‘Remember, It Takes Very Little Time for Liquidity to Change Direction’.

Street wisdom says the two factors that drive the market are liquidity and momentum. But Sanju Verma, in line with her unusual views on all things market, believes it is valuations that will drive both. The managing director and CEO of the newly formed Violet Arch Capital Advisors likes commodities, but speaks out against the tide of negative opinion on Europe’s debt crises. She believes the geopolitical situation in the neighbourhood may be the event to impact the India growth story than the unravelling of Europe. Verma spoke to DNA about why Germany will bail out Greece, why the government might favour rupee depreciation and how the currency’s fall would be a positive for commodity companies. Excerpts:

We haven’t seen strong inflows despite the market falling almost 20% from its peak. What do you make of the market valuations?

I always say that currency arbitrage, growth arbitrage and interest-rate arbitrage will ensure that money flows into India. But the reason we are currently not seeing flows is that even though interest rates are high here, inflation is higher. Once inflation comes down, which will take real interest rates higher, we would see inflows because the growth advantage is always there. Some amount of current risk aversion is unwarranted. When was the last time the index was trading at attractive valuations of 12.5-13 times one-year forward earnings — which may be somewhere in the range of `1,300-1,350 per share (Sensex) for fiscal 2013?

People may say the factors that drive the market — liquidity and momentum — are currently lacking. But I think it is valuations that matter in the long run and those look great at the moment. The markets are trading at a 20% discount to their historical mean price-to-earnings average of 15 times. So, if you are a value picker, this may be a good time to invest selectively. It takes a very little time for liquidity to change direction.
Could growth slow down further in the meanwhile?

No matter how badly we have been managing things, a GDP growth rate of 7.5% is very much possible. Consider a situation where agriculture grows at 3.5%, services at 9-10% and manufacturing slows down to 4.5-5%. The only thing to worry about is managing the current account deficit, which is inching up to 3% of GDP. It’s not that flows have not been coming to emerging markets. The three largest IPO (initial public offering) markets are in the Asia-Pacific region and there have also been considerable deals on the private equity side. Indian equities are not seeing inflows at the moment, but one game-changer would be when policy inertia is done away with.

How do you see the rupee doing over the next six months or so?

It’s kind of a chicken and egg situation as capital inflows would determine the time and magnitude of currency appreciation. However, the rupee may not appreciate much and we may see it at the most rebounding to `45-47 levels. That’s because the government would not want to have a stronger rupee at a time when revenues are hard to come by. Direct tax growth net of refunds and indirect tax collections have not been great and even the divestment programme is hanging fire.

So it is in the government’s interest to have a weaker rupee?

In order to rein in the fiscal deficit at 5%, let alone the targeted 4.6% of GDP (gross domestic product), the government would have to get revenues. In such a scenario, exports are the only sector which may help the government to get revenues and also aid the GDP growth when other growth verticals are not doing much.

A lot of exporters and importers were caught on the wrong foot...
Importers thought 47 is it, it’s not going to depreciate any further. Exporters got complacent. They had all taken hedges at 47. The moment it hit 47 they all unwound positions and the hedge ratios came down drastically. Out of sheer complacency, they felt it did not make commercial sense to hedge exposure. When the rupee moved from 47 to 48 upwards, importers started running for cover and exporters were caught with their pants down as they had all cancelled their futures at 46-47. And the Reserve Bank of India (RBI) refused to intervene — I think rightfully so, because it is supposed to only when there is a structural problem with either exchange rate or price stability.
Do you see more interest rate hikes?

If you ask me whether interest rates will go up or not ... till about a few weeks ago I thought the September credit policy hike would be the last one. Now, I don’t know. People who trade in non-convertible debentures (NCDs) are far better readers and gauge the rate movements well. Look at the NCDs trading at a discount despite having been issued at stiff coupons. It is a clear indication that there is another interest rate hike on the cards. I wouldn’t be surprised by one more 25 basis points hike — more so since the government has increased its borrowing programme by another `53,000 crore.
What sectors are you positive on?

If I were to posit that the rupee depreciation will continue, then commodities are a great bet. Aluminium prices in June were $2,400 (a tonne) which have now corrected to $2,100. Due to fall of the rupee from 45 to 49, the effect of the decline in aluminium prices on the LME (London Metals Exchange) on margins is now compensated. Lower commodity prices because of lower growth will hurt companies, but there is a catch. If you are in India and invested in a commodity company which is a huge exporter, then the fall is cushioned. In the case of steel companies, it is a known fact that each time there is a depreciation in the rupee there is a huge impact on them. But in fiscal 2013 steel companies are likely to turn net exporters. The history of Indian commodity companies has shown that every year India has turned into a net steel exporter, steel companies have not returned money to investors because steel prices locally start trading at a discount to the import parity price. Purely because of the fact that steel demand is just not in pace with steel supply, I would rather be in the non-ferrous space rather than the ferrous space.

On to global events, will Germany bail out Greece?

The cost of bailing out Greece is much lower than the hit they would take if it was allowed to go bust. It is in Germany’s interest to bail out its prodigal neighbour. There are fears that Greece would be ejected out of European Union (EU), which seem unwarranted. If Greece, Portugal and Ireland were to be kept out of the EU, their GDPs would see close to a 40-50% contraction, but at the same time, Germany would also feel the heat as its GDP of close to $ 3.5 trillion (`230.51 lakh crore) would then reduce by 20-25%. So the worst-case scenario won’t happen. I won’t say that Greece doesn’t matter, but the fact is the problematic economies like Greece, Ireland and Portugal together are very small. You would have serious problems at hand if Italy and Spain, too, go bust as their combined GDP is close to €2.5 trillion (`164.65 lakh crore). But the problem in Italy and Spain is of perception; there are no liquidity or solvency-related issues. Even if one were to consider exposure of banks in these countries to Greece, it won’t be more than $250-300 billion (`12.33-14.8 lakh crore). So if one were to consider the worst-case scenario that banking system in Italy and Spain were to fall off the cliff, even then only 15-20% of their GDP would be affected and the multiplier effect necessarily won’t be humongous. One more point which I would like to highlight is that the US still plays Big Brother, still calls the shots. It’s not for the love of Greece or Germany that Tim Geithner (US treasury secretary) has been making efforts to resolve the European situation. Ideally, the north European economies would love to see their southern counterparts go bust, but the fact is that 80-90% debt of the troubled economies is insured — and these would have to be borne by large US insurers. So whether Germany likes it or not, the US would ensure that the burden of default insurance does not fall on its insurers. It’s just a lack of coordinated decision-making that has resulted in the crisis getting bigger today.

Apart from global issues, what are the major concerns for institutional investors at the moment?

Policy paralysis is at the heart of all the issues and one of the reasons why the Indian market is where it is. Look at the banking sector. Out of 60-odd public sector undertakings in country, close to 43 either don’t have full-fledged chairman or have an acting chairperson and 13 of them have chairmen who have hardly 2-3 years left for retirement. Consider the case of the metal sector, where the discontinuation of ‘go, no-go’ policy was supposed to make environmental clearances less cumbersome for corporates. But before one could dance with joy, there comes a caveat that the Ministry of Environment and Forests would set up a nodal agency and the clearances for mining would have to be compulsorily approved by the respective nodal agencies in each district of the state, and the cost of setting up these nodal agencies would have to be mutually borne by respective industrial houses or miners in the region. Now what’s the use of having such an agency where there’s a clear conflict of interest? It’s just adding one more procedural layer without doing your homework. On the other hand, the telecom sector, which was a blue-eyed boy till two years ago, is facing a problem of plenty with too many government bodies acting as regulators and one doesn’t have a clue as to who’s the final authority. Similarly, in the case of infrastructure, there have been cases of company-specific decisions between two companies being questioned by a third party with the case referred to judicial system resulting in cancellation of order awarded. So, what I am saying is, at the end of day, you can’t beat the markets. If markets grow, the business grows and everybody makes money. The market pie has shrunk not because of micro or macro picture, it has shrunk because people are tired of the fact that there is so much inertia.

How do you see the Indian growth story over the next 2-3 years?

We should not do anything stupid. Even if we do nothing, we just stay put, we have our future cut out for us. Remember that Chinese banks will raise $70-100 billion to re-capitalise over the next 2-3 years. I’m talking about China because India will do well if money comes to emerging markets and half of that emerging market money normally flows to either China or India. In 2010 we pulled in $30 billion, or 50% of the overall emerging market flows. India has outperformed every year that emerging markets have pulled in a huge amount of money.

Any six-sigma event that we should be watching out for?

The geopolitical situation is a big caveat. You have on the one hand the Talibanisation of Pakistan and Chinese incursions, which are things that cannot be wished away. I think the geopolitical tilt is changing with other smaller neighbours finding new friends. A lot also depends on the United States’ Middle East policy. That can be a huge issue for a country like India, which imports 70% of its crude. These are things we do not have control over. For us, a six-sigma event is not a Greece defaulting, or a Portugal or an Ireland being ejected out of the EU; for us that would be whether the Talibanisation of Pakistan could lead to another Kargil, or whether oil diplomacy by virtue of what the US and Saudi Arabia decide to do, plays spoilsport.

Source : dnaindia.com