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The earnings of Indian companies are recovering and the country is witnessing green shoots in various sectors, Rana Gupta, managing director, Indian equities, with Manulife Asset Management, said in an interview.

“When we talk to corporates, we get a sense that the rural economy, which was not doing so well in the past few years, is seeing green shoots. We can also see other indicators like auto sales, commercial vehicles sales, cement among other sectors," he said.

Gupta also dismissed the return of political risk as a long-term concern, but added that this could lead to increased volatility in the markets in the near-term.

According to him, most medium-term risks to India come from external factors—crude prices, lack of exports growth and agriculture output being volatile and erratic.

Edited excerpts:

When you look at some of the news and conversations from India, is the return of political risk a concern? Is this a medium-term concern for the country?

In the next 12 months, we will see very important state elections and then we’ll have the central elections, and so political risks will rise. We do not see it as a long-term concern, but in the short and medium term, market volatility will surely rise.

In terms of it being a concern, it depends on the investment horizon—for those with medium- and long-term horizons, like us, it is not a big concern, as the economy is picking up, and that should help core operating growth.

If you take a step back and take a long-term view, you’ll see that subsequent governments have continued with the good work of the previous government.

But short-term volatility is not ruled out at all. Most medium-term risks to India come from external factors—first is the crude prices. If this goes up, India’s trade deficit expands, current account deficit expands and the rupee weakens.

If we look at why that is happening, it is because, all this while, one of India’s weakness has been lack of growth in exports. That remains an area of concern that has to be worked upon.

Another medium-term concern is agriculture—subsequent governments have worked on it, but over a period of time, agriculture output has been erratic and volatile.

Globally, if trade wars escalate, do you see inflation making a comeback in India?

We have to wait and see. If, going forward, the US imposes more tariffs on Chinese goods, that will lead to higher inflation in the US. Now, whether that inflation will be a globalized phenomenon, and impact India as well, will depend on the kind of retaliation that comes from the trading partners—if the latter also imposes tariffs and import duties, then it becomes a globalized phenomenon. While there can be a risk of trade wars leading to higher inflation and lower growth, you have to wait and see.

When you look at India from here, is ad-hoc policymaking a concern? Does it appear that the country does not take into account the unintended consequences before it enacts policies—be it the recent move asking banks to scrutinize all advances above Rs50 crore, or the ban on promoters and related parties from bidding for auctioned assets under the new insolvency code—there are several other examples.

We look at this a bit differently. Let us take the case where promoters and related parties were banned from bidding for auctioned assets. This may seem ad-hoc, but there was a need to address this problem.

The bankruptcy code was one of the most remarkable rule changes that the country has seen—now bad assets go through resolution and a new entity takes it over, and they become operative in the longer-term—it is a positive step.

This is the first time that this has been attempted in India—it is a massive structural change.

Now, could the new rules be more foolproof, and could it have been better?

Yes.

But a start has been made, and there were gaps in this policy—the government responded to it to plug them. It may seem a bit messy for a while, but when you do this kind of structural change, this is bound to happen. But the bigger picture is that this is a very big long-term structural change.

Will the Punjab National bank (PNB) scam lead to tighter regulations in the banking sector, and will this, in turn, hurt credit growth? Where do public-sector banks go from here?

Yes. After the PSU (public-sector) bank recapitalization, which was a positive step, we had turned bullish on credit growth from PSU banks.

Post the PNB scam, and as there are some other investigations happening, we’ve dialled down.

We do think that credit growth from PSU banks will not be very high, and for sectors such as gems and jewellery, the impact will be big.

Barring the top one-to-two PSU banks, I am afraid there is not much to look forward to from this space. They still have quite a bit of bad loans and while they’ve got capital from the government, that may not be enough, and they need to raise some on their own—we do not think that this will happen immediately. So, barring the top 1-2 PSU banks, the going will get very tough.

The Indian equity market still seems expensive despite the recent correction. Are valuations a concern?

The way we look at it, after the correction, India’s one-year forward P/E (price-to-earnings ratio) has come down to 16—this is a little higher than its long-term average.

In times of good earnings growth, we see that a bit higher than average P/E can be sustained. This time around, whether we can sustain a higher P/E will depend on local and global factors.

The P/E ratio in the context of operating earnings of growth is reasonable—we don’t find it expensive, but we are mindful of the global and local developments.

We are emphasizing on operating profit because we think reported profit growth will disappoint. On 12 February, the Reserve Bank of India (RBI) came out with a circular asking banks to end several forms of loan recast—the provisioning cost will be very high for banks going forward, and that will erode the earnings growth projected by everyone.

So, reported earnings growth will be much lower than what the market is expecting—this is a one-off provision that will happen only in 2018-19, and may be reduce significantly thereafter.

Therefore, for this year, we are only looking at operating earnings profit growth.

Overall, has earnings really come back? The recovery we are seeing in the earnings growth over the last couple of quarters—are the green shoots real? We’ve been discussing this for past three years.

Yes, but let us focus on the operating earnings level. Operating earnings profit is coming back—if you look at the reported numbers for the past two quarters, Nifty operating profit grew 15% year-on-year.

We’ve already had two quarters of double-digit earnings growth, and going forward, at the operating level, we think that it will be sustained.

When we talk to corporates, we get a sense that the rural economy, which was not doing so well in the past few years is seeing green shoots.

We can also see other indicators such as auto sales, commercial vehicles sales, cement among other sectors.

When you talk to Indian corporates, is there a divergence on how you look at the country and how they see it?

Sitting here in Singapore, it is difficult to figure out why the economy has picked up because all the indicators you look at—broad macro indicators—gives you some sense that growth has revived.

But when you talk to corporates who are primarily in the consumer-focused businesses, whether it is rural or urban, you get a sense that the consumption growth is now broadening out.

What has happened was that, because of demonetisation and GST, the organized sector had gained a lot, largely in urban areas.

That gain is broadening out.

Corporates have been telling us that they are seeing green shoots in rural areas as well—for example, given the kind of industrial output we see, it was difficult for us to understand why commercial vehicles are doing so well.

When we talked to the corporates, and let me be candid—sitting here, we did not get to see this—because of GST, the logistics structure is getting into a hub and spoke model—therefore, the commercial vehicles operators are shifting to either high tonnage vehicles, or a lower tonnage one. There are many bottom-up examples—from rural growth to commercial vehicle industry, falling credit cost for rural-focused non-bank companies—all of these are not very obvious when sitting here.

What is your take on the sectors that have a high exposure to the US—such as pharmaceuticals, information technology (IT), steel, gems and jewellery?

Most of the gems and jewellery companies are not listed. Steel does not have a very high exposure to the US—they have indirect exposure. As of now, the tariffs that have been imposed is a very small portion.

As far as IT and pharmaceuticals, with respect to US protectionism, so far nothing has happened. We will not pre-empt this. Fundamentally, we like IT. We see that for IT, after three years of underperformance, we see some bottoming out.

Investors positioning in IT is light and expectations are low, and we think that while IT companies may not give you great numbers, they may beat modest expectations.

On pharmaceuticals, this sector is where IT was about a year ago. Maybe the downside is limited, but it is a very slow rebuilding process as many of the plants for the large pharmaceutical companies have still not cleared. At the same time, we don’t see much of an upside either.

What does India need to do to get foreign institutional investors (FIIs) to change their mind and again come back in a big way?

Yes, FII inflows to India have not been strong. A couple of things need to happen—first, from a broad macro perspective, the GST revenues, while it has stabilized, it is running below the budgeted rates, which is causing worries that fiscal deficit will be higher than expected.

Our view is that, with the economic buoyancy that we had spoken about, GST numbers will get there.

Second, bond yields in India have risen a lot—if RBI acts and helps cool off some of those high yields, that will also be positive.

Third is crude price. If it goes up to $70 (a barrel), FIIs will be concerned. On the other hand, if it falls to $60 (a barrel), investors will see that as a positive. The longer-term solution to this is to increase exports. Again, long-term solution towards having a stable GDP is to reform agriculture so that the volatility goes away.

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