Rupee Fall Can Hinder Rate Cuts, Warns Emkay’s Manish Sonthalia Neha Aravind NDTV Profit

Manish Sonthalia: Again, you know, we begin with a bit of pessimism as we step into calendar year ’25 and this is on the back of a few things. All of that is very well known. But just to reiterate, there’s no earnings growth.

Earnings growth is low double digits, 10-12% sort of an earnings growth is what we can at best expect, given how things are, things can change at the margin, but as we see things from our vantage point, currently, we are looking at a 10-12% earnings growth. We are having an overvalued currency. You are seeing FIIs just press on relentless sales. I mean, that’s not going to stop, unless and until the rupee depreciates more. That is one.

Third is the broader markets are grossly overvalued. When we look at anecdotal data, whether you look at the previous peaks of 2007, the Lehman crisis of 2017, we are at one and half times deviation away from the mean on the upside. So there is no comfort in the mid and small cap valuations per se and the fourth is basically your plethora of IPOs, QIPs that have been pouring in. We are sucking out liquidity like anything. So India had the highest number of IPOs in calendar year ‘24 and the scenario doesn’t look any better in calendar year ‘25, a whole lot of IPOs are still lined up.

Of course, it’s a different thing that FIIs are selling in the secondary market and buying in the primary markets. That’s a silver lining, but that’s how things are. Money is just getting pulled out of the secondary markets, left, right and centre. So given all this backdrop, I think again, you know, you’re dealing with two major events, the regime change in the U.S, January the 20th, when you have a new President come in, a lot of measures that have been articulated by him, whether that could come through sooner than later, it will have repercussions for Emerging market as a whole.

In totality, as we see the run-up to the inauguration of the new President, or government/ appointment of the new President, you’re seeing a whole lot of selling that is happening across emerging markets and obviously, India is a part of the emerging markets. It’s advantage developed markets vis a vis, let’s say, emerging markets. That’s one.

The second is obviously the budget and again, out here, you know, the broad parameters are well known. You know, you know the problems. You have a falling consumption, you have a falling investment by the government. You know, corporates are deleveraging the balance sheet. The government is deleveraging the balance sheet. There are articulations about containing the fiscal deficit to 4.6% of the GDP for fiscal ’26. All of this doesn’t bode well for growth. So, you know, these are some of the parameters that we’ll have to look out for as we move into the first quarter of calendar year ’25 or the last quarter of fiscal year ’24 and then see how things play out the rest of the year.

There are a lot of challenges, and I think it will be a potential as far as the markets are concerned, no low hanging fruit. All the low hanging fruits have been taken in the last four years.

Manish Sonthalia: So that’s the conundrum. If you have a Rupee depreciating, then the environment in India is going to be inflationary, and that’s going to be a headwind for rate cuts. Right now, everybody is building in rate cuts by the RBI in the first quarter of this calendar year, or at best, the second quarter of this calendar year. But should the rupee depreciate another 3-4% from here and the situation and the narrative could change, you know, you really don’t know, but right now the fixation is preference of inflation over growth.

The markets would love growth over inflation. That’s the conundrum. I think probabilities of rate cuts are still high, for the first half of calendar year ’25 but it’s not a given. A lot will depend on inflation. Right now, inflation is broadly under control, but who knows what’s going to happen to oil prices and the Rupee deprivation? What sort of imported inflation will you have in the country and all of that is still all up in the air.

Manish Sonthalia: So Niraj, there are 57 sectors in India, very broad based. The Indian markets are very broad based. But I think the big theme for at least the first half of fiscal ‘26 is going to be your rupee depreciation. So you load onto sectors, which are going to benefit out of a depreciating rupee and these are large sectors. You have a pharmaceutical, you have an I.T., you have a Banking system which will come out of lows of ‘25 and you know, you have at the margin, deposit accretion better than credit growth. NPAs are broadly under control.

Of course, retail inflation, retail NPAs are now inching up, but the corporate side of the book is perfectly fine and valuations are perfectly okay. You have platform companies, you know, both on the consumer side as well as the financial services, the Para banking side, those look good. You know you have the Insurance play where again, you know you will come out of a very low pace into a growth space for fiscal year ‘26 and ‘27 and again, valuations are corrected. So there are pockets where you will find islands of safety. Of course, by design and default, we don’t take cash calls, but the idea is to remain in cash proxies.

Of course, you have Reliance which is a good enough cash proxy, or you have large Banks, both in the public sector space as well as the private sector space, which act as cash proxies. That’s how you balance your portfolio in times of uncertainty and low growth. As I said, within the broader markets, because you have 57 sectors on an index wide basis, the small cap and the mid cap index looks very, very overvalued, some 40 P/E, we have never seen these sort of valuations on the mid cap and small cap index anytime before. But you know, there are still opportunities within individual names in the broader markets, provided you take a two to three-year viewpoint, you have enough opportunities. So I think again, it is going to boil down to stock specific within the broader markets and within the large-cap space, you will have these four, five large sectors where you know, you could have relative outperformance vis a vis the rest of the market.

Manish Sonthalia: First of all, these long dated order book positions, whether it be the energy transition, etc. You know, when the market tends to give valuations to these companies based on long dated order books, I mean, this is something that is being overdone, and these will have to go through time correction or price correction. So renewables, energy transition. These are great themes for the next five, six years. But on the one hand, to have an arbitrage between, let’s say China, which is the biggest supplier of all energy modules. We’re talking about solar out here and a lot of bunching up of capacity is because of the rush to meet this 500 gigawatts by 2030 and after that, you will really have the growth paper off.

Here you are having the market to value them so fancifully that there’s nothing left on the table. So you’re absolutely right. Both these themes are, you know, very well placed between now and the next five, six years. But there has to be some margin of safety when it comes to, you know, valuing the earnings that you see over the next four, five years. I mean, just that these themes will play out, can’t really price them five years out in terms of earning. So, you know, after they go through some time, correction, price correction, they will jolly well and look very good for the portfolio, and this would run true for all the industrials, or, let’s say, the government infrastructure. First of all, there is not too much certainty as to how you can achieve a 4.6% fiscal deficit without containing your expenditure side or without building a massive revenue. So, you know, government expenditure has to happen. But which areas will see an expenditure boost, which will see a cut, all of that we know in the Budget. So the Industrial side, the Renewables, the Power, the Defence, Railway these are slightly overdone, and because of the stratospheric valuation, they’ll have ample room to correct before you can actually find margin of safety to be included in the portfolio.

Manish Sonthalia: So Equity as a percentage of financial savings is definitely going up and this 5% of the total wealth of the country resides in financial assets, as opposed to, let’s say, 15% in gold or 15% in real estate. I mean, this has changed at the margin during the pandemic, and it’s only continuing. So again, out here the profit pool, where it’s going to get shared between your number of players, I think there’s ample visibility of not only earnings growth, but even multiples.

You know, these could structurally get re rated, the exchanges, the wealth management platforms, the broking platform. Of course, breaking this quarter is not going to be a great quarter, but because of the changes by the regulator. But from a long term point of view, these are, again, buy on dips. You know, you have the payment Fintechs. These, again, platform companies where there’s a huge amount of non linearity and, you know, the delta in revenue and the delta in costs are not in tandem. You know, the revenue line moves this huge operating leverage, which translates into superlative earnings growth. This is not going to stop between now and the next five-10 years. Again, since the profit pool is getting shared between two players, three players, I think this is again, a great opportunity, a great sector to own at all decline in the market.

Manish Sonthalia: Absolutely, these are great opportunities, whether it is electronic recycling or copper, aluminium, or rubber. You know, just got to build earnings growth and the valuations per se. But the whole point, let’s say, is to talk about metal recycling companies. You have companies out here trading at 50-60 P/E multiples, of course, for a 20-25-30% earnings growth, that’s perfectly fine.

So as long as PEG multiples remain less than two, you still have opportrupunities in the individual names, whether it is rubber recycling or metal recycling or plastic recycling. I mean, these are great opportunities to own, but only mindful of valuation, nothing else.

Manish Sonthalia: So Precision Engineering is coming up as a very big theme as far as India is concerned, not only from the point of view, it’s an electronic manufacturing services, the EMS space, but also, you know, the aircrafts and the orders that we have in the MRO space, you know, the maintenance and repair operations within the aircraft, because India is going to import a whole lot of airplanes between now and the next five sixes, all the major airlines are really booking a lot of planes. So this whole ecosystem regarding precision engineering, whether it comes to defence or, let’s say even MRO, or let’s say EMS, there’ll be individual companies which will have heightened earnings growth.

The whole crux out here is to see how good and earnings growth you’ll have and this again, will rest on how good order, good position you have. But again, out here, it is the same thing, you know, long dated order book position, if you value it too soon. I mean, at some point in time, these companies will go through time and price corrections, you know, the market tends to value these companies in the next five years, sort of an order book position and it doesn’t really work like that. You get the point that you have visibility of the next five years, but there has to be some lapse of time before you start pricing in all that order, position into the market capitalisation.

This will remain true as long as you have a scarcity premium coming to a few of these names. You have a few listings in the precision engineering catering to the aircraft side and you know, Boeing and defence and all of that. But as you see more players, you know the scarcity premium in terms of valuations will also revert back to them.