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  • Nilesh Shah

    MD, Kotak AMC
    Shah has over 25 years of experience in capital markets. He has managed funds across equity, fixed income securities and real estate. He has studied at the Institute of Chartered Accountants of India. Shah has also co-authored a book - 'A Direct Take'. His dream is to go backpacking with his better half some day.

What to do when what’s cheap is not safe, and what’s safe is not cheap

The credit and deposit growth in the banking system is down to single digits.

ET CONTRIBUTORS|
Dec 10, 2019, 02.55 PM IST
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The government is trying to fix the engine, the tyre and the fuel flow while also driving the car.
September quarter GDP growth at 4.5 per cent has come in line with the Street expectations. The question now is: how soon will the economy see a turnaround as the corrective action of fiscal and monetary stimulus come into play?

The credit and deposit growth in the banking system is down to single digits. On the other hand, CPI headline inflation is inching closer to the 4 per cent mark, while core inflation is below the 4 per cent mark. Part of the slowdown has been due to corrective action to change the longer-term growth orbit.

For example, earlier the real estate sector was dominated by small developers taking consumers for a ride. RERA has brought in accountability and helped safeguard buyer interests. As a result, developers are now changing their business models. The issue now is to release the capital trapped in the real estate sector. To address that, the government’s recent Rs 25,000 crore package to the sector may help reduce the stress and unlock capital, but effective implementation will be key as the stipulations are stringent.

Likewise, the long-pending NPA problem in the banking sector, which had remained pushed under the carpet for long, has been brought to the fore and a robust mechanism and resolution process was instituted. This helped clean up balance sheets and prevented potential economic turbulence that was getting pushed back for the next generation to handle.

Similarly, the inefficiencies and leakages in the social services sector were plugged by using the JAM (Jandhan-Aadhar-Mobile banking) mechanism. CPI inflation, high fiscal deficit, high current account deficit and interest rates have all been brought down through coordinated policy measures.

These were bitter, but necessary, medicine that had to be administered. And a unwanted after-effect of these otherwise productive measures has been the slowdown in the economy.

But the economy needs to be prepared for the new age. Japan, Korea, Thailand, Taiwan, Singapore all overtook us in the 1960s, 1970s, 1980s. Then, China came from behind and outperformed us in the manufacturing race in the 1990s and 2000s. Even a war-ravaged country like Sri Lanka outperformed us in per capita GDP growth.

The government is trying to fix the engine, the tyre and the fuel flow while also driving the car. One series of reforms has been done. Now other major structural changes would also need to be taken up to bring the economy back on the high-growth path.

For any economy, access to cheap funding is the turbo-fuel. We, too, need to do what has already been done in the US, the UK, the EU, China, Japan and other places. The interest cost for the borrowers must be brought down. For that, the banking system must be flushed with liquidity.

Additionally, quick mechanisms must be found to remove NPAs from the financial system while also professionalising it. The government and RBI have many tools available to achieve these objectives. And they are showing the urgency in applying them. Also, procedures must be put in place so that piled-up litigations do not end up disrupting vital projects. Pinpointed sectoral packages may also be needed to resolve the bottleneck issues.

The market has three compartments: Sensex is at a lifetime high, but the other two – midcaps, as well as smallcaps – are down between 20 per cent and 40 per cent from their respective lifetime highs hit in January, 2018.

The market today may be pricing in a recovery in earnings growth: December quarter 2019 growth may be better than that of September quarter 2019 (and March quarter 2020 economic growth may be better than December quarter, 2019).

Already, the Reserve Bank of India (RBI) has pumped liquidity into the domestic banking system and interest rates have come down substantially. A positive step like disinvestment of a large public sector undertaking (PSU) can on one hand reduce fiscal worries, and on the other, confirm that the reform agenda remains a priority for the government.

Put all these things together, and the market now feels growth has actually bottomed out in September 2019, although data for October 2019 does not give the confidence that this has happened.

The market is still pricing in growth and earnings recovery in largecaps in the days to come. Having said that, it is time to be cautious about valuation. What is looking very safe is not looking cheap and what is looking cheap from a valuation point is not necessarily safe (except for the last few days’ rally).

Smallcaps and midcaps across a variety of sectors provide you that comfort on valuation. But one will have to be careful in choosing stocks to invest.

At the current juncture, investors may consider neutral allocation of assets to equities with a preference for smallcaps and midcaps. Lumpsum investors may invest in balanced advantage funds or use the STP route to invest in equities. The current juncture of the market would require coordinated efforts by distributors and mutual funds to help maneuver investors through this volatile period. We at Kotak Mutual Fund remain committed to serve this cause.
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
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