Balance between regulation and credit flow vital, says IIFL's Nirmal Jain

Jain, also managing director of IIFL Finance, weighed in on earnings misses in the second quarter ended September and said that relative expensiveness of Indian markets was one of the factors behind the record foreign institutional investor (FII) outflows in October.

Edited excerpts of the interview:

What will be the impact of strengthened provisioning for non-banking financial services companies (NBFCs) and curbs on loan disbursement by certain micro-finance institutions (MFIs)?

The RBI’s tighter provisioning norms for NBFCs and high interest rates in the MFI sector aim to enhance financial stability and mitigate risks. While these measures protect borrowers and ensure sector health, they pose challenges for financial inclusion, especially as these firms serve unbanked and underbanked communities. Striking a balance between regulation and credit flow is crucial to avoid negative long-term impacts on financial inclusion.

Does the rising share of personal loans as a percentage of non-food credit worry you?

The increasing share of personal loans, which represented 30% of non-food credit as of June 2023, has raised regulatory concerns due to the risk of defaults, especially with unsecured loans. Reports of rising delinquencies among over-leveraged retail borrowers highlight this issue. The RBI has responded by implementing stricter regulations, such as higher provisioning for NBFCs and (has been) nudging MFIs to keep interest rates lower. Continuous monitoring is essential to prevent middle-class overleveraging, maintain asset quality, and uphold financial stability.

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Do you see credit growth continuing to outstrip deposit growth of banks?

An elevated C-D (credit-deposit) ratio, which hit a decade-high of 80.3% in March 2024, signals that banks are lending a large portion of their deposits, potentially leading to liquidity challenges. While credit growth remains robust, recent data (as of September 2024) shows a 7.3% increase compared to December 2023, indicating moderation. Deposit growth still lags credit growth, prompting RBI to encourage banks to adopt innovative strategies to boost deposits. The gap is expected to narrow, with banks focusing on improving deposit mobilization to maintain a balanced C-D ratio and ensure liquidity.

 

FIIs sold heavily last month. Will this trend continue or pause after the US election results?

One major reason for aggressive FII selling is the relative expensiveness of the Indian market, which trades at 22x one-year forward earnings, comparable to other emerging markets and the US (also at 22x). Strong domestic flows have supported market levels in India, preventing significant corrections that might slow down FII selling. Therefore, even after the US elections, FII selling could persist for a while.

Which candidate is better for India—Trump or Harris, and why? How would the markets react?

The choice between Trump and Harris involves nuanced considerations, as each has distinct advantages and drawbacks. Trump's presidency could enhance India's strategic and defence ties as a counterbalance to China. However, his unpredictable economic policies—like increased tariffs and stricter immigration rules—might disrupt markets and affect India's trade and talent pipeline. On the other hand, Harris’s leadership would likely continue current policy trends, fostering stability in international alliances and trade, benefiting emerging markets like India through predictability and steady growth. However, her policies may lean toward progressive measures that could impact corporate taxation and global capital flows. Markets would weigh the strategic advantages of Trump's high-risk moves against Harris’s steady, predictable policies.

If FII selling continues this month, can MFs act as effective counterweights given that they could have deployed the cash they were sitting on?

In the short term, SIP (systematic investment plan) inflows should continue enabling domestic funds to counterbalance FII selling. However, as witnessed in recent months, the market has struggled to maintain the Nifty at 26,000. Persistent FII selling could lead to testing lower levels. Additionally, with earnings growth momentum remaining weak and initial signs pointing to aggregate PAT (profit after tax) growth for Q2 (September quarter) of less than 5% YoY (year-on-year), market levels may remain suppressed. If growth does not pick up and the market underperforms, there is no assurance that domestic SIP inflows will stay strong. Nonetheless, the long-term outlook for the Indian economy is positive, indicating robust SIP flows over time, despite possible intermittent corrections.

Has the market pullback been primarily driven by missed earnings growth in Q2?

Earnings misses, particularly in the staples sector, have indeed contributed to the market pullback, as rural recovery has been slower than anticipated. While capital goods companies like L&T have shown strong performance and electrical infrastructure suppliers have posted decent volume growth, indicating infrastructure progress, private capex is also gaining momentum. Banks have been cautious with loan growth to align with their loan-to-deposit ratios, and OMCs (oil marketing companies) have taken significant inventory write-downs due to crude price corrections. But softer crude prices are actually a positive for earnings and the economy. Mid-cap IT companies have mostly met or exceeded expectations. Overall, aside from commodity companies, the market has managed to stay afloat.

This year has been exceptional for fundraising. Will the trend continue, or are retail investors becoming more cautious?

The quality of IPOs has been high with companies like Hyundai and Swiggy, known for strong management and solid business models. Unlike past cycles, there has not been a flood of low-quality offerings. Most recent entrants are mid-caps, and their high valuations have led to reasonable IPO pricing. Our data shows that most IPOs over the past three years have provided market or above-market returns from their listing price, even if not from their first-day close. This trend is expected to continue.

Will the RBI cut rates in the upcoming policy meeting?

In my view, RBI should consider a rate cut soon, given the clear signs of weak corporate earnings and consumption growth. While RBI remains cautious about inflation, global trends indicate cooling inflation, including in the US and Europe. Although food inflation has stayed elevated in India for nearly two years, it hasn't spread widely. Globally, monetary easing is underway, as seen with rate cuts by the US Fed and ECB, reducing the risk for RBI to begin easing, potentially in December.

Which sectors are you bullish on, and which would you avoid in Samvat 2081?

The IIFL Capital research team is bullish on hospitals, insurance companies, power sector businesses, and OMCs. They advise caution on expensive PSUs, defence stocks, overvalued mid-caps, smaller banks, and consumer staples.

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Will you increase allocation to gold or fixed income, or keep it unchanged?

We are entering a global monetary easing cycle, during which gold typically performs well. The opportunity cost of holding gold is declining, and geopolitical risks are rising. Central banks are also increasingly concerned about currency weaponization as a sanction tool, supporting continued gold demand. Although gold prices have risen, maintaining some allocation is advisable.

For fixed income, we expect yield compression due to cooling inflation and global bond index inclusions, which could provide medium-term bondholders with good returns. Thus, fixed income exposure is recommended for a balanced portfolio. Allocation depends on existing portfolio composition, risk appetite, and cannot be generalized.

What are the odds of a prolonged correction for retail investors who joined late in the rally?

We are at a low point in corporate earnings growth and GDP. Further deceleration is unlikely, and monetary easing will provide support. Private capex is expected to pick up in the next 12-18 months, creating a strong base for the Nifty. Persistent FII selling could limit gains, but as growth resumes, equity markets should deliver returns, likely in the low double digits.