We need a voluntary asset quality review for NBFC sector: Saurabh Mukherjea

Anand Kalyanaraman BL Research Bureau | Updated on August 14, 2019 Published on August 14, 2019

SAURABH MUKHERJEA, Founder & CIO, Marcellus Investment Managers


Over the past few months, concerns about the slowdown in the economy have taken centrestage. Speaking to BusinessLine on the sidelines of the CFA Society India 4th India Wealth Management conference, Saurabh Mukherjea, CFA, Founder and CIO, Marcellus Investment Managers says a remediation of the NBFC crisis is necessary to get the economy back on track. Edited excerpts:

What is your outlook on the economy?

We haven’t had a capex cycle for eight years. So, we have run off the growth runway. What accentuates the situation is the NBFC crisis. In the last couple of years, I have been saying that this NBFC crisis is overdue. The IL&FS meltdown has triggered it. I believe that if the RBI were to address the core drivers of the crisis over the next six months, it is entirely feasible that towards the end of the year, we can see the beginnings of a recovery. Without remediation of the NBFC crisis, I think the economy will keep sliding for an extended period.

What should the remediation be?

What we need is a voluntary AQR (asset quality review) for the NBFC sector. It was done to the banks three or four years ago. Voluntary AQR would involve the RBI inviting the top 15 NBFCs to submit their accounts and financial statements for a review.

NBFCs who do submit their accounts for review and pass the process should end up with a lower capital requirement. The RBI should grant them lower risk capital weights, which would effectively allow the NBFC to take up more capital gearing, and thus generate more ROE. NBFCs who refuse to go through the process will then implicitly get a black mark from the money market.

At the moment, money markets have lost faith in the NBFC balance sheets, and in the credit rating agencies’ ratings. Due to this atmosphere of lack of faith, the entire sector is drifting into oblivion. By doing a voluntary AQR, the RBI will separate the men from the boys, the women from the girls, so to speak, and allows a part of the industry which is in good shape to pull through with renewed faith from the money market that these NBFCs have bonafide, genuine accounts and that they can be supported and backed.

Earnings growth of India Inc has been weak for a long time now. When do you see earnings picking up?

That’s co-related with the capex cycle. We are a conventional economy. If you don’t see capex for eight years, you can’t expect earnings to come out of thin air. The capex cycle looks unlikely to recover this year given the state of the financial system. Therefore, it is highly unlikely this year that we will see the standard fantasy expectations from local brokerages of double-digit earnings growth. So, if the RBI addresses the NBFC challenges, I think, potentially next year, we could see the revival of the capex cycle and perhaps in FY2021, there could be double-digits earnings growth after eight years of single-digit earnings growth.

What is your outlook on the market?

Like a broken record, I have insisted for the last four years that the Indian market is overvalued. I stay with that. But that never gets in the way of making money. You don’t make money in the stock market because the market is cheap or the market is expensive. You make money by identifying great companies — with clean financial statements, making essential products and having monopoly franchises. All three criteria have to be fulfilled together.

Did the Budget get it wrong on the surcharge and its implication on FPIs?

With the benefit of hindsight, we can all pretend that we all know everything. To be fair, on July 5, I thought it was a sound Budget. I don’t think the Finance Minister realised or indeed, any of us realised what the implications of the surcharge were. In retrospect, belatedly, we are all wiser from what’s happened. I am sure responsible, wise people in the government are looking at the situation. And I am sure they will try to remediate the situation sooner rather than later.

The auto sector is in deep trouble. What is the way ahead? Especially, given the government push towards electric vehicles.

The auto sector is obviously dependent on credit from the NBFC sector. And as we discussed, the NBFC sector faces a credibility challenge.

On the shift, I am not an expert on how quickly India will move from internal combustion engines to electric vehicles (EVs). I hear about the government’s desire and pronouncements to hasten the transition. I also hear about companies like Maruti talking about what they could do to launch EVs. But to a non-expert like me, it is not very clear at this juncture how quickly we could get an affordable EV for the auto market in our country. I think two-wheelers might happen sooner, perhaps even public transport as well. But on the family car, it’s not clear how quickly we can get an affordable EV in the country.

What impact will the EV push have on the oil companies in the country?

Look, these are mostly government-owned entities. So, I am sure the sovereign will look after them, and make sure that their expertise and financial strength is appropriately utilized. It’s never been clear to me why anybody in our country invests in stocks where the government is a majority holder. The government has to look after national and social interests rather than profits for minority shareholders; that’s only fair. It’s very appropriate in this situation as we transition from conventional autos to EVs that the entire oil ecosystem being owned by the government, it has the greatest chance among many other large economies of having the smoothest transition.

In a private sector owned oil industry, they would obviously have a vested interest to promote fossil fuels over EV. But when the government owns the oil industry, it will hopefully let the broader interest of the citizens prevail over the narrow interest of the shareholder of the oil and gas companies.

But investing in PSU stocks, whether they be banks or oil companies, given that the government is the largest shareholder, you have to realize that your interests are subsidiary to the national interest.

Can the government afford the loss of the revenue that comes from the petroleum sector, given that it is such a major contributor?

That’s an easy switch. Whatever becomes the dominant mode of transport, you can change the tax structure on that. I don’t think that should be a major concern. During the switch, it is unwise to tax because you then delay the switch. But once the switch happens, bang!

The real estate sector is in the doldrums. How can it get out of the mess?

I had said in an infamous note published 4 years ago that given that rental yields are 2 per cent and the cost of borrowing is 8.5 per cent in residential real estate, you will need a major correction to bring back a semblance of normality to the sector. We are still looking for that elusive correction in residential real estate. Pending that, it is difficult to see why younger people will make a beeline to buy expensive flats in cities across the country.

The delays in the IBC process threaten to derail the process. How should this problem be addressed?

I am not surprised by it. Obviously, when you have so many myriad interests at play — promoters, minority shareholders, secured creditors, unsecured creditors, operational creditors — it’s difficult to understand how you can suddenly click your fingers and have an American style process. You can keep make keep making changes to the IBC but it is bound to be a long process where using case law and precedent, the IBC turns into a practical code, where by sheer weight of precedents, you are able to create a rule book that guides resolution. But we still have some way to go before the case laws are established and the rule book is done to further the insolvency process.

Is the RBI really independent now?

Independent Central bank has always been an oxymoron. Ultimately, in any democracy, democratic representatives are answerable to the public. And whether it is the UK, USA or India, it is a little unrealistic to see that Central banks have been independent of the representatives of the people. For instance, the Federal Reserve governor is chosen by the US President. Given that, to say that the Fed Governor works absolutely independent of the US President is unrealistic. Similarly, the Bank of England Governor is chosen by the British cabinet. Similarly, in our country. So, it is a nice fantasy that people have that the Central Bank will operate with different utility functions, with a different set of preferences, utterly independent to the needs of a democratically elected government. It was always unrealistic and remains so. I don’t think that suddenly in the past 2-3 years, the paradigm has shifted, as much as people make it out to be.

There have been questions raised about the credibility of our macro numbers. What are your thoughts about that?

I think, to be fair to Arvind Subramanian, he wasn’t the first to question the numbers. And to be fair to the Government of India, they have defended their position resolutely over the last couple of years. So, clearly both sides are saying things that make sense to some extent. So, what seems to be required is a group of distinguished statisticians – of independence, calibre and weight – who can look at what is a complicated subject, and make a rationalization of that. I am not so worried about what has happened in the past - whether over the last 7-8 years, the growth was 7 or 5 or 4 per cent is not going to make it any better for you and me. But what should be of greater concern to all of us is what happens going forward. If we are not able to calibrate the speed at which India is growing, it is very difficult for the RBI, for instance, to formulate policy, or a fund manager like me to figure out how to position my portfolio, or for CEOs to figure out how much capex to do.

Published on August 14, 2019
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