Broader market to catch up as recovery plays out, says Mahesh Patil

We expect the numbers for the December'19 quarter to show early signs of economic growth bottoming out, says Mahesh Patil

Even as the headline indices are expected to deliver modest returns in FY21, fund managers are expecting a pick-up in the broader economy, triggering a recovery in the beaten-down mid-cap segment. Mahesh Patil, co-chief investment officer (equities), Aditya Birla Sun Life Mutual Fund, tells Jash Kriplani about what makes him bullish on growth. Edited excerpts:

Your views on monetary policy and the impact of Operation Twist? 

The monetary policy has been fairly accommodative in 2019 with the Reserve Bank of India (RBI) embarking on a 135-basis point (bps) rate cut, besides keeping liquidity fairly abundant. However, the transmission of policy rates has been a problem. Despite the rate cuts, it has not yet meaningfully translated into banks’ lending rates. The RBI is also looking at various options to see how this transmission can happen. Given the rise in headline inflation and emerging risk on oil prices, we do not see a rate cut in the near term. The RBI’s Operation Twist has been able to reduce long-term rates with the 10-year G-sec yield declining by approximately 25 bps following the announcement. This should help better transmission of lower rates. 

Is cost of funds likely to remain high for lower-rated borrowers? 

For a lot of AAA-rated borrowers, spreads could compress in the next two quarters as liquidity has improved. The risk-aversion in market has also eased somewhat. Overall, the liquidity in the system now is over Rs 3 trillion, thanks to RBI's foreign exchange operations. So, we should start seeing an uptick in lending as lenders seek better yields. 

How will the economic recovery play out?

It will be gradual. From the fiscal standpoint, there is limited room for government spending. The government is likely to allow the fiscal deficit to widen a bit this year and be more accommodative to stimulate growth. We expect the numbers for the December quarter to show early signs of economic growth bottoming out. This is because we expect consumption to slowly start improving from the first quarter of FY21. Though kharif crop output has not been good because of unseasonal rains, rabi yields are likely to be good as water reservoir levels have been fairly reasonable. The spike in food prices will lead to higher rural income. Some of the sectors like auto — which have seen slowdown earlier — should slowly start to look better as the low-base effect starts to play out. Also, improvement in government spending and easing of tightness in the debt market will help drive up growth. With things at the margin improving, we expect the economy to grow at 6 per cent in FY21, from 5 per cent we are expected to report this year. 

Do the Indian markets look expensive versus other emerging markets?

What the market is currently factoring in is the fact that earnings have been depressed for corporate India because of the slowdown that we have seen over the last couple of years. A lot of sectors could see a bounce back next financial year as GDP growth recovers. Earnings growth can be much higher than the overall nominal growth in GDP. The consensus earnings growth estimates are thus showing strong growth of around 23 per cent in FY21. If we are able to deal with the current issues and as the benefits of structural reforms play out, our potential growth rate will be much higher than any of the other emerging economies. So structurally, if India's GDP growth rate is going to be higher, and earnings growth is also outpacing on a depressed base, our market when adjusted for growth may not look as expensive as it seems vis-a-vis other emerging markets.

Are valuations likely to remain high?

Because of the above factors and a risk-on trade globally, we will continue to see valuations remain at elevated levels. We think the market is fairly valued and don't expect the multiples to re-rate further. There could even be some mean reversion of valuation multiples over the long term, as fundamentals and earnings growth catches up. Returns from the headline market could be slightly lower than earnings growth as multiples are already factoring in better earnings growth to some extent. 

Will market polarisation continue? 

While we don't expect a sharp correction in quality names, we could see the broader market catching up as domestic recovery plays out. Meanwhile, quality names in the frontline indices might consolidate, or move in-line with the markets. The broader market is linked more to the domestic economy and as the recovery plays out, earnings growth here can outpace the frontline stocks. Also, valuations are more reasonable there as the broader market has not participated in the rally over the last two years. There has been polarisation at the sectoral level, too, and beaten down sectors can see some normalisation.

In which sectors do you see investment opportunities? 

Small-ticket consumer discretionaries could bounce back faster. The move from unorganised to organised players and increasing per capita income will benefit this segment. Better-managed private banks will continue to gain market share. Pharma also offers a good risk-reward opportunity. There are also select public-sector companies where we see good value. We like cement as an indirect play on infra and a possible revival in the housing sector play out.

Can you sum up your market outlook for the new year?

For the headline indices like the Nifty, this will be a period of consolidation. The fundamentals are likely to play catch-up this year. The Nifty return will be modest, say, in high single digits. However, as the broader economy starts to catch up, the participation from the broader market could be much better. We could see mid-caps outperforming the Nifty this year. 

How do you see government spending impacting the fiscal deficit?

The government spending was a bit slow at the beginning of this fiscal year because of the Lok Sabha election. However, there has been a healthy pick-up in spending in the last few months as the government tries to support economic growth. On the other hand, tax collections have been quite low. Given the weakness in private demand, we expect the government to continue supporting the economy through higher spending despite weak tax collection, and hence some fiscal slippage looks inevitable. 

What do you make of the recent announcements on infrastructure?

The roadmap for infrastructure investments re-iterate the government's broader vision to boost infra. However, the government's ability to fund the huge investment in the infra segment is limited. Even off-balance-sheet funding through companies like NHAI is going to have limitations. The balance-sheets and risk-appetite of the private sector also don't seem to suggest that there will be big private sector investment anytime soon. However, the sector still holds a lot of promise because of the fact that there is a pressing need for building infra in the country. If the government is able to tap global investors, we could see the funding gap closing up. There is enough liquidity in the global markets that is floating around, and if we have a strong policy framework, we can attract large foreign capital. So, right now, we are cautiously optimistic on the infra segment.

Debt has been a constant Achilles heel for India Inc. Are Indian corporates and promoters now better-placed on this front?

Overall, we see corporate India in a deleveraging mode. The IBC (Insolvency and Bankruptcy Code) process for resolution of stressed companies has put fear in the minds of promoters that if they default, they stand to lose total control of their company. Promoters are increasingly looking at means to sell non-core assets to reduce the promoter-level debt. With easy liquidity and low yields globally, the appetite for foreign funds to buy distressed assets has increased and we have seen quite a few deals recently in the NBFC, infra and real-estate space. There are still a few sectors like telecom where high-leverage has been a long-standing issue, but the good news is that the government is being supportive in addressing the problems by providing some relief. It is considering options like a minimum floor price on tariffs and deferment of regulatory payments, which would help players improve their profitability. As the outlook for the sector improves, we could see players raising equity funding to further improve the leverage ratios. 

Are we seeing green shoots on the global front?

Globally, the growth outlook has improved a bit. We saw the global growth outlook was weak in 2019 but some recovery was visible towards the end of the year. The easy monetary policy of global central banks and the increase in the money supply should help revive global growth. The easing of trade war tensions and stable macro conditions should support growth in the emerging markets, too. The commodity prices, especially metals, have already started firming up in anticipation of this.