As per the latest RBI data, liquidity deficit
as measured by fund injections by the Reserve Bank of India (RBI) into the
banking system was INR1.47trn as of September 18, the highest since April 2019.
The Reserve Bank of India (RBI) injected Rs
1.47 trillion on Monday and Rs 1.46 trillion on Tuesday. Market participants
believed that the disbursement of Rs 25,000 crore as the second tranche of
incremental cash reserve ratio (I-CRR) will not be enough, and the liquidity
might tighten further to Rs 2 trillion in short term due to tax outflows and
arrival of the festival season.
“For now it looks like going into the festival
season there would be more outflow and cash leakage from the system. It will
lead to higher deficit for the banking system,” said Naveen Singh, head of
trading and EVP at ICICI Securities Primary Dealership. “There are other
factors at play. We are not seeing much dollar flows coming into the system and
the RBI has been continuously defending from the other side. We are not seeing
any inflow from the Fx (foreign exchange) side, and the RBI is not in the mood
to add durable liquidity in the system. Gradually, the liquidity deficit might
go up to Rs 3 trillion, but not in the immediate future,” Singh said. (Business Standard)
Advance tax payments took place last week,
while outflows towards Goods and Services tax will be completed by Wednesday,
with bankers estimating aggregate outflows of up to 2.50 trillion rupees. The
impact has magnified as the twin outflows have occurred in the same reporting
fortnight, at a time when a chunk of the money is not available for use as it
is blocked in the incremental cash reserve ratio (I-CRR). Moreover,
"another drain on rupee liquidity could be from RBI's (Reserve Bank of
India) FX intervention if depreciation pressures on the rupee persist,"
said Gaura Sen Gupta, an economist with IDFC First Bank. (Zawya.com)
The RBI had decided on September 8 to
discontinue the I-CRR by October 7 in a phased manner. Out of the total I-CRR
maintained, 25% was disbursed on September 19, another 25% on September 23, and
the remaining 50% will be released on October 7.
For the past nine months, the fears of slowdown
have been totally unfounded. India’s real GDP growth was better than expected
(at 6.1% YoY) in 4QFY23 and then improved in line with expectations (at 7.8%
YoY) in 1QFY24. Not only India, the US economy too has been much more resilient
than our predictions at the beginning of the year.
In view of this, we upgrade India’s real GDP
growth projection to 6.0% YoY for FY24 from 5.6% YoY anticipated in Jun’23 (and
vs. 5.2% YoY in Mar’23). We, however, keep it broadly unchanged at 5.4% for
FY25E (projected at 5.5% in Jun’23). Further, nominal GDP growth forecast is
also kept unchanged at 7.8% for FY24, since higher real growth is entirely offset
by a cut in GDP deflator forecast. It is likely to improve ~10% for FY25,
slightly lower than earlier projection.
After lower-than-expected retail inflation in
Apr-May’23, CPI inflation has been much higher in 2QFY24 led by vegetables, pulses
and spices. Accordingly, we raise our CPI inflation projection to 5.6% for FY24
(from 4.3% earlier) with a slight upward revision in FY25 (to 5.3% from 5.0%
earlier). Accordingly, due to downward revision in GDP deflator, the nominal
GDP growth forecast is kept unchanged at 7.8% for FY24, and ~10% (from 10.5%)
for FY25.
India’s merchandise trade deficit widened to
USD 24.2bn in Aug’23 (USD 20.7bn prior). Although August marked a moderation in
decelerating trend in trade activity during last four months, however it is too
early to call it bottoming out of the weakness in overall trade.
Manufacturing PMI indicated improved export
demand, which we believe will reflect in India’s exports data in the
forthcoming months. Services exports declined for the first time, this is
in-line with the weak guidance given by the Indian IT companies. As crude oil
prices are expected to remain elevated in the near term, it adds to the upside
risk to India’s external imbalances. We re-iterate our expectation of CAD at
1.4% of GDP for FY24.
Trade imbalance widens further: The sharp deceleration in trade activity during the past four months,
moderated in Aug’23. However the decline in exports (-6.9% YoY) was sharper
than in imports (-5.2% YoY). Strong sequential gains in imports (10.8% MoM) vs
in imports (6.9% MoM) widened the trade deficit further to USD 24.2bn in Aug’23
vs USD 20.7bn in the previous month. On a FYTD basis (Apr-Aug), trade deficit
of USD 101bn in FYTD24 is lower than the levels seen in FYTD23 (USD 113bn).
Flat core exports; First decline in
services exports: At USD 34.5bn, India’s
exports continued to decelerate with strong sequential gains (-6.9% YoY, 6.9%
MoM). Non-oil exports remained flat (0.2% YoY) however the fall in oil exports
was sharp (-31% YoY). India accounted for 40% of global rice trade in 2022, the
ban on exports of parboiled and broken rice was supplemented with exports duty
(20%) which reflected in the sharp decline (-10% YoY, -4% MoM) in rice exports.
As per the findings of the manufacturing PMI, export orders have been robust
even in Aug’23. Firms reported incremental orders from Bangladesh, China,
Malaysia, Singapore, Taiwan and US which we believe should reflect in the trade
data of forthcoming months.
While on the services front, exports (prelim)
declined (-0.4% YoY) for the first time in Aug’23 (Ex 5) after showing signs of
moderation since Apr’23. Since software forms major portion of our services
exports, this fall can be attributed to the reduced demand for software exports,
as reflected in the moderating deal wins by Indian IT companies.
Continued deceleration in imports: The deceleration in imports continued for eight months in a row,
however recorded a consistent growth of 10% on a 4yr CAGR. Sequential uptick in
Aug’23 (10.8% MoM) is unlikely to sustain. Close to one fourth of India’s
imports consists of oil imports; the sequential gain in oil import (12% MoM) is
on the back of an uptick in crude oil prices. We expect that the crude oil
prices to remain elevated in the near term which will exert pressure through
rising oil imports. Coal imports (-43.5% YoY, -6% MoM) are at its lowest in
last two years (USD 2.6bn), which is reflecting the downtrend in coal prices
after it peaked in May’22. At USD 4.99bn, Gold imports (38.8% YoY) were the
highest in last fifteen months. Imports of machinery and electronic goods have
been consistently growing with 4yr CAGR of 7% and 10.3% respectively. But with
the ban on imports of laptops and PCs w.e.f 1st November, it is
highly likely that imports of electronic goods will moderate.
Crude oil prices expected to remain
elevated; CAD expected at 1.4% of GDP: Rising
crude oil price is capable of impacting India’s external balance, India crude
oil basket has risen sharply by 8% to USD 86.4/bl in Aug’23. Brent crude prices
breached the USD 94/bl mark after OPEC’s prediction of supply constraints in
the oil market, estimating an oil deficit of 3.3mn barrels (mbpd) while IEA
estimated a moderate 1.1 mbpd deficit during Q3FY24. We expect these prices to
remain elevated in the near term as this spike is not demand-led but it is
engineered through curtailing supply by oil producing countries. On the demand
side, we expect China’s demand to come online in a gradual manner. Hence any
expectation of pull back in prices will only be on the back of increased
supply. Our expectation of CAD at 1.4% of GDP in FY24 would be at risk if
monthly run rate of trade deficit breaches USD 20bn mark (Currently at USD 20.2bn).
We take a deep dive into the liability profiles
of India NBFCs in light of regulator (RBI) caution on NBFCs’ elevated reliance
on bank funding (link ) and further increase in yields across different
constituencies by ~10-15bp since 1Q24. Our analysis of rates and liability mix
of NBFCs shows that cost of funds (CoF) should peak out by 3Q24, after rising
~30-40bp from 1Q24 levels. This quantum of increase is higher than guidance
given by most of the NBFCs. Further, the benefit of policy rate cuts, if any in
1HFY25, on cost of funds for NBFCs should be visible only in 2HFY25.
NBFCs’ reliance on bank funding remains
at elevated levels: As of FY23, bank funding to
NBFC/HFCs constituted ~57%/44% of their total borrowings. Further, bank loans
to NBFCs/HFCs have almost tripled to ~INR13.7tn in Jul’23 at a CAGR of 21% vs
12% for overall bank credit, with PSU banks having 65% market share in it. Bank
funding to NBFCs/HFCs reached ~64% of their net worth in 1Q24 (PSU banks: 102%)
vs 35% in FY17. We expect NBFCs’ reliance on bank funding to come down in
coming quarters, driven by a pickup in alternate sources of funding (e.g., bond
market/securitization).
Increase in CoF for NBFCs has been lower
than broader increase in interest rates: During
4Q22-1Q24, when repo / 1Y T-bill /1 Y Corp AAA yield inched up by 250bp/242bp/248bp,
most of the NBFCs/HFCs barring CIFC and SBI Cards saw a <100bp increase in
funding cost vs a >100bp increase for large banks. Compared to CoF of
3QFY19, when the policy rate was at similar level of 6.5%, cost of funds for
NBFCs are still lower by up to ~200bp.
Hence, we believe it is quite evident that
repricing of NBFC liabilities is still underway, as it happens with a lag both
in the upward and downward rate cycles.
Cost of funds could rise another ~30-40bp
from 1Q24, and likely peak out in 3Q24: We
expect CoF for NBFCs could rise another ~30-40bp from 1Q24 before peaking out
in 3Q24. This increase would be driven by 1) another ~10-15bp increase in
yields across buckets since 1Q24; 2) a further increase in cost of NCDs, as
coupon rates for maturing NCDs in remaining FY24/25 (~25%-50% of 1Q24
outstanding NCDs) are ~100-200bp lower than current yield; and 3) MCLR-linked
bank loans are still getting repriced upwards due to a lag. This CoF increase
of ~30-40bp during 1Q24-3Q24 is higher than the guidance given by most of the
NBFCs and the average 20bp increase built into our current estimates. Hence, there
could be ~1-5% risk to our FY24F EPS coming from pressure on CoF.
Benefits of potential policy rate cut in
1HFY25 to accrue only in 2HFY25: We expect benefit
of any policy rate cut in 1HFY25 on funding cost of NBFCs to accrue only in 2HFY25.
Bank funding forms >50% for NBFC liability side. While repo/T-bill linked
bank borrowings will get repriced downward immediately, it will take time for
MCLR-linked bank borrowings to reprice downward as well. Further, we estimate
that ~60% of a repo rate change gets transmitted into MCLR. On the bond side,
NCDs maturing even in FY25 has lower coupon rate compared to current yield
which is already factoring in repo cuts.
SBI Cards/Five Star/CREDAG to benefit the
most purely from CoF/spread perspective: Only
from funding cost and spread perspective keeping other things constant, SBI
Cards (SBICARD IN, Reduce), Five Star (FIVESTAR IN, Buy) and CREDAG (CREDAG IN,
Buy) should benefit the most in a declining rate cycle as only ~23%/27%/40% of
their borrowings are fixed, while the entire loan book is fixed in nature. We
expect LIC HF (LICHF IN, Buy) should be negatively impacted the most, as ~43%/99%
its borrowings/loans are floating in nature. Having said that, cost of funds is
only one of many factors we look at to arrive at our rating on various stocks.
A reverse valuation exercise of the major
listed defense stocks implies that they will capture the bulk of defense capex
in the future, which is contrary to historical trends. Indian defense stocks
have witnessed an explosive rally in their stock prices over the past few
months on expectations of strong spending by the government and indigenization.
We concur with the growth part, but are less sure about the implied
profitability assumptions.
Indian defense sector is showing signs of
exuberance
The Indian defense sector has witnessed a sharp
rerating and delivered massive returns over the past 3-6 months on (1)
expectations of large spending by the government for an extended period of time
and (2) steady increase in indigenization. Large deal wins of companies boosted
investor sentiment. In our view, the stocks largely factor in the
aforementioned positives, but not potential risks of (1) delays in ordering and
(2) lower profitability.
Listed defense companies will need to
execute Rs1.3 tn of defense orders PA
Our reverse valuation analysis based on the
current market capitalization of a basket of major defense stocks suggests that
these companies will need to execute around Rs1.4 tn of defense orders annually
to justify their current stock prices.
For context, these companies combined revenues
of Rs625 bn in FY2023. Our assumptions bake in the average margin profile for
these stocks (see Exhibit 5). We would note that we have not considered a
number of private companies (difficulty in segregating market cap. pertaining
to the defense segment alone) and government organizations (unlisted) in this
exercise.
Defense capex for domestic procurement at
Rs1.6 tn in FY2026E
India’s total defense capex increased at a CAGR
of 9% over FY2017-23, resulting in a steady decline in its share of overall
government capex. We note that India’s defense imports were around Rs400 bn in
FY2019-20. We estimate a market opportunity of Rs1.6 tn for domestic
procurement by FY2026 based on our assumptions of (1) strong growth in overall
defense capex and (2) low growth in imports due to indigenization.
As such, the basket of defense stocks will need
to capture a significantly larger share of India’s domestic defense budget
compared with history, even as more private companies are entering the sector.
Profitability may be bigger challenge for
companies and investors
We are not sure about the future profitability
of the defense companies, as (1) their current profitability seems to be on the
higher side, (2) the defense industry could become more competitive with the
entry of private sector players and (3) government may tighten procurement
terms (monopsony buyer), as domestic production capabilities scale up over
time. We would note that lower profitability assumptions will imply much higher
implied revenues, which may not be feasible in the context of the market opportunity.
We remain cautious on PNGRB’s decision to
implement common carrier for product pipelines due to the challenge it poses
for OMCs. OMCs own ~90% of marketing infrastructure including pipelines,
marketing terminals and depots. While pipelines constructed under bidding
process already have provisions for common carrier, older pipelines are still
lacking behind.
Overall utilization of product pipelines at 68%
in FY23 does present an opportunity to other interested parties including
private players. Pipelines provide the cheapest method of transportation, as
next best coastal is ~46% costlier while roadways are even twice as costly. In
addition to the cost of creating new infrastructure, uncertainty of obtaining
right of using land for laying pipelines remains a key challenge limiting
expansion of private players in product retailing. However, post implementation
of unified tariff of natural gas pipelines, we expect PNGRB to open petroleum
product pipelines, a step that may sound like fall of the last bastion for
OMCs.
Although HPCL/BPCL/IOCL are trading at
0.9/1.2/0.8x FY24 PBV, a look at their long term valuation charts suggests that
they could still correct from here. More importantly, the common carrier access
of product pipelines may result in sustained de-rating of these stocks even
lower.
Almost all marketing infrastructure owned
by OMCs: India has total ~22,500km of product
pipelines and ~5,000km of LPG pipelines, almost all owned by OMCs. There are
310 marketing terminals/depots, 91% of which are owned by OMCs. Out of 283
aviation fuel stations, 89% are owned by OMCs and 90% of 87,458 retail outlets
are also owned by OMCs.
Pipelines are the most critical part of the
supply-chain as their construction takes long time. Just to share a
perspective, Kochi-Bangalore gas pipeline has still not been completed even
after a decade of commissioning the Kochi LNG terminal.
Common carrier access could break the
oligopoly: Private players have largely remained
at bay (6-7% market share in sale of petrol/diesel in FY23) given 1) pricing interventions
in petrol and diesel resulting in non-competitive environment, and 2) high cost
plus time involved in laying marketing infrastructure alongside risk associated
with it. However, at times OMCs have bled in terms of losses in marketing
segment due to inability to pass on high cost to consumers, over a longer period
of time; they have shown resilient profits.
The common carrier access in product pipelines,
could thus, lower the entry barrier for private players, thereby challenging
dominance of OMCs over a period of time.
Marketing margins losses continue: Average HPCL and BPCL returns have under-performed Nifty by 15/7/6%
in past 3/6/12month, while IOCL’s performance has given 8% underperformance
against Nifty in 3 months (overperformed 3/16% in 6/12m) due to inability of
raising retail prices amidst rising crude oil prices. As per our calculation,
the gross marketing margin on petrol and diesel stand at Rs5.5lit and loss of
3.8/lit respectively in Sep’23 compared to Rs10.6lit/10.2/lit in 1QFY24 and Rs8.4/2.7/lit
in 2QFY24YTD.
