar, Chairman & Managing Director, Angel Broking, Mumbai, shares his thoughts on reasons for market being cautious ahead of the budget and likely post-budget scenario. Excerpts.

Q: The normal pre-budget rally is missing this time from the capital markets. Is it a reflection of the fact that the market believes that nothing positive may come out of the budget or is there any other reason?

Ans: Our markets have recently fallen by about 10 per cent and several of the midcap counters have especially taken a battering. The main reason for this was that the Sensex was priced to perfection at 20,000 levels. But since the past few months, a host of information flow has been suggesting near-term execution hurdles to India's double-digit growth ambitions, while at the same time inflation and current account deficit are relatively high. Accordingly, the Sensex has corrected to a much more reasonable 15x P/E now. Moreover, the Indian markets have underperformed other emerging markets recently and the Sensex is now trading at lower valuations than the Shanghai Composite, in spite of enjoying stronger structural tailwinds.

Q: Are you pinning your hopes on the budget to give a new direction to the economy? If so, how.

Ans: Our economy has the potential to grow by 10 per cent, but has got chained to a moderate 8 per cent GDP growth rate on account of supply constraints and no doubt a lot can be done on the policy reform front. For instance, opening up of the sectors that can attract foreign investments, such as retail, insurance, etc. needs to be hastened, especially as we have not added to our forex reserves of late. Moreover, other emerging markets have been growing on the strength of the higher contribution of exports to their GDP. Our government also cannot afford to ignore this lever of growth and more momentum is needed to incentivise manufacturing exports through SEZs, etc, especially when our closest competitor’s currency is pegged.

Moreover, in a resource-rich country like India, it is unfortunate that we are ending up importing significant amount of coal and also steel, even though we have huge resources. So, the government needs to take urgent action to reverse this situation by fast-tracking policy reforms. Also, it goes with saying that no country can grow without ramping up the infrastructure investments. So, our current infrastructure investments of 5-7 per cent of GDP need to go up to 9-10 per cent, if our growth trajectory is to go up.

Q: A reason for the upturn witnessed by the market in 2010 was the flow of FII money. This seems to be on the reverse gear now. Do you expect that with the US economy on the mend, the reverse FII flow would lead to large scale selling?

Ans: FIIs have sold about $ 1 billion of equities this year and while market pundits will retrospectively explain the reasons for this as high inflation, like I explained, inflation is only part of the problem. The Sensex has corrected to a much more reasonable 15x P/E now. Moreover, the Indian markets have underperformed other emerging markets recently and the Sensex is now trading at lower valuations than the Shanghai Composite, in spite of enjoying stronger structural tailwinds. In fact, Dow Jones in the last 6 months has appreciated by 20-25 per cent, Chinese markets have appreciated by 10 per cent, while Indian markets have come down by 10-12 per cent.

The fact is that last year we received $29 billion of FII inflows, but no one made much money last year as the markets were moving sideways, so there is little scope for profit-booking by the FIIs. After a 10-12 per cent correction, I don’t expect the FIIs to sell further and book losses, especially considering that our markets have become really cheap now.

In fact, there are some arguments doing the rounds in the markets recently that with the US economy improving, money will flow back to the US markets, but this does not make much sense at all. The fact is that global prosperity is symbiotic for emerging markets – when those economies do well, we benefit in growth terms. And moreover, we also benefit from higher FII inflows, not lower, as can be clearly seen from the history of the last bull cycle!

This makes sense, because after a temporary run-up in their markets when their economic cycle turns for the better, once again FIIs turn to emerging markets, which is where the real growth opportunities are. Also, when things are going well at home, the global risk appetite is also higher, which further encourages the flow of money into emerging equity markets like India.

Q: Are there any signs of the economy reviving? If you see them, in which sectors this is evident and how important are they for the revival of the market?

Ans: In the third quarter results also, majority of the sectors have continued to do quite well on the top-line front, largely in line with our expectations. It is just that, margins have been hit for some companies due to the rising raw material prices, which I believe is a temporary factor. In 2011, I believe that the markets will continue to closely monitor near-term execution, especially in sectors or companies with less-than-exemplary corporate governance or inherently low-entry barriers. Hence, notwithstanding India's robust long-term GDP growth outlook, sectoral strategies and stock-picking will remain vital to overall healthy portfolio returns. From a sectoral standpoint, in my view, post the correction, banking and infrastructure sectors are looking especially cheaply valued. Also, I continue to find huge value in some of the bottom-up picks in the midcap space, which are either high-quality entry-barrier businesses or are available at dirt cheap valuations.

Q: With elections in many states coming up shortly and the mood sullen among the voters, the budget is expected to be populist. Do you think such a budget, that may raise fiscal deficit, would have a positive or negative impact on the market?

Ans: As far as fiscal deficit is concerned, the government had committed in the last budget to a sustained path of fiscal consolidation and looking at the already rising interest rates, it is important that the government delivers on this front. Unlike last year, when the government received Rs 1,00,000 crore from auctions of 3G and BWA spectrum, there are no such benefits expected in the short term. Any further increase in fiscal deficit would further harden the interest rates, eventually hitting the credit demand in the economy.

Q: Which is the single most important issue that you want the budget to address to revive the positive mood among the investors? Why domestic investors are shying away from the market?

Ans: Looking ahead, I believe that an increase in policy reforms and faster project clearances would hold the key for taking the GDP growth rate beyond the 8-8.5 per cent expectations. Clearly, in case of most of the economy’s current woes, what is coming out is that our economy is being held back due to supply-side constraints and lack of execution, whether it is agriculture or mining or infrastructure. It is important that the budget shows decisive commitment and clear action on the government’s part to fast-track the removal of all these shackles to our growth so that the private sector can achieve its maximum potential.

Ironically, looking at the way the midcap stocks have been hammered recently and looking at the market volumes, it is evident that retail participation is very low – a case history repeating itself again, where retail investors seem to bow out of the markets just when stocks become really cheap. I would urge them to not get trapped into this kind of sentiment-driven investing and firmly grab this opportunity being presented by the markets. All in all, even with our GDP growth trajectory at 8-8.5 per cent, the Sensex is looking reasonably valued trading at 15x P/E, and investors should take this opportunity to make good allocations to equities for healthy returns in the coming year.

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