Sunil Subramaniam, MD & CEO, Sundaram Mutual, says because of reduction in the interest rates in the debt securities market, these balanced funds, which remain now the only way for a person to participate in a reducing debt market in a tax-efficient manner, is through hybrids. So you will see a lot more money flow into hybrids, and because they flow into hybrids, there will be a lot more money for buying equities also from that. So it is a double-edged weapon in that sense, that as people allocate their money into hybrids, not only debt securities will get more subscription, but equities will also be buying more power from allocation of flows. It is a very big positive.
One section of the market really liked the Budget a whole lot, especially the way yields came back. Earlier, our panelists were making a point that this is much more meaningful than what the Street is realising right now because it could lead to lower inflation going forward and hence rates going lower. What are your thoughts on it? What could it do to stock market valuations overall?
Sunil Subramaniam: The first thing is that this has multiple implications. The first point is that the crowding out effect of the government will be much less, leaving that much more capital for the private sector to raise. That is a very important thing because when the government comes and borrows a lot more, they crowd out the private sector and then interest rates rise at that time. But because the government has announced a much lesser borrowing programme for next year, it creates room and space within the space for the corporates to borrow, as and when the capex programme of the private sector starts.
Now, bear in mind that has not yet happened. So when that happens, the government’s decision means that there is enough liquidity and bank funding available. That is very good news from a capital market perspective because otherwise banks’ NPAs also have been declining, credit upgrade ratios have been improving. So everything is set for the capex cycle to start. That is the best news from a medium-term perspective, that this is an additional supporting factor.
The second factor is if the government is borrowing less, then the pressure on yields, when crowding creates the space, it also reduces the pressure on yields. So what this does is obviously banks, so PSU banks, for example, who have large holdings in excess of the CLR requirement with the government, they can have mark-to-market gains on the portfolio. So for the banking sector, this is a positive, which then spills over to mutual funds also, which have significant allocation to the banking and financial sector because they are a big part of the index.
The third aspect of this whole less borrowing programme, which comes to the market, is from a debt perspective. Last year in the Finance Bill, the indexation benefit for debt was removed. So what has happened is that this year, the entire focus of people wanting to take advantage of interest rates has been through hybrid mutual funds, which have an equity plus debt combination because once you keep 65% in equity, so you have balanced advantage funds, aggressive hybrid funds, multi-asset allocation funds, bulk of them keep equity at 65% and balance they put in debt.
Now, because of this reduction in the interest rates in the debt securities market, these balanced funds, which remain now the only way for a person to participate in a reducing debt market in a tax-efficient manner, is through hybrids. So you will see a lot more money flow into hybrids, and because they flow into hybrids, there will be a lot more money for buying equities also from that. So it is a double-edged weapon in that sense, that people allocating their money into hybrids will mean that not only debt securities will get more subscription, but equities will also be more buying power from allocation of flows. So again, it is a very big positive.
Second aspect is the fact that the finance minister has projected not only lower market borrowings, but a lower fiscal deficit with a confirmation that that 4.5 of FY25-26 will be held, means that from a rating perspective, if India’s growth numbers start to look even better than they are, then there is a good chance for India upgrade to happen.
If India gets a rating upgrade, whatever, during the course of the year, that is a fantastic positive for the equity markets. And top of all this is that the bond index, right, our inclusion from June, which is another fillip. Now, if that government is going to allow that money to come in that will give a further downward pressure on yields and hence strengthen all of this that I am talking about. So this report card budget, which is what I would like to call it, because largely it was a report card and has given all the positive signals for the equity markets, because equity markets love lower interest rates as an overarching thing. So I think it is a huge positive.
Today, the market may not be reacting because it is probably anticipating a lot of benefits and all of that, certain things had gone waiting for that. Maybe that has not happened, but that is okay. Today’s market reaction, you can ignore. I think this is a very good budget.
What are your thoughts on the earnings quality coming so far, especially on the top line front?
Sunil Subramaniam: It has not been great. It could have been better. Coming after the delayed festival season, the numbers we were anticipating should have been much better. So honestly, they have not been great. It is fairly tepid, if I would say, but it is not fully done yet. We will wait and see. Certain numbers like the auto numbers, which have come out, have come out very well. The broader market auto premiumization was already evident, but at the lower end of the cost curve that was not there. Today those numbers have started coming in and looking better.
So I would still wait to give a final judgment, but the initial ones have been a bit tepid. That is what I would say.
On the valuation front are you also of the view that certain pockets of midcaps smallcaps are getting frothy or is it not right to paint the entire thing with the same brush?
Sunil Subramaniam: It is not an easy question to answer because what has happened is that a significant proportion of the midcap and smallcap universe and index is linked to the infrastructure, to capital goods and infra and defence and manufacturing. Now, as the government has continued its emphasis in this budget also around that space, it is a fact that private sector capex has not picked up as anticipated. It is getting delayed.
The reason for that is that the consumption numbers of the mass market premium consumption have been going up but the mass market consumption has not gone up after the second V-shaped recovery after the Covid. So, it has got stuck at about 76, 77% levels. Unless there is a strong breakout in terms of the consumption growing and hence the capacity building going, threatening to go past 80, then a private sector capex, which is in the talk today, will have to get converted to action.
So in that run-up what is going to happen is, first consumption needs to go up. Today we are seeing the signals of that. If you see the auto numbers coming in, you see the FMCG numbers coming in. Those have to go up first before the private sector capex can start.
But capital allocation wise, over the last year, year and a half, the capital allocation has moved towards infra at the cost of consumption. Now, prior to this month January onwards, the banking sector had got allocation too because NIMs were widening and everything. But this month you have seen a big correction in banking. So, what is happening is that the capital allocation, I feel that within the infra space, the valuations are, I think, looking on the richer side.
I would expect capital allocators who actually look at valuations to allocate capital to shift money away from the infra space, albeit that the budget has been pro-infra, into the consumption because I believe those numbers are going to start looking better from an earning season perspective.
Especially in the run-up to the election, you will see a lot more money flow down into the bottom of the pyramid of the economy and you will see the mass FMCG and the low-end consumption numbers pick up. So, this capital reallocation will mean that, overall, the market may consolidate, may move slightly higher but within it, I believe there will be a leadership from banks.
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