In the first part of this three part interview; Aseem Dhru, managing director and chief executive officer, HDFC Securities speak to Sanjay Kumar Singh on a wide range of issues ranging from European sovereign debt concerns to the Q2 corporate results.
A Citigroup strategist named Geoffrey Dennis has predicted that a ‘super-Goldilocks’ economy will send shares to record highs next year. He says that the MSCI Emerging Markets Index will jump 30 per cent to an all-time high in 2011, fuelled by the Federal Reserve's bond-purchase plan. Do you agree with this assessment, especially with respect to the Indian market?
The MSCI Emerging Market index is up about 16 per cent while the MSCI World Index is up only 7.4 per cent this calendar year. Emerging markets have seen record inflows this calendar year of about $60 billion in stocks and $46 billion in bonds.
The long periods of anaemic growth and near-zero interest rates that we see in the developed world create a conducive situation for emerging economies to get the liquidity inflow that moves up asset prices. Besides, you have large doses of money being injected through quantitative easing in the US. Just as water seeks the lowest level, money will seek the highest returns and will chase the high-growth economies. This record printing of currency across the world is likely to exacerbate the already high flow of funds into emerging markets. It will do two things: create asset-price bubbles in the host country and strengthen their currency, thereby affecting export capabilities. The strengthening of the currency will drive up the dollar-denominated returns of the pools of hot money.
The emerging market trade is now the biggest consensus trade since the Japanese yen carry trade. In the near term, the momentum play is likely to be in favour of emerging markets. But consensus trade usually reaches a tipping point after which it reverses. The market moves ahead of expectations. The market has already discounted the effect of QE2 and it is unlikely to cause further large doses of money coming into the market. So, our house view is that we are unlikely to see this kind of a jump in the emerging market index.
Is there a danger of India moving into bubble territory because of huge liquidity inflows?
India's share of global GDP is 2.2 per cent, while its share of the world market cap is currently at 2.8 per cent. The consensus Sensex earnings estimate is at Rs 1,045 for FY11. Our own estimate is a more conservative Rs 1,025. Our market is not cheap, but we still have a long distance to go before it gets stretched into bubble territory. Is a bubble possible? Sure. Is it likely? I don't think so.
Has the international situation turned grimmer in recent weeks?
The structural imbalance between the US as a consumer and China, Germany and Japan as producers is not an easy one to restore, especially when one country's medicine becomes another country's poison. The US needs to import less, produce more locally, and export to generate jobs and to save more to repair its fiscal excesses. The world wants the US to do the opposite — continue to borrow and consume.
The world is in the middle of a currency war where nations are in a race to debase their own currencies, lighten the burden of their loans, and become more export competitive. Artificial intervention in currencies and trade protectionism are creating tensions between nations. Europe continues to find itself in a vortex of decline. Japan is now more than a decade and a half in stagnation. The investing world classified investments in the developed world as market risk and investments in the emerging world as credit risk. In recent years this has turned on its head with emerging markets falling in the market risk category and some of the developed markets falling in the credit risk category.
Asia, including India and China, is slowing down. China has always been difficult to read. Some data on the inflation side suggests that China may be overheating and needs a soft landing. Worries about the success of QE2, European sovereign debt concerns and stalling growth in Asia have all emerged at the moment. Yes, the international situation has turned grimmer.
In Europe we have had a crisis in Iceland, Greece and now in Ireland. How serious is the risk arising from these periodic crises? And what repercussions, if any, could they have on the Indian markets?
The risk is substantial. Structurally the balance sheets of companies or countries can't be repaired overnight. The build up of sovereign debt has happened over decades. Ireland, Portugal, Greece, Italy, Spain — all these countries have been a concern for quite a while.
One of the biggest disadvantages of having a common currency is that a country, when in trouble, cannot use monetary policy of intervening in the currency to fix the problem. But the advantage is that all countries of the European Union have stood en bloc and bailed out the trouble spots so as not to have a contagion effect. In Europe, they put together a one trillion dollars bailout package about two years back. They have also decided to support Ireland and Greece in crisis. These countries were in near-default situations but bailout packages have helped contain and address the problem. But the nervousness of a further worsening of situation in Europe will keep world markets on the edge and India will be no exception.
So this problem is not going to go away very soon.
Today the world is dealing with uncertainties of a very different level. Every action in the market has an unintended consequence. Right now the biggest worry is: what will be the collateral damage from this huge inflow of liquidity being put into the system to keep the patient alive? How will the patient respond once he gets out of the ICU?
There are news reports that Sebi has asked fund houses not to invest in the debt of real estate companies. What are Sebi's fears regarding the sector?
Real estate companies have a very strange situation. They have a long gestation period between the start of a project and the beginning of cash flows. Real estate companies have been purchasing land in auctions at very high rates. Then they wait for the approvals to come in and then for the project to come up. All this takes anywhere between three to five years. Only then do they see cash flows.
The structural issue with real estate companies is that they borrow at three levels: the SPV level; the company level; and then at the level of promoters through pledging of shares. The leverage that real estate companies end up taking is sometimes far in excess of their ability to service even the interest on these loans. They have land in their balance sheets. So the wealth is there but cash flow becomes a problem. In 2008 and 2009, even mainline real estate companies had struggled to honour their interest commitments.
So the regulator's concerns are genuine. Lending to this sector should be done by people who understand the sector and can estimate the cash flows from a project rather than by those who just look at the interest rate and invest in their debt paper. In 2008, several mutual funds had transferred their devolved real estate debt to their parent company.
Read Second part of this interview on January 7, 2011
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