India may see a trade surplus after 10-12 years; to keep currency stable: Prashant Jain

‘Sectors where the fixed costs component is higher will be hit sharply’

I have been reasonably confident that life will come back to near normal pretty quickly, says ED & CIO of HDFC AMC.

Why don’t you share the big picture with us first and then I will get into the specifics.
These are clearly unprecedented times. But yes, there is now some more clarity in views. The current year will be an outlier year and it will be an extremely difficult year for the economy because for two months almost half the economy did not function and that will lead to a significant economic impact; analysts now estimate between 5% to 10% GDP contraction in the current year and very broadly, those numbers appear to be realistic. It will have a significant fiscal impact as well because there will be severe loss of revenues. Corporate profitability will also be hit sharply, especially in sectors where the fixed costs component and discretionary element of sales is high.

The good news is that the external side of India looks to be very strong and India is very uniquely placed amongst the emerging markets. Unlike most of them, we are a large oil importer and our exports are relatively less. On a net basis, the fiscal deficit will go up 2% to 3% and on the balance of payments side, India could look at a year of trade surplus in the current year after almost 10-12 years. Therefore, currency should remain stable. I think interest rates could move lower.

I think it would be best to skip this year whenever we are thinking about the economy or the markets. Why I am saying that is last year, let us say the economy was 100 and current year just for the sake of argument let us assume it is 90. Most of this de-growth is because for two months the economy functioned at only half the capacity. So the impact of that itself is 8% because two months divided by twelve is roughly 16% and half of 16 is 8%. So bulk of the de-growth in the current year is being contributed because half the economy is not functioning for two months.

Next year will be a normal year. Therefore on this low base of 100 becoming 90, we will go back to 100 automatically to my mind because of 12 normal months. So next year optically the growth will look to be in double digits and neither this year is a representative year of long term economic growth of India and nor will be the next year. So we should ignore the current year in our calculations and in our estimates and we should just focus on next year. Ignore the growth of next year as well but from a valuations perspective or markets perspective or macroeconomic perspective, next year will be a more normal year and after that life should come back to normalcy.

How does one go about predicting and talking about the future when it is so uncertain? How can one position capital for future returns?

The future is always hard to forecast and Einstein said that I do not worry about the future; it comes soon enough. I am not claiming to be able to forecast the future accurately but to base your judgements on the current environment to my mind would be a mistake because let us not forget that the real economic impact is because of the lockdown and once it is lifted, you will see life will come back to near normal pretty quickly. People may still not step out of their homes unless it is essential; only half the people may come to offices but at least in terms of economic activity, demand conditions will limp back to normal quite rapidly.

If you go back and visit events like 9/11, Lehman, Asian crisis, we had heard similar sentiments even back then. It would be wrong to extrapolate the current economic conditions into the future. There is a strong tendency in businesses and in life for mean reversion and sitting at one extreme, we should not extrapolate extreme situations. I have been reasonably confident that life will come back to near normal pretty quickly.

When it comes to mastering the art of understanding market cycles, you have done very well. The market can be divided into two; non-financials and financials. Frankly, the non-financial part has not done bad, but it is only the financial part of the leverage play which is completely on the butcher block?
You are right. For the last few years, the consumption growth in India was supported by fast growing retail loans and we also saw higher corporate slippages. In a way, it is both fortunate and unfortunate; it depends which way you look at it. Just when the corporate NPAs were coming to an end and one was hoping that the financials will report normal earnings, we are hit with this. I think the smaller retail loans will get impacted in two or three ways.

When corporate profits come under pressure, the wages will come under pressure whether we like it or not because companies need to endeavour to maintain profitability and at times like these, companies tend to take a very hard look at the costs. So wages are coming under pressure which will inhibit the ability of or willingness of people to take on loans. So there will be a strong tendency to cut down on anything that is discretionary. Post the YES Bank restructuring and the challenges that the bond markets in India are facing because of what has happened in the mutual fund space, what is happening in the bond markets and the ability of small banks and NBFCs who were mainly focussed on extending the small retail loans, both the capability and the willingness, will consequently change. Simultaneously, because of the moratorium, time will tell what are the slippages but in this cycle, we will see what was happening to corporate loans will probably happen to the retail loans, at least in certain pockets and I think that is what the markets are reflecting.

When retail loans do not grow, PE incomes suffer, balance sheet growth suffers and there are provisioning costs to be made. So you are right and in a way it is fortunate because had both these happened simultaneously, it would have been a far greater challenging situation and that is why it is okay because it is a better situation to be in because once the corporate pain is out, that is when you are faced with this once in a lifetime kind of a situation.

Let us say SBI and ICICI Bank do have a large retail book. While the corporate book may not take a scary dip because the government has decided to roll out a guarantee, there is liquidity and a lot of deleveraging already happened before the crisis. But if retail delinquencies start, ICICI Bank, SBI and HDFC Bank will also suffer?
You are right. There will be pain but the pain will not be evenly spread across the various entities. The retail loan composition for some of these banks is high. The underlying loan composition and the customer segmentation and the customer profile is quite low and banks that have focussed on mortgages, salaried customers mainly in large corporates or government sector or even if you have extended automobile loans or unsecured loans, your customer profile is better; then the impact would be far less. I do not think you can simply say that x retail loans across entities will behave similarly. The next six months-12 months will be very interesting and we will get to discuss with greater details when we have more data.

Most of the mutual funds currently are overweight financials and that is largely because of benchmarks and the positioning. Do you think it is the positioning which is also hurting financial stocks?

I would not say all funds are overweight but yes, somewhere someone is slightly overweight, neutral and slightly underweight but since the financials are such a large weight in the benchmark it is held by most institutions and mutual funds. I am sure other institutions have barely significant positions in this space and what is true for local investors is probably even more true for the foreigners because if you look at their positioning, it is far bigger overweight in that space and that is probably what we are seeing. From the prices, there is considerable amount of selling in that space mainly from the foreigners because the last six to eight weeks have seen the highest ever FII selling intensity and if half of your portfolios or 40% or 30% for some was in this space, it is hard to conceive that space would not have seen selling.

The selling is driven by the worry around the evolving situation around NPAs and driven by moratorium shutdown and loss in wages; so both growth and the asset quality is the issue here and that is why we are seeing this outcome. But whatever you and I said is by and large known to everyone and these are very top down views. The key again is to ignore the current year; look at it as a gap year and the moment you start focusing on fiscal 2022 or 2023. I think at least our judgment becomes better as to what we are getting and what we are paying.

Today the situation is such that after this significant correction in the financial space, some of the largest banks in the country are trading near one time book and the public sector large banks are trading at a fraction of book value and you can build in reasonable amounts of stress. But as long as you agree that what is happening today is temporary and I do not want to extrapolate that into the future, then when you are buying a large competitive business around book or below book, chances of going wrong are quite low and let us not forget that this environment is actually very supportive of the large banks.

What this has done is the events of the last few quarters have highlighted the importance of the liability franchise both for banks and for NBFCs, which markets have long ignored. The banks with strong liability franchises will come out stronger in this environment because they will gain market share from smaller banks, from NBFCs and from the bond markets. Also, let us not forget that the large banks were either not in a position to be doing small retail loans across the board; some of them were doing it but now with the rapid migration towards digital loans and the fast progress that we are making in using the data which these banks have, they will compete very effectively in the very small loan segment. Aso, the large banks, the tech savvy banks and the banks which have good liability franchises actually will come out very strong with higher market shares even in the retail space.