Markets always absorb geopolitical shocks, says HDFC Securities CEO

Prospects of higher growth, political stability, and superior returns will continue to attract foreign capital into India, believes Dhiraj Relli, managing director and chief executive officer, HDFC Securities. In an interview with Ashley Coutinho, he says the Indian markets have been trading at a premium to other emerging markets and will continue to command higher valuations. Edited excerpts:

What is your equity outlook for the coming months?

Markets have been volatile lately as the Indian economy countered multiple headwinds in a short span of time. Higher energy costs are fueling inflation across the economic spectrum. Consumer inflation has surpassed the upper band of the Reserve Bank of India’s (RBI) comfort zone and wholesale inflation running in double digits. This is forcing the hand of central banks like the US Fed and India’s RBI to unwound unconventional monetary policies and turn more hawkish.

Foreign investors have suffered heavy losses in markets like China and Russia on account of regulatory and geopolitical uncertainties. Prospects of higher growth, socio-political stability and superior returns, however, will continue to attract foreign capital into India. Indian markets have been trading at a premium to other emerging markets and it will continue to command higher valuations. The Nifty is now trading at 19x 12-month forward earnings, which is in line with its 10-year average.

Will the Russia-Ukraine conflict create a more lasting impact on the equity market?

If history is any guide, data shows that the equity markets have recovered sharply after an initial reaction to war-like events as they have absorbed the shocks due to geopolitical events. The Nifty index fell by 8% after Russia attacked Ukraine, but it recovered and regained the pre-war levels despite higher oil prices, in only nine trading days.

How much of a pain point will the surge in crude oil prices be for India?

India is vulnerable to higher crude oil prices as it depends on imports for more than 85% of its oil needs. A rise in prices leads to higher input cost and stokes inflation across the economy. This will force the RBI to go for liquidity tightening measures followed by rate hikes. Sustaining of Brent crude oil price above $120 a barrel would add $60 billion to India's import bills and raise the fiscal deficit by 30 bps. It also lowers the real economic growth than predicted as higher input cost will add more burden on the Indian economy.

What is your view on mid-cap and small-cap stocks?

Mid-cap and small-cap indices performed better than large-cap indices in financial year 2020-21 (FY21). The Nifty100 Mid-cap and Nifty100 Small-cap indices moved up by 46% and 60%, respectively, outperforming the 24 per cent gain in Nifty 50 index. We know that returns from stocks depend on earnings. Those companies that are able to pass on the higher input costs to their customers and still manage to grow their volumes will show superior earnings growth and will remain in demand.

What are your estimates for FY23 corporate earnings growth? Will capex pick up this year?

India’s economy is accelerating, which is quite evident from the strong growth in high frequency numbers. Corporate earnings remained resilient despite the varied challenges with the third quarter. For FY23, Nifty earnings are expected to grow by 20 per cent. A lot of companies have already reported pre-Covid-19 earnings levels and we feel that the corporate credit growth cycle has started. The structural reforms by the government could bring in higher GDP growth in the next 2-3 years. In the FY23 Budget, the capital expenditure target for FY23 has been upped by 35.4 per cent, to Rs 7.5 trillion. This hike will boost economic growth and will create more jobs.

Which sectors are you betting on right now?

Overall, we have a positive stance on the IT sector over the long run and investors should use any dip in stock prices in the next few months to accumulate large cap quality IT services stocks. This year, the Indian IT sector has witnessed $30 billion of incremental revenues and an overall growth rate of 15.5 percent, the fastest since 2011. The industry has also set an ambitious target to touch $350 billion revenue by FY26 which implies a double-digit annual growth rate.

Acceleration of digital transformation could provide strong revenue visibility into diverse areas across BFSI, engineering, telecom and automotive verticals. Higher employee costs, however, are impacting the margins and we may see the same trend accentuating when companies announce their quarterly numbers in the next few weeks. We also feel financials, pharma firms and capital goods sectors are set for outperformance. The asset quality outlook for financials is promising as the majority of the non-performing assets (NPAs) have been recognised and moved to the resolution phase. We expect lower slippages, higher resolutions and recoveries in the coming quarters.