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Satish Ramanathan, head, equities, Sundaram MF believes that Indian markets may see more downside…

"Both the US downgrade and India's political process have hurt investor sentiments" Not just the downgrade of US sovereign debt by Standard & Poor's, it is also the nature of government decision-making vis-à-vis business, especially the backtracking on commitments, that has hurt sentiments towards risky assets like equities, says Satish Ramanathan, head of equities, Sundaram Mutual Fund, in an interview to Sanjay Kumar Singh. He also believes that there may be more downside left for the Indian markets as they are still trading at a premium to Asian peers.

There has been a big pull-out by foreign institutional investors (FIIs) in August. What was primarily responsible for this? The figures said that India had got around $2 billion plus so far and almost $1 billion plus got pulled out.
I think even more than that. I think, perhaps, by the end of today we will see $1.6 or 1.7 billion being pulled out. I think the couple of things that have hurt FII sentiments are the political process, and the global uncertainty. So, a lot of money is being pulled out. India's inflows have been anyway very weak at $2 billion. We think that that is one of the primary reasons why the market has been very volatile.

Do you see the economic and market conditions improving on account of inflation coming down? Commodity prices are slated to come down.
Yes, commodity prices could cool off. This will be a function of China and its growth and demand for commodities. Were China to cool off a little more materially, then commodity prices would ease.
But I think the government's approach will be that it would rather have slower growth for the next one or two years till commodity prices are really not moving up in a big way, rather than take a bet and reduce interest rates, say three to six months from now. So, it would not be right for us to believe that interest rates will be reduced unless growth slows down very dramatically.

The Fed's statement, it appears, amounted to an admission that the US will have slow growth for the next two years. So if the US and Europe are all going to do badly, could the Indian market emerge as a safe haven this time? It didn't happen earlier despite a lot of talk of it.
No, I don't think India will emerge as a safe haven.

Could we see more FII inflows?
FII inflows will not happen yet simply because Indian equity markets also have to correct. They are still trading at a premium relative to peers in Asia. Therefore, in terms of valuations, there is still some downside before FII inflows could come in a significant manner. That's something that we need to bear in mind.
Also, the market has a bar bell shape today with good-quality companies trading at very high premiums and lower-quality companies trading at very low prices. That's the kind of situation we are in right now.

Don't you see a likelihood of huge FII inflows despite India growing at 7 per cent plus while the developed world is going to have an anaemic rate of growth?
No, it won't happen because ultimately people first make an allocation to an asset class, which is equities. Then out of this asset class they make an allocation to emerging markets, and out of that they make an allocation to India. So, if emerging markets are not doing well, then it is unlikely that India will attract an undue share of money before the dust settles.

But isn't India better placed because of its domestic consumption-driven economy compared to Korea or Taiwan, which are more dependent on the West?
India is definitely better positioned because of its domestic consumption, and because of the fact that infrastructure is underdeveloped. But the basic thing we need to bear in mind is that for an investor the opportunities lie across the economy, and not just in consumption. That is because you have a limited number of consumption plays in the country. So to that extent, investors have very limited choice for playing the consumption theme. You should also remember that typically consumption is less capital intensive; it doesn't require a large amount of capital. While investors would like to buy consumption stocks, we need to keep in mind that they are already trading at above 20 times multiples. So, we could only see some money coming in here. But the big money has to come into infrastructure, toll roads, airports, etc.

Could you elaborate a little more on the political process that you spoke about? What is the deterrent there?
I think investors and businessmen have become unnerved by the fact that older contracts are being re-examined. For instance, in mining the government has come out with a mining distribution tax, wherein a mining company will have to pay out 25 to 30 per cent of its profits for social development. This is something that has obviously made the mining sector that much less attractive. Whether it's right or wrong is a different debate, but the fact is that for an investor and for a businessman mining has become that much less attractive. The same holds true for several other sectors, where what was assumed would happen is no longer happening. It was assumed that the power sector would be able to pass through higher coal prices, but that's no longer happening. So several aspects are not guaranteed any longer and that, I think, is the reason why people are a little worried now.

Do you see chances of the markets moving up to higher levels, say from the 16,000-plus level to the 20,000-plus level?
Not in the near term.

So in your opinion it is not yet time to be more optimistic about stocks.
It is time to be optimistic, but I think one has to be cautious and start deploying money from these levels. But are we at the absolute bottom? The answer is no.

How will earnings growth be this year?
Earnings growth will be muted this year - about 8-10 per cent for Sensex companies. One factor is that commodity stocks are not adding to earnings growth. And financials, which are one of the large drivers, are not performing in a big way. Financials and commodities together constitute 50-52 per cent of the index. If they don't perform, then we have a problem.

Which are the sectors you are bullish about over a three-year horizon?
The two sectors that we are optimistic about are gas transmission and consumption. In the gas consumption sector growth rates are strong. This is still an under-penetrated part of the economy. Energy consumption via gas is likely to go up in future. Valuations are also reasonable within this sector. Many companies are generating free cash flow. And finally, this is a high RoE (return on equity) business.
We are looking at the consumption sector through retail, garments, textiles and FMCG. We are looking at high growth, high RoE businesses here. Consumption is growing rapidly due to penetration into tier II and tier III towns. Valuations are reasonable here: they are sub-15 times.

Which are the sectors you are pessimistic about currently?
We are worried about the power sector and financials. In case of the power sector, there is lack of clarity on issues such as coal allocation. Moreover, the health of state electricity boards is a matter of concern. In the case of financials, their exposure to infrastructure and state electricity boards is a matter of concern.

What would your advice to equity investors be for tiding over the current turbulent environment?
It makes sense to continue investing systematically in equities and ride out the volatility over the next 12-18 months. The recent fall in the markets has been sharp, and it has thrown up interesting opportunities. Overall we remain optimistic about the prospects of Indian corporates. Valuations are also reasonable. Therefore, investors should look at this as an opportunity to keep adding good companies to their core portfolio.