Experts are looking forward to the budget for government’s controlling measures to combat inflation in India. Otherwise, they feel, there is a big risk that India might get into a tail spin because of high oil price and already high food inflation.
In an interview to CNBC-TV18, R Sukumar, Director of Franklin Templeton Investments warned that the government should control fiscal deficit, else there is risk of losing global interest in India on inflationary pressures.
“If the deficit also goes out of control then we have a serious risk that the projected growth trajectory may come down and inflation pressure might continue at significantly higher level and the foreign interest in Indian market could decline significantly,” he elaborated.
Sukumar thinks that there is possibility that the market has some more downside but some stocks might see upside while some may see some downside and probably the broad indices stay close to where they are.
The market seems quite worried about the spike in crude. However, Sukumar thinks it is not going to alter the long-term trajectory. “Any significant dips caused by the volatility could be buying opportunities for serious value investors,” he added.
According to him, India will see positive global flows in 2011. “Our share of the global flows will be lower compared to what we saw in 2010. But my estimate is still that we will see positive flows in 2011."
Below is a verbatim transcript of his interview with CNBC-TV18's Udayan Mukherjee and Mitali Mukherjee. Also watch the accompanying videos.
Q: How are you reading the global situation? The market seems quite worried about the spike in crude again, is that making you circumspect about the near-term?
A: That is definitely going to be a very important consideration in the near-term because many economies can not afford a very high oil price. The instability in the Middle East could make the oil price go significantly higher compared to the current levels. So, that is clearly a risk for some of the economies as well as some of the markets.
But having said that, I do not think it is going to alter the long-term trajectory. Any significant dips caused by the volatility could be buying opportunities for serious value investors.
Q: What do you sense in your conversations with offshore investors that you speak to, are they worried about India underperforming further because of inflation and crude price fears or do you think most of the selling, which had to happen, is done?
A: Most of the underperformance that has happened till now is primarily because of rotation. People moved from market like India to more export oriented markets which could benefit from improvement under global conditions. In 2010 or the first half of 2010, a very high proportion of money coming into emerging markets came into India and that was not a sustainable phenomenon and that had to reverse.
I think now is the time when people are looking at the real risk in India. How things pan out will depend on that the confidence that they gain from the policy direction from the government as well as how the companies behave under the current circumstances. These are going to be critical in the next two quarters. If the policy direction seems to be strong enough to de-risk the economy then I think the confidence will improve.
Similarly, focus of companies on creating value for the shareholders would also create confidence for the minority shareholders. So, these are going to be more important than before going forward.
Q: The only thing that has changed is that now we are beginning to see cuts in developed markets. In the past, at least in the near-term, when the crisis of these sorts happen, money tends to go back to the mother country. Would you fear that in the near term we may see more by way of outflow situation because of what has been happening in West Asia?
A: I still think that is not most probable situation because people are under invested in equities globally. I think there is potential for more allocation to equities. But if the West Asia situation becomes much worse than what it is today and we have serious disruptions of movement of oil and oil prices spiked to USD 140 and above then I think we have to re-evaluate the situation.
As of now, we still that is not a very likely situation. We think that things will be localised in some countries and there is going to be no large scale supply disruption. Under the circumstance, we still think that more money will go into equity markets. Our share of the global flows will be lower compared to what we saw in 2010. But my estimate is still that we will see positive flows in 2011.
Q: Do you see more downside to this market from here because we have fallen quite a bit but seemed to have bounced on lows? Over the next three months as the inflation situation cools down or sorts itself out, do you see the possibility of price erosion?
A: I think it is a possibility. But the most probable situation is that there is going to be divergence. Some stocks might see some upside and see some stocks see some downside and probably the broad indices stay close to where they are. I think that is the most probably situation.
As I said if the outlook becomes murkier, we have more problems in West Asia and the government is not decisive in controlling inflation and fiscal deficit, if there is no policy direction and if the corporate do not deliver value for the investors, I think there is a risk that is going to be a significant downside from current levels.
Q: On both those issues, the inflation situation and the deficit, how much detail do you think the budget will provide?
A: I think the budget should provide some insights into the fiscal deficit. The budget should address both in terms of controlling the expenditure and trying to improve the breadth of revenue base. The budget should be able to provide a strong insight into how the fiscal deficit is going to move.
On inflation, the budget might not provide all the data points that are required to estimate inflation because global commodity prices and food demand would have an impact and budget would not cover many of those topics.
The crucial thing is we need to control fiscal deficit and the government should move to clearly put that under control. Otherwise, there is a big risk that India might get into a tail spin because of high oil price and already high food inflation. If the deficit also goes out of control then we have a serious risk that the projected growth trajectory will come down significantly, inflation pressure might continue at significantly higher level and the foreign interest in Indian market could decline significantly.
Q: Up until now the premise for this calendar year was that somewhere around the middle point we would see a recovery, both in terms for prices for the market and interest towards India. Because of developments in West Asia, do you think that theory might have got turned on its head a bit?
A: I don’t think there is a 180 degree change, but there are additional points of concern which need to be addressed. It is within our capability as Indians to address those issues. The government and the companies have to move decisively to see what the issues that need to be tackled are.
Q: How are you approaching this whole oil space now in the light of what is going on with crude, both upstream and downstream?
A: When you look at the Indian oil companies, it is dominated by some of the public sector oil companies. They do not benefit significantly, when the oil prices go up. But they could lose a lot of money, when the oil prices go up, the marketing companies. Whereas producers, upstream companies, do not gain so much, when the prices go up. So, oil price going up brings down the overall profitability of the oil sector. It is not looking very exciting at this point of time.
In the case of Reliance, their main output is gas and the gas price is fixed. They again do not benefit from the oil price going up. The only company that could benefit a bit from the oil prices going up is Cairn India. But there are a lot of other uncertainties surrounding that particular company. If you look at the overall oil space, it is not something which is looking very exciting under very volatile scenario for the commodity prices.
Q: What about banks? Banks have corrected quite a bit, but between the PSU and the private sector lot, which ones do you think have come down to more attractive levels?
A: The PSU banks have corrected more than compared to the leading private sector banks. But there are more uncertainties in the PSU space as well. If you are going to see worsening of the corporate profitability levels and especially the weaker companies being affected more then some of the clients of the PSU banks might be under pressure. And that might reflect in their margins in terms of increased provisioning.
The deposit cost increases are going to be pretty high. That is also going to impact the net interest margins. We have to look at which banks can protect margins under very uncertain times. The banks where we have confidence are the ones which are worth investing and we find more choices in the private sector than the PSU space.
Q: What would your strongest conviction buy be right now in terms of sectors?
A: We have to look at sectors which are going to be less affected by inflation, oil prices etc. By and large, we are bottom up stock pickers. So, we look at the impact of all these developments on the profitability of the companies and how it affects the long-term outlook.
Within our universe, we think that majority of companies have no significant change. So, we are not looking at any big change in terms of our preference for stocks because of the recent developments.
Q: In your conversation with investors, how much of an issue has corporate governance standards become for people investing into India?
A: Corporate governance has worsened towards the last few years because of easy availability of equity capital. I think general standards have deteriorated. While it didn’t affect the market when there was very high level of liquidity, when the liquidity levels go down, it is going to have an impact on the market. That is one of the reasons I have been saying six months that will be a flight to quality, which has happened and actually accelerating at this point of time and might continue for some more time.
Investors are voting for companies where they have confidence in the ability of the management to create value for them in the long-term. As you can see from the stock market behaviour, a lot of companies are getting punished and there is a strong correlation between the deterioration in the corporate governance and in the performance of the stock.
Unfortunately, we could have had much better market conditions. We should have had much better market conditions, but unfortunately because of the deterioration in the corporate governance things have worsened for us.
Q: One sector that has been in the eye of this storm has been telecom? As a large investor, how have you positioned yourself in telecom over the last six months or have you cut down your weightages because of the lack of policy clarity there?
A: No, we have been holding on to our position in the telecom sector. We have been primarily holding companies which have a very strong operating metrics and which are profitable even under the current scenario. When the competition level decreases, which will eventually happen because majority of players cannot sustain operations for long, then the stronger companies would benefit. So, we think uncertain times are the times to buy into some of the stronger companies in the sector. We continue to hold to our positions in the telecom sector.
Q: You hear from the industry that mutual fund flows have not been too bad in January and February. In fact you have not seen net redemptions, but net inflows, has that been your experience as well at Franklin Templeton?
A: Yes. We have seen better flows compared to the earlier quarters. But compared to the potential of the industry, I think the flows are still at a very low level. I think it could be much better. Hopefully, that will happen over the next year or two.
Source: http://www.moneycontrol.com/news/mf-interview/govt-needs-to-control-fiscal-deficit-franklin-templeton_525439.html
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