Unmesh Kulkarni, Managing Director-Senior Advisor, Julius Baer India.
If Indian bonds could make their way into the JPMorgan global bond index, they could, to some extent, ease the impact of the strong US Dollar on Emerging Market currencies, including the rupee, especially with a hawkish Federal Reserve seemingly set for a more aggressive rate hike, says Unmesh Kulkarni of Julius Baer India.
JPMorgan has recently approached market participants and is seeking their opinion in this matter.
On the equity market front, the managing director and senior advisor at Julius Baer India, seasoned for about two decades in the wealth management industry, believes the premium valuations of Indian markets as against other emerging markets are likely to sustain because of superior earnings growth profile of Indian companies and a relatively faster economic growth of the country.
Besides, domestic flows have been resilient, and from FPI perspective, India remains an attractive destination, especially if some flows were to be get redirected from China, he shares in an interview with Moneycontrol. Excerpts from the discussion:
Do you think JPMorgan can include India’s bond market in its global bond index this financial year? And, if it happens, do you think it will translate into a higher FII inflow?
JPMorgan now looks more open to the possibility of including Indian government securities in its global bond index, given the fact that it has recently approached market participants and is seeking their opinion in this matter. There is a good possibility that if the market feedback on the inclusion of Indian bonds happens to be positive, JPMorgan may come up with an announcement in the next few months.
What does that mean for the Indian g-sec yields? Well, the markets are somewhat already celebrating the possible inclusion (although this is not confirmed yet), as g-secs have rallied ever since the news on this topic started flowing. The actual inclusion will certainly be a positive development, as it will widen the global investor participation over a period of time, especially from passive funds.
However, there are some challenges too. The Indian debt market is comparatively less liquid than other global debt markets, and this may therefore limit the extent of participation by global investors. Also, it remains to be seen what allocation is assigned to Indian bonds in the JPMorgan global index. Besides, even the existing limits are not currently fully utilized, as global investors generally have a preference for Indian bonds that are listed on overseas clearing platforms (such as Euroclear), where they do not have to worry about paying capital gains in India.
But on the whole, the inclusion would be a positive, as it could change the perception of global investors towards the Indian bond markets over a period of time, besides providing some relief to bond yields.
If Indian government bonds are eventually included in global bond index, what will be your strategy with the rupee against other currencies?
A possible inclusion of Indian bonds in the JPMorgan global bond index could, to some extent, soften the blow that the strong US Dollar is having on Emerging Market currencies (including INR), especially with the hawkish Fed looking set to hike the key policy rate further more aggressively.
Over the past one year, India has lost $80 billion of forex reserves and the INR has depreciated 8 percent to the US Dollar. FPIs have been net sellers in both the Indian Equity and Debt markets in CY22. While the FPI flows into Indian equities appear to be turning the corner, the inclusion of Indian bonds in the JPMorgan global bond index could just be the trigger to reverse the FPI flow situation in the debt markets.
The INR would certainly be a beneficiary of any such positive inflows, given the fact that it has borne the brunt of the FPI selling over the past one year. However, one cannot view this in isolation; a lot would depend on the strength of the US Dollar, the inflation roadmap in the US as well as in India, the Fed rate hikes, the RBI’s rate hike stance and consequently the interest rate differential that India offers, as this would partly decide the sentiment of foreign investors towards Indian fixed income.
Have you started taking positions in the IT space as it is 30 percent down from its record high levels?
On a selective basis, we like a few IT companies, primarily the larger ones. On the other hand, among midcap IT, despite the correction, valuations still seem to be on the higher side vis-à-vis historical averages.
On the positive side, the current deal flow seems alright, and the managements of IT companies remain optimistic on deal pipeline. The spending on cloud migration and digital adoption is expected to continue, as this is a longer cycle. Margins also have the potential to pick up as supply-side pressures have started easing and pricing environment also has the scope to improve.
However, the expected economic slowdown will weigh on the pipeline as well as the deal flow, possibly with a lag of 3-6 months, which will reflect in management commentaries post Q2/Q3 results.
Overall, we are therefore neutral on the IT sector. IT stocks have corrected, but from slightly euphoric valuations, which may not be the right benchmark to judge whether the sector has turned attractive from valuation perspective.
After the recent run-up, do you see the Indian markets valuations as expensive? Also, why is India enjoying a premium compared to other emerging markets?
The Indian equity market valuations are slightly on the higher side vis-à-vis the historical averages, with the Nifty one-year forward P/E at about 20x, which opens up the possibility of a correction – price correction or time correction – until earnings catch up with the valuations.
However, the overall premium valuations of Indian markets versus other emerging markets are likely to sustain, owing to the superior earnings growth profile of Indian companies and the relatively faster economic growth of the country. Besides, domestic flows have been resilient, and from the FPI perspective, India remains an attractive destination, especially if some flows were to be get redirected from China.
Are you gung-ho on the real estate space and cement sector?
The Indian real estate sector has gone through a structural change over the past few years. The sector is better regulated today, and many large developers have climbed up the governance ladder, having learnt lessons from the previous real estate cycle. Financially, the sector is looking healthier, with no major balance sheet concerns among the large developers. The demand-supply dynamics have also improved with a steady pick-up in demand (on better affordability and benign interest rates) and a reduction in unsold inventories, especially for large developers. We are therefore constructive on Real Estate and ancillary sectors.
Cement companies were impacted by higher energy and freight costs which led to pressure on margins, despite a gradual improvement in realisations. In the very near-term, margin pressures could continue while the full impact of cost inflation plays out.
Cement prices have started trending up in September after a sharp correction in July/August, which coupled with a decline in petcoke prices over the past few months, should help margins recover. Demand is expected to be resilient post monsoon, although we need to watch for the effect of inflation on rural demand, while the overall thrust on infrastructure spending should also spur demand over the medium term. Supply side should also see better discipline with some more consolidation expected in the industry. The overall outlook on this sector is looking positive.
Do you think profit-to-GDP ratio has further scope to expand faster in coming quarters?
Historically, Nifty’s profit-to-GDP ratio has averaged around 4.5 percent – 5 percent, with highs of around 8 percent, and this came down to sub 3 percent in recent years due to weak corporate performance. Since the past couple of years, however, the ratio has been trending up (moving closer to 4.5 percent), with corporate profitability growing faster than nominal GDP growth.
There is room for this ratio to inch up a bit further on expectations of the corporate profit growth to continue to outpace the nominal GDP growth. The key drivers for the improvement of the ratio are (i) the shift from unorganised to organised, and larger companies getting incremental market share, (ii) the overall expected improvement in operating leverage (and consequently profitability) and (iii) improving prospects for exports, especially with manufacturing activity in Europe seeing some challenges on account of rising energy costs, apart from the China+1 opportunity.
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