Banking has performed well in the past two years. How do you see the sector panning out going forward?
Singhania: The quality of our banks has improved significantly, in terms of operational matrix, asset quality, front-end visibility, service levels and modernisation and upgradation. Since they are in the business of lending money, there will be at least some amount of bad debts. However, there are hardly any large NPAs coming out of the system. In the near term, the sector faces the headwinds of inflation and tight liquidity. Banks stocks are inversely correlated to the interest rate outlook, hence the knee-jerk reaction of the market which led to banking stocks falling dramatically recently. We feel that the 17-18 per cent growth in banks' balance sheets is possible in India and no investor should ignore this segment.
Bank credit growth was falling in 2010 and then began to pick up. What was the reason for this?
Singhania: In 2008 and 2009, the financial markets and many corporates got the scare of their lifetime. Capex plans were drastically cut down. Now if a corporate cuts down its plans in 2009 second half, the impact is felt in the financial services segment with a lag. That is probably what happened early 2010. Also, when oil prices fell to around $35/barrel, the oil marketing companies needed no subsidy support and hence were not borrowing. To add to it, consumer confidence, in terms of housing and consumers loans, began to take off only mid-2010 onwards. All these factors contributed to low credit offtake. Telecom funding related to 3G auction also led to high credit offtake in early 2010.
Mohanty: A reasonable part of the credit will be the borrowing for the 3G auction. If one takes that factor out, will the numbers still be robust? In the past few months credit has picked up but I think we should read into the number more cautiously. Earlier when liquidity was significantly low, corporates would approach mutual funds, and as a result bank credit used to look anaemic. Now looking at market rates, corporates find it easier to approach banks rather than non-banking sources like insurance companies and mutual funds, thus inflating the bank credit number. So at a gross level, I do not see a significant increase in overall credit offtake.
Banks were pretty slow in increasing their fixed deposit rates. Are negative real interest rates a reason why currency with the public has increased?
Mohanty: There is more than one reason.
Real interest rates were negative because fixed deposit rates were not high. Hence financial savings have not grown because a lot of money got diverted to other asset classes like equity, gold and real estate. Money going into other asset classes results in a leakage of currency from the banking system. Inflation has resulted in 'money in the wallet' rising because you need more money to buy the same amount of goods you were earlier buying.
Social sector spending by the government has risen significantly, in terms of the NREGA, farm loans etc. All this is done in the rural sector. A large part of the rural population is outside the banking industry. So money is being spent which is leaving the banking system and entering the non-banking arena, which is a very cash-driven economy. When this happens, the time this money takes to come back into the system is significantly more.
All these reasons put together have resulted in an increase in currency with the public.
Was this also the reason for the liquidity tightness?
Mohanty: The earlier CRR hikes were one cause. Currency increasing with the public was another. The third is that though the government has spent according to its historical pattern, the withdrawals from the system were significantly more than normal. So spending has not increased to bring back those amounts into the system.
Also we believe that a lot of forex that has come into the system has gone into funding the current account deficit. So there has not been a meaningful build-up of forex assets with RBI for that liquidity to come into the system.
Where would you tell your investors to invest? You manage a power sector fund, an infrastructure fund, a banking sector fund and equity diversified funds too.
Singhania: It makes sense to invest in a diversified equity fund now. We are recommending four funds: Reliance Growth, Reliance Vision, Reliance Regular Savings Equity and Reliance Opportunities. We are positive on Power and Infrastructure from a long-term perspective. But over the past 12 months, there has been no movement in infrastructure projects largely because of land- and environment-related issues. However, notwithstanding disappointment in the recent past, we are very positive on infrastructure and power in the medium term. Banking and Pharma are also worth investing from a stable long-term returns perspective.
Reliance Growth, once such a good fund, did not put up a great performance over the past two years when compared to other funds in the 'Mid & Small Cap' category.
Singhania: When you look at fund performance, you have to look at the near term and what happens over a period of time. By nature, that fund is invested up to 70 per cent in mid caps. And we take a 2-3 year perspective when investing in mid caps. In this fund, we also had an Infrastructure exposure which has not played out. The market behaviour over the past three years has been diverse. Stocks which are of perceived quality are trading at 40PE and those with an iota of doubt are trading at 5-7PE. This is an aberration that cannot go on. Yes, I accept that performance could have been better but we are still one of the better options despite a few of our calls not working. Once confidence in the economy returns, the way the portfolio is positioned, the fund will do very well. In all long-term tenures, Reliance Growth Fund has always been rated amongst the best. In fact, in the recent NDTV awards, where Value Research was their research partner, the fund was rated the 'Long-Term Leader' with best returns in SIP over 10 years.
In the very same 'Mid & Small Cap' category, Reliance Long Term Equity has a good 2010, unlike Reliance Growth. Though both hit a rough patch in 2009. Reliance Vision too is not doing well in the 'Large & Mid Cap' space.
Singhania: In stock selection, a call might work in one year, not another. It happens with every fund house and every fund.
As for Reliance Opportunities, after consolidating in early years it has been a star performer over the last two years. Where Reliance Vision is concerned, we are working on the portfolio and other aspects and we are very confident that its recent under-performance will be a thing of the past. There too the portfolio is superb and poised to benefit in the next market upturn.
So first of all we ask ourselves, is there a rationale in that call? Over a period of time, are we able to do justice to our investors? We have an open mind, we view our failings in perspective, we look at how we could have done better and what we could have done differently. So we are always in a mode of improvement and betterment.
How are your debt portfolios being positioned?
Mohanty: We are not going too long on duration. Government sector bonds and G-Secs will be a function of the fiscal deficit number. The market will “accept” a number below 5 per cent as long as the supporting numbers are credible. As of now, it looks like a tough task achieving that number, unless there is sudden inflow due to an event like the 3G auction or a tax is imposed. Growth is consolidating, the U.S economy has started to do well which means the relative attractiveness of India drops marginally, disinvestment has come under a cloud and the sentiment in government securities is somewhat negative. So we need to see a credible move to a lower fiscal deficit to see some positive sentiment developing. So we are cautious on duration and will revisit it after the Budget is out.
You are then bullish at the shorter end of the curve simply because of the high CD /CP rates?
Mohanty: We are reasonably bullish on the short-end of the curve, by which I mean 3 months to 2 years. This space got very badly impacted by the negative liquidity situation.
What has been driving short-term rates higher than the RBI corridor is the liquidity tightness that began since the last week of May 2010 but peaked in December. This coupled with slow deposit mobilisation by banks has put pressure on CD rates. It took a while for banks to realign their fixed deposit rates and attract funds. And once deposit rates change, it takes a while for it to work through the system and resource mobilisation to take place.
If you look at the repo rates and overnight rates (January 20), they are at 6.25 per cent and 6.50 per cent, but 3-month rates are at over 9 per cent. Even March maturity rates are at 7.8 per cent. There is no reason for such a spread in rates.
A number of public sector banks were funding their liabilities through CDs. Due to SEBI regulations which got implemented by August 1, 2010, the demand pattern of mutual funds for CDs changed drastically, no longer was there a fair distribution across the curve. It was 3-month (or shorter tenure) CDs that were in demand, not 6-month or 1-year.
As government spending leads to increased liquidity and a better realignment of bank liabilities leads to lesser CD issuance, the front end of the curve should benefit over the next few months.
On the debt side, where would you tell your investors to invest?
Mohanty: Short-term funds, which have duration of 1-2 years, have really underperformed in the past six months. These will bounce back over the next 6-12 months. Looking at the CP and CD rates, FMPs are great products to get into. So are aggressive ultra short-term funds.
Based on liquidity requirements, investors should look at products with a 6-month to 2-year duration.
Reliance Mutual Fund has the reputation of taking risks to churn out that extra return. What is the risk you are willing to take?
Mohanty: We are willing to take that risk which the fund is mandated to take. There is no blanket high or low risk, as long as the risk is communicated to the investor. In an income fund, we may take a duration risk but not credit risk. On the other hand, in credit oriented fund, we take a judicious credit risk by opting for AA to A+ and rated papers but avoid duration risk. There is a huge range of products which offer different value propositions, with different risk-return paradigms. Keeping that in mind, we manage our risk according to the product offered.
CD: Certificate of Deposit / CP: Commercial Paper / SEBI: Securities & Exchange Board of India / CRR: Cash Reserve Ratio / GDP: Gross Domestic Product / PE: Price Earnings multiple / FMCG: Fast Moving Consumer Goods / IT: Infotech /SIP: Systematic Investment Plan / RBI: Reserve Bank of India / IIP: Index of Industrial Production / NPAs: Non Performing Assets / Capex: Capital Expenditure / G-Sec: Government Securities / FMP: Fixed Maturity Plan / OPEC: Oil& Petroleum Exporting Countries