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Govt must address MAT issue immediately: Deutsche Bk AG
02 May

The Indian government must bridge the gap between talk and action on tax and address the MAT issue immediately, says Gunit Chadha, co-CEO, Asia Pacific and member - global group executive committee, Deutsche Bank AG. Especially considering India has a negative history with retrospective taxation, there is a need to resolve this issue within the next 30-90 days, he says.

As far as Indian markets go, he continues to be bullish and is not perturbed by current correction. He says foreign investors are bullish about the structural reforms undertaken by the government. He adds that across global boardrooms India is being talked about.

According to him, the fact that India saw some crucial structural reforms being brought in by the government has put the country in a sweetspot, specially since global recovery remains fragile.

Below is the verbatim transcript of Gunit Chadha's interview with CNBC-TV18's Shereen Bhan.

Q: Let me start by asking you about the investor mood. Deutsche Bank says tactically cautious, strategically bullish. Is that an indication that the Modi rally, Modi wave, we had talked about it the last time you were on the channel and everyone has been talking about it post the elections that the NDA came to power has started to peter out?

A: Let us start with the strategically bullish part of it. If you go back 9-12 months and the big issue which is the big spoken word of policy paralysis and then you look at all the reforms which have happened over the new government coming into place. You have had the foreign direct investment (FDI) in insurance done, FDI in defence done, the coal bill done.

Q: FDI in pension.

A: There you go. The coal bill done, the mining bill done, you have got the difficult defence deals announced, you have got direct cash subsidies for cooking gas done, diesel deregulation done, two other very important reforms underway. Obviously there is a lot of political debate around those, very important both Goods and Service Tax (GST) as well as the Land Acquisition.

So, if you put the totality of the reforms, which has happened, and add to that the foreign policy where some very interesting moves have happened I have to say most people including myself and global investors would say a huge amount has happened in terms of policy paralysis. That word ceases to exist right now and it is a huge amount, a wave of structural reforms. In fact I would argue, many have argued that Mr Modi and the government have been in a hurry to do this but equally the impatience of the society.

Q: There is no argument that policy paralysis is over. The concern is that all of this is not yet translating into a recovery on the ground despite what the government holds out in terms of the GDP growth figure which the government itself by the way took with a pinch of salt before they finally decided to adopt the CSO’s numbers. But whether it is 8, 8.1 or 8.5 percent whatever the case maybe it hasn’t started to reflect yet in corporate earnings. Do you believe that in the short term we are likely to see more volatility, more pain from the stock market point of view specifically?

A: So now we are addressing a very different investor constituency, moving away from the FDI, moving away from long term strategic capital on which as you just said a lot has been discussed, a lot has been done. Let us now move on to the financial investors who are coming into the stock market. We have got to put a few comments on the table, one is that globally growth is much more challenged today than frankly where we thought even a year ago. US mixed data out there. We thought US will grow at about 3.5 percent, US is looking more like 2.8 percent this year. China slowing down faster than most have. Europe and Germany have actually done pretty well as a combination of the oil coming off and the Europe playing into the exports, but overall macros globally are challenging from a growth stand point. Then you put the relativity of what does India to the rest. India actually took not the monetary path to kickstart growth. In fact if anything else people were arguing India has been very cautious on the monetary side. You have had USD 100 billion reserves getting crated over the last 18 months. You have stabilised the forex, you have got current account deficits which have contracted significantly but in the bargain India did a lot of this structural reforms even around itself rather than use the monetary lever.

Then you were sitting on valuations on India which were looking pretty expensive relative to any other MSCI, relative to China and the others, 2015 comes along. You have China suddenly unleashing monetary policy again off a base of much lower valuation and liberalising and attracting foreign capital. You saw what happened to Shanghai Index and you saw what happened to Hong Kong. They were off a flyer this year. Ruble starts to come back and you see Ruble gaining strength off the very low base.

Europe comes back courtesy both oil and partly the depreciation and money starts to move into Europe. So, tactically India which was, you could argue overweight most investors and looking expensive at 17-18 times earnings and the fact that monetary policy lever had yet not fully kicked in I don’t think it is a surprise, but we should really judge the government.

Q: A quarter or two quarters down the line what are you estimating?

A: It is a function of global growth. We need global growth to stay fully intact. We think if global growth 2015 grows at about 3.3-3.4 percent no different from 2014 a little disappointing in that, we would like a little higher than that. There is excess capacity sitting globally. So there are some challenges in global growth. My view also is that a lot of Indian corporates were sitting highly levered with high costs of capital. Hopefully as those start getting corrected, they pull down the leverage with raising the money as they are doing and cost of capital comes down and we can talk about monetary policy. You will find that there is resurgence happening as far as companies toplines and margins are concerned. I still think we need to be patient into the second half of the year.

Q: So you are sticking to you Sensex year end target of about 33,000?

A: I had no real comments for that. That our analysts and I am sure he has been right in the past and there is no reason why he couldn’t be right this time as well.

Q: Let us talk about some of the triggers that you spoke of and let us start with the Federal Open Market Committee (FOMC) and as you rightly pointed out and this is the views of most people that we speak with as well as the Reserve Bank Governor that India is much more secure today and less vulnerable to the possibility of the Fed hiking rates. When do you envisage that and what could the short term impact really be as and when the Fed does decide to hike?

A: I wish I had a crystal ball unfortunately we don’t, but given the mixed data coming from the US though we still believe that notwithstanding a weak first quarter and some of the weakness carrying on into the second quarter as well we think US still will have a stronger second half and you could you could see US coming back to the 2.8 percent growth rate. In that scenario we think the Fed hike comes in September and probably into December if the weakness carries on. So, that is the timeline we think of September onwards for a rate hike.

From vulnerability standpoint actually it is interesting. The most vulnerable still are the Latin countries. Asia is still somewhere in the middle but within Asia actually it is only Thailand and India who have changed their position on their current account. Thailand has actually gone surplus and India has contracted the deficit account significantly. India stands out as actually having made the maximum move towards being less vulnerable over the last 18 months since the April 1 came into play and while I would have to say that there will be an impact in the currency, there will be an impact on the capital flows, India stays relatively better hedged today than frankly most of the countries in Asia.

Q: Will the impact be significant in the short term, in the immediate term post the hike?

A: Yes, it could be significant certainly and which has always been our advice to corporates that do hedge your dollar liabilities out which still are still biased of great dollar strengths. So, there could be an impact of corporates balance sheet and you just don’t want to get into that, but I have to say the bigger impact on Asia is not going to come from the US but it is going to come if China really slows down. If China gets into hard landing and starts to reflect growth which is sub six percent which they will again quickly use monetary policy and get into a form of China QE coming into play but if China slows faster than most people would anticipate then Asia really is vulnerable.

Q: What are your investors telling you? And you pre-empted my question because that is the big worry in the room at this point in time and this may be a strategic decision on the part of the Chinese government to actually slow things down deliberately, consciously. But what is the sense that you are getting from investors about what could happen if we do see a sub-seven percent growth rate for China?

A: We believe we will actually see a sub-7 percent growth rate for China, right? So, it maybe 7 this year, kick-started by monetary policy which gets much more favourable but, there is slow down happening in China on the property and there is slowing down in China in industrial production, on retail sales. But what the government is doing very interestingly, very much like the Indian government is actually making the structural reforms. So, they are truly trying to liberalise capital markets. They are trying to move from standard operating environment (SOE) led to into the private sector. They are actually lading to better efficiency of their stake on enterprises. They are truly trying to internationalise RMB, you could see in the special drawing rights (SDR) basket in 2015 end, 2016. So China is doing all these structural reforms they have to. And then we think they will use the monetary policy lever both on reserves as well as on the rate and hopefully that even if the get into the six or near six percent, it kick starts, it kicks back into the close to seven percent. But often it does not play out the way you intend it to.

We think China has the leadership and what it takes to navigate the economy. It has the resources but, if China were to actually slow down into that six percent or below, we have a serious vulnerability for Asia which is very dependant on China, because remember global trade is not going to be offset to China now because global trade is slowing down, US is slowing down, Europe while it is surprisingly on the upside and specially Germany, but Europe is going to grow at about 1.4-1.5 percent in 2015. That cannot offset a slowing China.

Q: Now, that is clearly a cause of concern. But you were talking about monetary policy in China. Let us talk about monetary policy in India. Governor Rajan is surprised to speak with out of turn policy cuts. Given the commentary coming in from the reserve bank of India where inflation currently is and of course the macro economic picture, do you believe that 25 is what we can expect in this year? Do you think that 50 could perhaps be the cut that we could anticipate for this year?

A: Well, firstly the governor has a very high credibility with international investors and he has more data points that any one of us too. So, let us give the benefit of doubt there. Also, we have to recognise that over the last 12 months, whether it was stabilisation of the currency, or getting inflation down by about 400 basis points or really creating resilience as far as the markets are concerned, India stands out and stands on as having done a very good job. But, on a spot basis, you have European Central Bank (ECB) which is really pushing down the quantitative easing (QE), you could have ECB, you could have European Union (EU) generate over 4 trillion of surpluses over the next decade. You have China which may be kick-starting a QE, Japan is going to continue its easing policy and US may defer out its rate hikes. Put that scenario together. And I see a lot of the Asian economies, whether it is Indonesia, whether it is Korea, whether it is Thailand, all getting into monetary easing. India cost of capital stays high. So, either we should have greater flexibility ot Indian companies to raise global capital without the restrictions of induced, tenor and sky's pricing, they could raise rupee bonds for instant treasure. Or otherwise we have to get into now starting to lower the cost of capital. Our view is that most countries are frontloading monetary policy right now. India would stand out if it did not, it already is at a point where I should be hurting demand. A lot of the inflation right now is more food linked so, unless the monsoon turns out to be terribly bad.

Q: Would you still worry at this point in time with the forecasting a sub-par monsoon.

A: I think RBI will be wise to watch what happens in monsoons or early monsoons.

Q: So, rate cut in June?

A: No. Our view is that you would have, you could have policy rate cuts happening both in June and August. I would think that somewhere between a 50-100 basis points.

Q: 50-100?

A: In this financial year could be well be warranted. Not withstanding what it does to potentially the currency at the result of the US rate hike. But given the fact that there is slow down happening around the world, you need some monetary levers coming in to play. Sitting at the comfortable position which we are today relative to 12 18 months ago.

Q: The Reserve Bank governor talked about the minister of state finance, talked about a possibility of full capital account convertibility, how do you react in response to statements like that?

A: In my view and that is clearly my view, I have not discussed this with either the governor or the minister state of finance, but it is my personal view that India is still several years away from that, and wisely so. Now, that is not to suggest that we should liberalise the markets to allow greater depth coming into the bond markets, we should do that, we should very definitely reduce the cost of capital for Indian corporates by allowing them greater access off shore, let investors come and buy rupee paper traded on the Euro clear. Let us make sure that the restrictions come off for Indian companies to hedge their currency risks without being too prescriptive. All of that is a move toward capital account convertibility and frankly China has the same view. China has exactly the same view, internationalise RMB and then over time move into current account convertibility. But do I believe that we are a short distance away from being currency convertible as we are in many other parts of the world? I do not think so. And I do not even think that that is the way we should go. We should keep some credential notch, allow global access of capital but ensure that Indian corporates are hedged on the explosion. That is a much better way around it rather than completely opening markets to make it capital accounting.

Q: Do you see the infrastructure sector turning around anytime soon at this point in time?

A: Very clearly, I think the government has done the right thing over here. The government pushing down into the state companies building out the roads, the construction industry or the railways or the defence. The government needed to do that and it has done absolutely the right thing. And it is interesting how under the Modi government, the government is going to flex its balance sheets more and more in that direction while creating efficiency in those very state-owned enterprises. So, this is efficient allocation of capital going from the state. And with the other structural measure of the government has taken whether it is on the fiscal side, etc, the government does have some ammunition available to go down this path. But from the private sector, frankly the leverage balance sheets, the deeply leveraged balance sheets are still staying pretty levered. So, there is limited capacity for that to happen. Some of the balance sheets which are sitting on very long cash including global balance sheets which are sitting on very long cash. What people are doing globally they have actually done stock buy-back, they have actually done played out extra dividends, they have trillions of cash sitting on corporate balance sheets.

Q: Yes, if you are Apple, you have USD 194 billion.

A: Unfortunately they are not on infrastructure but you have a lot of infrastructure pension funds who are looking to yield and you have a lot of corporates and if you track those companies in those long only funds into India, along with the Indian companies which are sitting long cash, you have to get some of the legislation around the land acquisition bill to clear out. I still find that we will need patience on that for the private sector. Do not expect that that gets played out over the next year. You also need an interest rate environment which is more conducive for you to do that. And finally if you talk to the global investors, they would say does India really have absorptive capacity for a capital and are there instruments that we could invest into? So, it is a practical issue, it is not the intent, it is a practical issue.

Q: When I spoke with the railway minister, he said he has got a lot of interest in pension funds that are looking at the railway story in India. When I spoke with the roads minister, he said there is a lot of pension finds out there who are looking at the India roads story. But what are you hearing? Is this for real?

A: Is there real money sitting out there in trillions of dollars? Absolutely, yes. Does that wish to get into yield assets? Absolutely, yes. Historically that money has stayed in the developed world. Because of the fact that there is greater comfort with regulation and there is greater comfort with governments. So, as whether it is the railways or whether it is the road sector or whether it is the port sector, reaches out to these long owned pension funds, they need to be a greater amount of regulatory certainty and government backing and so, you may initially find that the government uses state enterprises to be the ones which actually raise these resources who have the corporate balance sheet and as a result the backing of the government. So, yes, huge amount of availability of money. The way to tap it is still right now work in progress.

Q: Insurance, the pension sector you talked about the liberalisation, you talked about foreign direct investment (FDI), defence, that seems to be a sector that is likely to attract big ticket FDI. Which are the sectors that you feel most confident about insurances specifically do you really see new players coming in, new foreign player coming in, new money coming in?

A: Actually we see new money coming in. We don’t necessarily see new players coming in because frankly it is very difficult to untangle what already exists.

Q: So the existing players hike that.

A: Again the insurance industry needs some regulatory changes. You need to build some open architecture platforms out there in terms of bank assurance but very clearly you will see capital come into the insurance world. At the end of the day you got to open up India more and more to global capital. Now that does not mean we move into capital account convertible, that is completely different. But open it up and this government has actually shown not just the intent but the alignment across ministries to do that.

So, I am of the camp which says right now in any global fortune 500 boardroom India is sitting as absolutely the market where the board wishes to discuss investment opportunities, growth opportunities. Where else is growth in this world. US, yes it has got the size and it should still grow in the 2.5-3 percent, absolutely yes, Germany, yes should grow at two percent, have had a great start in this year, UK looking reasonably strong, rest of the world is struggling.

Q: And emerging market is patchy.

A: Emerging market is very patchy, China has a size, it has a scale, it is very well coming to foreign capital but it is sliding down. India frankly remains the only economy which is USD 2 trillion economy and which should grow at 7.5 percent or north of that in the next few years. So, when the world’s watch is growing at zero to one percent in deep deflation starts to look around what would they do with the trillions of cash sitting on corporate balance sheets. They can’t keep buying back stock and paying out dividends. India naturally becomes the recipient and Prime Minister Modi has done in my view an exceptional job of making sure that the structural reforms happen so that when money flows in it is coming with much greater confidence, meanwhile the public sector, enterprises will have to do the heavy lifting which frankly is something he is a believer in his world and it is absolutely the right idea. You could well see China as it transforms itself into a consumption led economy actually kick-starting investment back again to make sure that in the short term they don’t slip too far.

Q: Since India continues to be at this point in time the bright spot as far as the global market is concerned and the global economy is concerned what would be the single biggest risk, domestic risk for India and the single biggest global factor that could turn things awry?

A: The single biggest risk for India to me is notwithstanding all the assumptions around inflation if inflation gets out of control. If inflation gets out of control led by either poor monsoons or spikes in food prices for different reasons I just think the ability then to move India into a growth phase gets seriously constrained. So, to me the biggest risk in India still remains inflation and the biggest risk globally risk right now is anywhere between a disorderly events happening in Europe, the Europe actually right now from Grexit to Brexit to what happens in Europe. We need Europe to stay together, stay in a growth phase and China. Those are the two.

US we are talking about a growth in the 2.5 to 3.5 range on a bad day, good day. US moves the needle but I don’t think it is going to get into a shock. You could have external events between China and Europe which frankly would be a big worry and in India it could be inflation driven either by food or energy. Those could be the biggest risks I see for India. I am really not concerned about tactical portfolio money shifts from one quarter to the other quarter. It has been a wonderful quarter for China as far as portfolio investors as concerned, it has been a wonderful quarter for them as far as sort Euro stock 600 is concerned, that doesn’t worry me. Portfolio money will come to where clearly fundamental growth will emerge and India should be a beneficiary based on everything which has been done over the last 12-18 months.