Sunil Subramaniam, Market Expert, talks about three red flags we should be aware of. The first red flag is a very contrarian one. The inflation is coming down and that is good from a rate cut, good from RBI but for the rural economy, if food prices come down, the money in their hands is going to be down. If this inflation stays low, India’s nominal GDP will come down to around 9% from the 10% that we expect in the Budget. The stock market relates to nominal GDP. So Subramaniam does not want this low inflation to persist and prefers a decent 3-4% inflation. The second red flag is the Rs 1 lakh crore that people got in the Budget are being saved rather than being used for consumption. If savings does not convert into some spending, companies’ earnings are going to disappoint. The third flag is a Fed rate cut may push RBI to go for another 25 or 50 bps rate cut. Another 50 bps rate cut will signify that the RBI is worried about India’s growth prospects.
S&P has upgraded India’s rating to BBB, how do you see this as a significant parameter for investor sentiments?
Sunil Subramaniam: First of all, we got to look at the reasons for the upgrade. Mostly, it is just the statement of the upgrade and two things they have spoken. One is the government’s move towards fiscal consolidation. The second is the RBI’s supportive monetary policy. If you look at it, that means they are looking at the fundamentals. They are looking at how the country is being run. When we look at a stock, we look at the corporate governance of the stock before deciding because markets will come up and go, business will go up and go. How is the owner of the business managing his business in the proper way? Has he proper planning?
Similarly, for that, the equivalent of the owner of a business is the RBI plus the central government, the fiscal and the monetary policy. So, the big thumbs up to the way the country is being run, and that is one thing. From that perspective, you realise that this has come after the announcement of the tariffs which means that the bad news of the tariffs on the economy and everything they have taken into account with the confidence that the fiscal plus the monetary policy will take adequate action to compensate for whatever the loss is due to tariff. It is a very forward-looking rating to have come out at this point.
Just after the RBI governor had stated that growth is fine, the tariffs came and hit us. One would have worried whether the rating is going to get impacted by the tariff, but this has come after the tariff announcement. I would say that it is a big thumbs up to the way they see our country managing and they think we can handle the tariff situation.
Second, this rating upgrade is from an investor sentiment. For DIIs, I do not think it really mattered because DIIs were flushed with money, they were always confident about India’s growth story and they have been consistently buying driven by the investors giving them money. But there are various types of FIIs out there and I will point to two types of FIIs here. 
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The first is the long-term FII. They look at a 10-15-year growth outlook. For them, the risk and reward play a part. In this country, how much risk I am taking because I know India’s growth story is good. Now that the risk has come down a notch because of the rating, their confidence in allocating more to a growth country like India will go up. I expect long-term FII flows to come in. The second is the short-term FII, like a hedge fund. What they see in the short run is things like oil prices going up and down, things like currency going up and down. One of the things that a rating upgrade does is that it makes the currency stronger because the riskiness is a factor in the currency. Once you see that, India then is not going to depreciate so much. For an FII who is taking a punt on India or another emerging economy from a three, six-month time frame, the loss from currency will be much less from a country that has just been upgraded. So, their inclination to allocate more to India will go up and one portion of hedge funds in fact do not even apply their brains to it. They do algorithmic trading, that is they feed data into a computer which throws them up the number and very often the computer executes those trades. Once this rating is fed into the system, India’s eligibility to get more money automatically sits up and I would expect some amount of buying to step forward. So, that rating by an US agency goes a very long way in these uncertain times.Yes, and that is a reality check for the US as well. I want three red flags that you would want to count for us now going ahead.
Sunil Subramaniam: The first red flag is a very contrarian one. The inflation is coming down and that is good from a rate cut, good from RBI but for the rural economy, if food prices come down, the money in their hands is going to be down.
Further, if this inflation stays low, India’s nominal GDP will come down to around 9% from the 10% that we expect in the Budget. The stock market automatically relates to nominal GDP. I do not want this low inflation to persist. A decent 3-4% inflation is acceptable and should be there. So, my biggest worry is that continuation of this low inflation scenario will hurt the mood. If you go back to 2018, it was a negative rural inflation which led to the slowdown in the Indian economy. So, my biggest red flag is let this inflation not keep slipping into negative territory and very low. It should be decent.
The second red flag is that people are taking the Rs 1 lakh crore giveaways from the government and putting it into savings. We are seeing that in the mutual fund flows in the SIP book. I want them to spend it. They are still not showing the inclination to spend the money that the government is giving to them. This festival season is a big examination for that. In this exam, if people do not switch into consumption, unless there are mode changes to buying, it is not going to be good from a stock market earnings perspective because just saving everything means that the mutual funds will go on buying and the valuations will remain high unless the growth comes and justifies it. If savings does not convert into some spending, earnings are going to disappoint.
The third red flag is that if the Fed does a rate cut – and there is a 95% probability of a September rate cut – the pressure on RBI to do another rate cut is there. If the RBI goes for a further 25 basis points rate cut, that is okay. But if they show a 50 basis points rate cut, it is a red flag for me. Why? Because that means RBI is worried about growth. I do not want that to happen. The market prays for more and more rate cuts. Yes, it is a short-term bump up the market will get. But long-term, if the RBI is going for a 50 bps rate cut, it means there are some worrying signs on the growth side.
The pharma sector is also seeing signs of volatility. Pharma is not just a sector but it has sub-sectors in it where we talk about healthcare, diagnostic, laboratory, CDMO, hospital. Is this dip an opportunity to enter or is this volatility rather an opportunity to enter?
Sunil Subramaniam: The big fear is what Mr Trump is talking about, that tariff on pharma will ultimately go to 250% or alternatively putting pressure on the pharma companies to reduce prices which means it will be at the cost of margins. So, that is the one big uncertainty which is affecting pharma because the earning season for pharma has been fairly decent. So, to that extent I would suggest a balanced approach to pharma which means you balance your portfolio between external oriented generics and CDMO and domestic oriented hospitals, diagnostics, and the likes because the earning season has been good, and it is a defensive sector.
When FIIs come back, they will definitely allocate to pharma, except for what Trump does about pharma is a big question because there are two views about that, Ultimately the US government foots the healthcare bill and any tariff can mean that the US’ subsidy goes up so the cost will have to be borne by the government and not by the consumers there. So, I would say it is better to hedge your bets in pharma, stick to that as a reasonable part of your allocation, but balance it between external oriented and domestic oriented so that you are protected in the event of some bad news, at least the domestics will come and support you.