Fate Of Financial Sector Crucial To India Market Outlook, Says Kotak’s Sanjeev Prasad

The fate of India’s financial sector may be key in determining the outlook for the Indian equity markets, according to Sanjeev Prasad, managing director and co-head of Kotak Institutional Equities.

Given the high weightage of financial stocks in local indices, uncertainty over the impact of economic weakness on the financial sector could continue to act as a drag on the broader markets, Prasad said in an interview with BloombergQuint.

The Indian economy is seen contracting in FY21, for the first time in decades. Kotak Institutional Equities sees the economy contract by 5.8 percent this year compared to an estimate of 5 percent growth before the Covid-19 crisis hit. This sharp weakness could lead to a further build up of bad loans on the books of Indian lenders.

Prasad sees “a very high level of risk” in the small business and personal unsecured lending segments. These risks may be more elevated in the current economic downturn compared to corporate lending risks, which have already crystallised to a large extent.

Even if banks and NBFCs report decent numbers right now, markets may like to wait to understand the final outcome of the Covid-19 crisis on the bank balance sheets, Prasad said. “Unfortunately there won’t be much clarity for the next two-three quarters on the eventual level of non-performing loans and what kind of credit costs one should be factoring in.”

According to Prasad, since some parts of the equity markets have already recovered from the initial selloff, financials may be key to the future outlook. “Other parts of the market are already up. Consumer staples and pharma stocks are already at or above pre-Covid levels. So I don’t know what will drive the market if you financial stocks don’t perform,” Prasad said.

India To Lag Global Markets

Apart from the drag due to financials, Prasad sees Indian equities lag global markets for two other reasons.

Many of the developed countries appear to be past the peak in terms of new additions of Covid-19 cases. In addition, these countries have large fiscal space and have seen a huge amount of monetary support. Unfortunately, India doesn’t fare well on either of these two counts, Prasad said.

Institutional investors remain fairly skeptical at this point in time, Prasad said, adding that the finer details of the government’s economic package have not “excited them.” “The package is attempting to address the supply side but at this point in time, the problem is more on the demand side.”

In terms of valuations, the market is trading at about 18 times March 2021 earnings, if you project flat earnings growth over March 2020. Even in March 2022 projected earnings, the Indian markets are trading at about 14-14.5 times. “Looks ok but we need more confidence on the trajectory of Covid and the economy.”

Limited Fiscal Room; Some Monetary Space

Prasad said the current economic landscape can be divided into three buckets.

The first is the segment where demand would hold even during the lockdown and after the lockdown. Items like consumer staples, pharmaceuticals and telecom would fall into this bucket, Prasad said.

The second bucket is where demand could be heavily impacted during the lockdown but will see reasonable recovery thereafter. Low-ticket consumer discretionary items, such as kitchen appliances etc, may fall in this category.

The last bucket would be where you would see severe demand destruction during and after the lockdown. This bucket includes anything related to investment, including housing, or large-ticket consumer discretionary items, where consumers will postpone purchase decisions even if they have money.

Measures taken by the government so far tackle hardships faced by the most vulnerable sections of society, small business and, to some extent, non-bank lenders. The steps, however, do not provide much impetus to weak demand conditions.

From here on, the ability of the government to provide fiscal support may be limited. “We are already looking at a combined fiscal deficit of 11 percent, which is clearly on the higher side. I don’t know what more the government can do beyond maybe another 1 percent or so of spending,” Prasad said.

On the monetary side, the RBI may be able to cut rate further if the supply side isn’t disrupted and inflation doesn’t rise.

Watch the full interview below: