I'm not overly concerned about foreign investors pulling out: Gopal Bhattacharya

Interview with Head, Global Markets, India, Societe Generale

Concerns over the directive on participatory notes (P-notes) despite the reassurance by the government amid weakness in Chinese stocks, cast a shadow on the Indian bourses as well. Gopal Bhattacharya, Head Global Markets, India, Société Générale, tells Puneet Wadhwa that he expects economic growth in India to outpace China over the next four to five years. Edited excerpts:

China seems to be surprising financial markets. First, it was equities and now, gold. How do you interpret these developments?

True, the markets were initially taken by surprise. I think this is the beginning of a trend for the Chinese economy. Over the next several years, China will struggle with a fine balancing act in reforming an excessively investment-led, high-debt economy, towards a more consumer-centric and market-driven one.

It is now widely accepted that China’s debt has grown much too fast since the crisis and now the level is uncomfortably high. Debt itself might not be the core of the problem, if it goes towards productive purposes.  But, there is increasing evidence of borrowed funds generating diminishing returns and consequently increasing debt-servicing issues. The problem has been compounded by both large borrowers and lenders being state-owned.   

State-owned enterprises (SOEs) and local government financing vehicles (LGFVs) might have the largest share of doubtful debt. While this encouraged debt accumulation, it also (with borrower and lender being state controlled or linked in some way), contained risks of  large-scale financial market contagion. However, the condition of implicit state guarantees could be changing.
 

What’s the solution to this ?

China will have to carry out this massive debt re-structuring exercise very carefully, especially in a slowing external environment. Our analysts feel this will take a combination of extending duration of debt, lowering interest rates and write-offs. While debt markets are being liberalised, some sectors will require state assistance to help digest inevitable losses. At the same time, authorities will have to ensure adequate liquidity to prevent a credit crunch or further deceleration in growth.

Overall, we believe growth deceleration would continue in China. Our analysts project annual GDP growth (gross domestic product) between 5.5 per cent and 6.5 per cent over the next few years. Separately, in my view, the action of authorities in the
recent stock market crash has eroded their credibility to some extent.

Do you expect global growth to get slower? What are the likely implications?

I think the global economy is likely to grow at a slower pace compared to previous decades and this is likely to last for a prolonged period. Between 2015 and 2019, our analysts expect global GDP growth to range around three per cent or lower. Of this, the developed world will see growth around two per cent. On average, emerging markets will grow at a somewhat faster clip of four to five per cent.

Traditionally, export-led economies have done well in this scenario. Over the next few years, this growth model is likely to change. US consumers are not willing to undertake large scale leveraged spending as in earlier times and China is looking to cut its spending on infrastructure. Growth will have to depend more on domestic demand and few governments are willing or have the capacity to undertake massive public spending. So, windfall gains from a lower crude oil price and accommodative monetary policy, in my opinion, will not last too long.

How does India look as an investment destination?

Purely from an investment perspective (once you remove investor bias, home country familiarity, etc), India remains attractive. In our opinion, India will grow between 7.5 per cent and 8.5 per cent annually for the next four to five years. This also implies that India will outpace growth in China.

But isn’t foreign investors’ patience with India running out?

I don’t think so, especially not for investors with a longer term perspective. I think India is undergoing a fundamental transformation, which will play out over the next 10–15 years, as long as there is policy continuity and political stability. As regards the macro-economic situation, I think the Indian economy has bottomed out, though the recovery is not very firm and is yet to gather momentum. On inflation, while India has clearly benefited from lower oil prices, the current government’s management of the food economy has been quite good. Overall, I am not overly concerned about foreign investors pulling out of India. Rather, I feel the best is yet to come.

So, besides India, which regions look investment-worthy?

Purely from a growth perspective, the US and perhaps Japan are well-positioned among developed economies. The US is likely to grow faster –relative to other developed economies. Most of the negatives in the US have been frontloaded. Slow growth in the first quarter was perhaps an aberration. For the rest of the year, the GDP numbers should be better. For the full year, we expect the US to grow around 2.5 per cent.

Having said that, one needs to watch the unemployment rate, which we expect to drop to around 5.1 per cent by the year-end; which is considered at or close to full employment. By the September meeting of the FOMC (Federal Open Market Committee), the picture will be clearer as regards strength of US recovery. We expect the first and the only rate hike in 2015, 25 basis points (bps) in September and another three to four hikes the next year.

Besides the US, Asia and parts of emerging Europe look good. These are some of the bright spots in the world. I expect the money to flow to these regions with a strong bias towards India. I think this time the markets are ready for the impending US rate hike and I am not unduly concerned.

Which sectors, in your opinion, are likely to get foreign investors’ attention in India?

In terms of favoured sectors, I think the financial sector will continue to do well. This includes housing finance, which should do well. Banks are a bit iffy at this point as a lot of private sector banks are richly valued, a lot of new niche players (payment banks, etc.) are slated to enter and that will increase competition and there will be increasing regulatory costs. Having said that, money will flow into banks as they remain a proxy to economic growth.

Companies that are led by consumer demand should also do well. We expect the government to spend more money on infrastructure-related projects, which in turn, should benefit related companies.

Would you prefer domestic economy plays over export oriented stories in case of India as well?

I think this is a very stock / company specific thing. At a time when the global growth is slowing and economies are trying to look inward as opposed to exports, there are select export-led companies in India that are doing well and should continue to do well.

When do you see the earnings cycle turning for India Inc? What are your estimates for earnings growth for FY16 and FY17?

I expect corporate earnings to revive by the second quarter of the next financial year (FY17). I estimate between 15% - 17% earnings growth over the next two years.

How much room does the Reserve Bank of India (RBI) have to cut rates?

We believe that the RBI will cut rates twice this year. By December - end, we expect two cuts of 25 bps each. This should get the 10-year bond yield down to around 7.15% levels.

Which sectors are likely to do well over the next 12 - 18 months?

Other than the sectors discussed earlier, I believe the pharmaceutical sector is still attractive but again one has to be stock specific here. Not just pharma, but I expect healthcare in general to do well. The government's 'Digital India' initiative will also help all kinds of IT companies; besides the major players. The infra-push of the government if implemented well, will have major multiplier effect.

What's the outlook for commodity markets - crude oil and gold?

I think oil prices will remain low for a substantial period of time. Prices should hover around the current levels as new supplies, new technology and a shift towards clean energy all combine to cap prices. In my view, the global per capita demand for oil has already peaked. Gold prices, too, are likely to remain soft unless the developed nations get their fiscal policies hopelessly wrong and print currency indiscriminately. That doomsday situation, I believe, will not happen soon.