Prasun Gajri, chief investment officer of HDFC Life.

In an interview with Financial Chronicle

March 31, 2013:Even with low GDP growth, markets can deliver excellent returns. What matters is the market view on valuationsand earnings growth, says Prasun Gajri, chief investment officer of HDFC Life. In an interview with Financial Chronicle, he says valuations are quite reasonable and in fact very attractive in a few sectors at the moment.

The interview excerpts:

At this moment, do you find more reasons to be pessimistic on Indian equities or otherwise? Please explain why? The recent downturn in the equity market has been triggered by a bout of risk aversion due to developments in Cyprus and to some extent, due to the political uncertainty at home. We do not think these developments will have an enduring impact on the market. The euro area will continue to see a few more of such crisis situations. The situation is unlikely to improve substantially in the near future, nor are we looking at any disastrous development. The political developments at home are likely to cast a shadow on the market. Though an early election does not look imminent as yet, the probability has definitely gone up. This uncertainty will be negative for the market in the short term. However, beyond the increased chatter over the shape of political alignments and alliances, we see little impact on medium- to long-term prospects of the market. Therefore as long-term investors, we continue to be optimistic on the market. Even the diehard optimist wont give India slightest of chance to clock more than 6% growth this year. Will it mean a sluggish stock market through the year? Markets do tend to discount future expectations into prices. So we reckon that our stock market has already discounted the expected sluggish growth for this year. Secondly, even with low GDP growth markets can provide excellent returns. What matters is the market view on valuations and how earnings growth will turn out to be over the next couple of years. And valuations are quite reasonable and in fact very attractive in a few sectors. The lower core inflation gives RBI room to ease interest rates further. We have most likely seen the worst of current account deficit and exports are showing signs of a pickup. Globally too, we are seeing improving prospects for growth in major economic regions apart from Europe. So actually we do see more reasons to be optimistic if we shift our gaze beyond the immediate future. So, what would be your key worries, or downside risks? My key worries would be a spike in crude prices and any sign of contraction in global liquidity and, therefore, flows to countries like India. In spite of the recent rate cut by RBI, there is no sign that banks are going to pass it on to consumers. Secondly, when Basel-III takes effect this April, it is widely believed that banks will be forced to go on the back foot. Does a tight liquidity situation bode well for the economy? There was almost no transmission of the latest repo rate cut into banks lending rates. A s you mentioned, tight liquidity has been the key reason for banks holding on to their rates. However, we believe this tight liquidity is a seasonal phenomenon. This year, the government has curtailed its spending sharply over the past few months, in order to meet its fiscal deficit targets for the year. Going into April, we expect liquidity to ease as government spending picks up and bank credit demand wanes. We see banks cutting their deposit rates and subsequently, lending rates as well, from April. So the transmission of the repo rate cut will happen with a lag.

Basel-III takes effect this April, and the implementation schedule stretches till 2019. Banks will have to hold more capital and greater amount of liquid assets on their balance sheets as well as additional capital buffers. We do not see the new framework to be onerous for banks in India and they do have strong capital ratios and hold a sizeable portion of assets in liquid instruments. We do not expect Basel-III implementation to have a meaningful impact on liquidity. Post March 19 RBI policy review, many economists are of the view that the legroom for further rate cut has got reduced drastically. Whats your outlook on interest rate movement through the rest of the year? The view of limited headroom for further interest rate cuts is based on the current levels of inflation and current account deficit (CAD). But, the picture is likely to be quite different for core inflation. We believe core inflation is more relevant from a monetary policy perspective, as it represents the items whose price levels show some sensitivity to interest rates. The current account deficit has deteriorated quite sharply over the past year. However, more recent data point to a possible change in trend for CAD. We believe RBI will have greater room for interest rate cuts during the year. Even if RBI limits its explicit rate cuts going forward, it has more tools in its kit to nudge interest rates lower. There is a potential risk that the political uncertainty will hurt the rupee more than anything else? The rupee continues to be vulnerable on account of our dependence on capital inflows to fund the CAD. Any political uncertainty can have impact on these flows and as a consequence could hurt the rupee. While this continues to be a worry, it is comforting to know that the CAD probably was the highest in Q3 of FY13 and we should get a lower CAD in Q4. This should help the rupee. Moreover steps are being taken to help attract more debt flows and decisions like raising the fuel prices for end customers will help control demand for these products. We are worried, but we believe the worst is behind us. Have earnings downgrades bottomed out for India Inc? Or is there worse in store from the March quarter? I do not thinks the earning downgrades have bottomed out across sectors, but in some sectors we definitely are bottoming out. Our main worry is that the consumption-related stocks are still showing reasonable earnings expectations and these numbers may need to be revised downwards given the slowdown in consumption. Domestic savings and retail participation in equities have not really picked up in spite of several measures taken already. How do you look at the scenario and what needs to be done to drive domestic savings? The government has already taken measures on the taxation front to make retail participation in equities more attractive. However, these are what may be termed as push factors and they play a relatively minor role in encouraging equity participation. The bigger factors are what may be termed as pull factors, i.e. attractive returns. Retail participation will increase only if there is greater confidence that equity markets can see sustained outperformance over the medium term. We expect that the coming year could be different. How have you been playing in the market of late? Are you buying shares aggressively or are you still in the wait and watch mode? Our philosophy of investment in equities remains the same across market cycles. We focus largely on bottom-up stock selection and aim to invest in companies that have a sustainable business model and are available at attractive valuations. Hence, the process of investment is an individual stock level call, and not a macro decision of increasing or decreasing exposure to equities. However, in terms of sectors we are underweight on high-valuation defensives as well as sectors where balance sheets are under stress on account of high leverage.

From a bottom-up approach, any particular sectoral or market cap-based trend you may be seeing? What we are witnessing is foreign liquidity chasing a small number of high quality companies even though valuations are quite high. Thus companies with cheaper valuations are languishing while many expensive stocks are getting even more expensive. It is difficult to say how long such a trend will last. We believe that a well-diversified portfolio of good companies with reasonable valuations can do well over the long run and the current environment is giving an opportunity to build such a portfolio. Even with low GDP growth, markets can deliver excellent returns. What matters is the market view on valuationsand earnings growth, says Prasun Gajri, chief investment officer of HDFC Life. In an interview with Financial Chronicle, he says valuations are quite reasonable and in fact very attractive in a few sectors at the moment.