All eyes are set on February 28, when the Finance Minister will announce the budget for 2011. Most experts are not pinning high hopes on it and think that it is unlikely to trigger any positive trend in the market. A positive budget, however, may fetch in some foreign institutional investors (FII).
In an interview to CNBC-TV18, Nitin Rakesh, CEO of Motilal Oswal Asset Management Company said that the focus of the budget is fiscal deficit and government’s divestment plans. Investors are looking at subsidies in food, oil and fertilisers, he added.
Rakesh further added, "If you bring into account things like goods and services tax (GST) and the Direct Tax Code (DTC), we need some direction on that front as well. It’s really a question of how the government is going to lay out the roadmap for containing the deficit and carrying forward the tax reforms because those really tie into the deficit number."
According to him, the government has to either lower taxes or increase prices of oil, else the oil marketing companies will not be able to bear the brunt of the current crude price.
"We need a direction on that front and that will continue to cap the upside in the markets in the short run," he noted.
Below is a verbatim transcript of Nitin Rakesh’s interview with CNBC-TV18’s Udayan Mukherjee and Mitali Mukherjee.
CNBC-TV18: How worried are you about what’s going on in the world now and the way it has led to crude spiking?
Nitin Rakesh: The events in the Middle East have managed to, not only continue from one country to other but also surprised a lot of the analysts that predicted it to be a much more contained phenomenon. It does not spell good news for us from a crude oil perspective. We have clearly seen the spike go well past USD 100 and stayed there, if anything its actually gone higher.
Clearly, we have a predicament. The government budget will set out what they are going to do on the fiscal deficit front. Oil marketing companies cannot bear the brunt of this current kind of crude price unless taxes are lowered or prices are increased. We need a direction on that front and that will continue to cap the upside in the markets in the short run.
CNBC-TV18: We have a pretty high sensitivity to every per dollar increase in crude as we have seen in the past. What kind of downside risk do you think has opened up for the market because of this situation?
Nitin Rakesh: The only two ways out of this situation are either we take a stance that we took three years ago and effectively absorb the bulk of the oil price increase and effectively create an oil subsidy bill for ourselves. The other way is to effectively deregulate completely and do away with subsidy.
We have to have some middle path that the government will have to set out for the budget. Investors don’t like to see bleeding downstream companies or even upstream companies. There has to be a certain balance that has to be laid out and there is clarity awaited on that front.
CNBC-TV18: Expectations are running low in any case from the budget but have these developments made it even more of a marginal issue?
Nitin Rakesh: It’s not so much a marginal issue. The focus on the budget really seems to be on two fronts. One, how you are going to contain fiscal deficit because that seems to be the biggest macro question everybody is asking right now especially in the wake of slowing FII flows because they wont step into the short-term flows that we need.
Since we cannot have any cuts on the planned expenditure side, the subsidies then come into question so its food, oil, fertilizers. These are three segments that investors are going to watch out from a subsidy point of view.
From a revenue generation point of view for the government, even if you include the disinvestment revenue of Rs 40,000 crore current fiscal and probably a similar number next fiscal, we still have a certain shortfall that the government will need to fulfill. If you bring into account things like GST and the DTC, we need some direction on that front as well.
It’s really a question of how the government is going to lay out the roadmap for containing the deficit and carrying forward the tax reforms because those really tie into the deficit number.
CNBC-TV18: A large part of the deficit containment this year happened from asset sales but the way crude has spiked, the first big one is the ONGC FPO. What happens there because there is complete lack of clarity on the oil policy, do you think they can go ahead with the FPO in this environment, unless they choose to bite the bullet one way or the other?
Nitin Rakesh: It is not just ONGC, its ONGC and IOC. Both of them were gearing up for an FPO at some point in the next few weeks. However, that remains a big question mark and that is why the budget is not so much about anything but how the government is going to clarify what we are going to do about these expenditures that are non-planned expenditures.
At least in our mind, those are the two things we are focusing on - can we see some more clarity on the tax front because that ties into government revenues and can we see some more clarity on the non-planned expenditure front.
CNBC-TV18: If that happens then you might get clarity on that front but the government or the finance minister may only be able to guide a 5.2 per cent kind of fiscal deficit for next year which may make the market very unhappy if it is absorbing this oil issue?
Nitin Rakesh: Then they are looking at an odd 4.8 per cent target which is what we are expecting. I don’t know whether the market has discounted anything better or worse. That is why we have a macro headwind that is not going to go away anytime soon. Events in the Middle East haven’t helped us at all. The global growth hasn’t helped us because that continues the pressure on the inflation front, primarily, based on the raw material prices that most companies are looking at.
It’s a bit of a headwind situation at least for the next three-six months. Once it looks like we will have to discount these issues, the markets will have to live with these. So far, we have held up really well in the last couple of weeks after we made some sort of bottom around 5,200. But I don’t think we are out of the woods yet, purely, on the basis of some of these events that we are foreseeing right now.
CNBC-TV18: We haven’t lost that much money either. For the month to date we have lost about $400 million in terms of FII outflows. Do you think these developments might be the catalyst to accelerate the outflow situation?
Nitin Rakesh: I don’t think the outflow is such a big worry. The issue really is what the next trigger for the market is. We had $30 billion of inflows last year and the market was up 18% for the calendar year. We have had less than $2 billion outflows this year and the market is actually down that much. I don’t think it’s a question of us worrying about outflows so much as what is the next trigger for investors to continue to bring more money in.
Based on the feedbacks from FIIs, at this point in time they are underweight to neutral which means even though they may not be driving money out in hordes because of this whole developed markets and emerging markets rebalancing play going on but there has to be a significant trigger for them to actually reallocate money into India.
We are competing for capital with the likes of the US and Germany. So, it’s not an easy slam-dunk that it was in 2010. The bigger question is what is that trigger that will actually bring capital inflow back in? I don’t think outflows are going to be that significant a number.
CNBC-TV18: The market has been extremely worried about infrastructure. How would you approach that and how much do you think the budget could actually do for this sector?
Nitin Rakesh: The biggest worry in the market has been the cost of borrowing for that sector because it is a very capital intensive play and it is one of the most interest sensitive sectors as well. It is really a question of at what point do we think we have peaked our monetary tightening cycle.
In addition, while the order books continue to stay okay, we have not seen that kind of an acceleration in the capital goods books based on the last quarter numbers. There is a certain headwind that sector continues to face, whether you are in construction or in capital goods. That is clearly reflected in the numbers of both L&T and BHEL in that order.
What the budget can do for them besides outlining other infrastructure planned outlay, there is very little scope that we give the companies or the share prices in the short-run any big boost purely on that front.
CNBC-TV18: What did you make of the RIL deal and what kind of range do you think the stock will hold over the next few months?
Nitin Rakesh: Calling the range is a little tough. The deal has done a couple of things for the stock. Firstly, the balance sheet has become very strong and has lifted a certain amount of gloom from the stock in terms of the concerns that people had. Secondly, the impact of having access to the technological inputs that they need for the gas block is a big positive.
Based on what we have seen in the last 24 hours, most sell side firms have upgraded the stock. It looks like we probably have an environment where the stock will actually perform much better than it has over the last couple of years.
So, its good news for the company, for the market and for that sector per se. What seemed to have been a pretty dull and tedious effort now seems to have actually moved on to a different plane altogether. We are fairly pleased with what’s happened with the deal. Obviously, we need some more clarity on taxes for example or the use of funds in the RIL balance sheet.
CNBC-TV18: If your call is that the next few days might be quite shaky for the market, how do you expect the broader market to perform in that light?
Nitin Rakesh: The direction will be set by the larger names. Considering there is a fair amount of newsflow expected either from the Middle East or from our upcoming budget, it is really not a call on segments whether it is midcaps or largecaps. It is really a unified call on what the overall direction of what the market is likely to be.
At this point we are more focused on these events getting priced in. Once you have that opportunity to understand the direction for the next one year based on the budget, you have a better chance to evaluate the broader market.
We definitely continue to use this opportunity to buy into things that are in very comfortable valuation ranges, something that was not true two-three months ago. We don’t think that it is a complete washout situation right now. So, continue to use this opportunity to buy into names that you have a high conviction on.
CNBC-TV18: Tactically, how are you approaching the budget as an event? Are you going in very light, keeping cash levels high and what are you recommending doing?
Nitin Rakesh: The idea is not to keep cash levels high but we are focused on what the direction will be laid out, in terms of some of the events on for example deficit, non planned expenditure and tax reforms.
The call is not to actually stay in cash or not because I don’t think the impact on the market is going to be that significant, at least in the short-term period. Yes, there is going to be volatility but I don think the idea is to try using that volatility.
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