In a discussion with ET Now,CEO,andCMD,discuss the big picture and how demonetisation will impact the market.Edited excerptsFor an old timer this may just pass as a structural change.It is a structural change. This one big step (demonetisation) has completely changed the way India has functioned all these years. Fundamentally, it is making India far better.Where I see a big picture change coming in is that the macro variables such as fiscal has been challenged for the country and largely due to the fact that tax compliance in the country has been relatively poor compared to most of the Asian economies.The tax to GDP ratio is still about 12.5%. The number of people who are actually paying tax, filing a tax return is only about four crores. The number of people who are paying more than a crore of rupee tax despite India having a large pool of wealthy people is only about 48,000 or 50,000 as per the income tax statistics.Therefore, this actually brings a complete change in this segment. Then, second is the inflation. The last almost about decade or so India has been struggling with high inflation mainly because food inflation has been high and the consumer ability to buy assets at any price led to higher price increases and this has been another big factor which hopefully will change because of demonetisation.The last but not the least, with GST coming in, the whole black economy is getting reduced significantly and becoming part of the main economy. This has to lead to an increase in taxes. Many times, when you go to swipe your debit card or credit card in any of the jewellery or other shops, they say if you give cash, you can save 2% tax. But the whole system could change which ultimately lead to an increase in tax collection, therefore fundamentally it is a big change that has been brought in for the country which will have an impact in the longer term in making the fundamentals of the economy much stronger in relation to the most of the global economy.But can markets afford this kind of fundamental change when earnings have not been great? The only engine which was working for us was the consumption engine. Investment cycle has not picked up. Exports are slowing down because of the global situation. Indian markets were expensive and there was a hope that earnings recovery will take markets higher. Now that hope has got dashed. Your biggest engine or the biggest humming engine which is the consumption engine has now got stalled. So I worry about the aggregate picture.: What you are saying could be true but I think it is a temporary phenomenon. While the consumption pattern in the country has been the biggest driving factor, we also need to understand that consumption pattern is rising because of a ) increased level of income in the hands of people and that is not going to get reduced significantly because of this factor. b) Agricultural output. As long as agriculture output is high, the rural economy does well, then you will see the spending pattern remaining high. c) Of course, is the government spending initiated towards building the infrastructure, mainly towards increasing employment. In the last few years, the Government of India has been the biggest spender in terms of creating the infrastructure and therefore increasing employment.The government is able to bring the focus back to the broad economic growth. Then the consumption led growth need not necessarily got impacted. Even in the recent past and the last one year, all of us have turned extremely bullish on consumption pattern. It is mainly because of Seventh Pay Commission payout that has happened. Is the story changing? Absolutely no.Yes in the longer term, of course, things will settle down but in the interim, how long will it take for the market to price in, to digest all the adjustments because in the near term, earnings are bound to get impacted.It could be about two or three quarters maximum. Even one of the largest consumer driven companies have appreciated from their own business point of view despite knowing the fact that it will have an impact on their own business for the next one or two quarters.I think the question is should we take such a big decisions looking at one or two quarters impact or should we take such decisions taking note of longer term healthy structural growth that could be delivered for India as a country?All of us and maybe the large pool of Indian consumers have to look at it from the longer term point of view. Even as a money manager, investment managers look at whether this actually lead to sustainable growth for India in the longer term though it will come at the cost of the short-term impact. The answer is yes. The other assumption is though a lot of people have been worried about two wheelers sales, the decision of the consumer who actually wants to buy a car or maybe a two wheeler is not based on the cash he has. His decision is on the basis of what he wants actually. Therefore, if somebody is buying a two wheeler in semi-urban rural economy, he will go and buy whether he has cash or whether he has money in the form of bank account.The way the traders, intermediaries, maybe the dealers who actually have been largely accustomed to doing transactions only through the cash, need to change it. This will take some time.Bajaj Auto said in an interview that their sales will fall 25% in November. Do you think that will be short lived? Can it bounce back by January-February or do you think it will take longer?One of the questions which I have been asking myself is when do things come back to normal? Today the sales drop is not because of note bank. I do not know how money is to be spent. I have money in the bank account but I cannot withdraw it and the money that was otherwise available in my hand for me to spend is not there. So there is a change of behaviour that can lead to actually drop in the sales. What they are saying could be true but once the system comes back to normal, the spending has to come back. The other one fundamental may be the behaviour which has to change.There is need-based spending and luxury-based spending. Whether the luxury based spending is going to continue for some time will be a question mark and most of us would also realise that in the last one and a half months, I have cut down my expenditure so much and is my life changed? Has it actually inconvenienced me? If the answer is no and then probably the spending pattern is especially in the luxury goods items may see some kind of impact. One has to be prepared for a slowdown in terms of spending.Everyone is saying that inflation will come down. But inflation is also a function of global commodity prices. If global commodity prices come down, inflation will go higher. So I really do not buy the argument that inflation will come down structurally.Of course, while the point is right, even structurally if you look at the commodity cycles globally, it is now reaching a stage where the supply demand gap is more or less getting balanced and we are not seeing significant spending towards infrastructure or various other spending which will drive the commodity prices globally.Most of the global economies, the producers of the commodities are also now looking at a stable cash flow rather than actually a cash flow which is extremely volatile. Therefore one of the assumptions that we have to make is that the commodity prices will remain largely stable.Second, in the last few years the Government of India have taken many steps to ensure that despite they need to take care of the farming income, and they were not kind enough to increase the minimum support price which has been one of the primary drivers of inflation.Even this year, the Government of India did not increase the minimum support price. That means they are quite conscious about keeping inflation under control.Third of course is the fact that middleman drive up inflation which of course eats up the margins. They took steps on the food inflation and have reduced the power of the middleman.If you could put all together and this demonetisation coming in, then we will probably see the inflation staying relatively under control.What do you expect RBI to do in December 7 policy because of demonetisation and also due to the sharp depreciation in rupee as dollar has strengthened globally? How will this equation shape up over the course of the next three to six months?As far as the currency movement is concerned, with $4-5 billion FCNR (B) outflow before the demonetisation exercise, actually led to some rupee depreciation against the US dollar. But having said that, India with the change that we have seen probably will see biggest inflows among the emerging markets in the bond market and mainly on back of recent RBI move.The repo rate is about 6.25 and the bond yields are close to about 6.25 and short term rates will also factor in rate cut. Knowing the way the RBI has been seamlessly looking at various factors and the expectation that is building up about a rate cut in December. At best we can expect about 20 bps rate cut in the December though the market is expecting about 50 bps cut.Also the way the bond markets have behaved to ensure that liquidity is back to normal and RBI has announced CRR hike to mop up excess liquidity, may be once the government approval comes and the RBI also has to take continuous steps to ensure that liquidity is not the primary reason for the price increase. These are some of the things I think we need to expect in the next few months.: So from an investment perspective in the next two to three quarters if this sector is to correct because of the demonetisation, is now the time to chip in money because eventually from a one year timeframe, these sectors could be winners?Yes, exactly.All of us are looking at what could happen this quarter and what could happen in the next two quarters but at the end of the day we need to accept the fact that the entire thing is being done with a clear deadline.A lot of people have been suggesting that demonetisation exercise should have been carried over a five-year period. But that would be extending the uncertainty over a five-year period.Having now put a deadline of 31st December and probably 31st of March, we are working with a deadline that means that the people will actually takes the next level of steps as this gets completed which will help the economy rise to the next level.Therefore the one quarter impact that we are seeing in terms of the price movements has to be seen as an opportunity for one to look at the individual businesses.While we talk about consumption and companies like Jyothi Labs, we were looking at what HUL has done since November 9th.Precious little, the stock price has just not had any kind of an impact, a lot of volatility maybe but completely flat. So maybe FMCG is not being battered down so much but pure play consumption names, consumer financing names have all gotten impacted and the prices have corrected. Is that a space you would look at? Would you look at those battered down names as an investment candidates, selectively but will you look at them?: Not necessarily. One of the big picture is coming in, is that with the change in the impact of the demonetisation, the large pool of the private financials who have been charging the customers at exorbitant rate of interest, could get collapsed.: And will go to?: And will go actually to the organised players.To banks and MFIs both?: To the banks and MFI, both, that is one. Second is a large pool of consumers who have been actually used to paying all these years say per month rate of interest of 2%, 2.5%, 3%, all of them actually will start wondering why should I borrow at these levels, I will rather go to the organised players and borrow at a lower rate of interest where the interest rate cost actually for the large pool of common man will come down. There are many people who borrow anywhere between Rs 1.5 to Rs 10 lakh. For all such consumers who have been paying their income only for paying the high cost interest payment and that segment will collapse and they will probably actually-- be able to tap the organised channels including the PSU banks and private sector banks with retail loan books.You said three-four quarters of earnings dampener may be. What about equity markets correction? Is it done with?It is, more or less. Market does not give time to correct for too long and any event that is an unexpected, gets punished. The way we have seen the market correcting in the last few days is quite significant and may be the downside just from here it is gets significantly reduced. Post 31st of December, things will be back to normal. Look for the budget and how the GST rates are going to be fixed. All of that will start driving the growth momentum. If that sustains, then people will gradually forget about reduced earnings expectations which I would assume is getting priced in with downside getting limited.How has the month of November been for you has there been a sharp drop in offtake of products?As far as our products are concerned, there is a little impact on FMCG segment because of the currency demonetisation, otherwise the rural sector is very buoyant . 80% of the country has received a good monsoon.When you say little can you define little for me is it 5%, is it 10%, is it 15%, is it 20%?See about 80% of the country has got good monsoon and it is having an impact in the agricultural produce and employability and has given us a good demand in the rural sector, But for the hitch of this demonetisation, it should have been much more better.One of the assumption that is being is made that the whole demonetisation would actually change the way the unorganised channel will move towards organised channel and from your business perspective or from the large consumer driven business perspective, do you see that big change is actually coming from the country as a whole?Yes, to a great extent.The other point is the way that GST is introduced. Then we probably will see tax compliance especially with the change in the tax structure come into place. This will provide a huge opportunity for branded players as smaller players will get crushed out. So from a market standpoint, how can one capitalise on this big reset?If you look at one of the bigger segments which is real estate, we have fragmented players operating in different markets across the country and we can call it organised channel. The bigger people who actually are driving this segment. And a lot of these unorganised players who also have been driving locally. With the change coming in, increasingly people who are taking the bets on the unorganised channels as a consumer will probably shift towards organised channels that is one assumption.In financial markets, history does not repeat itself but it rhymes and history is rhyming again, FIIs are selling. So for a smart buyer if you buy right now, can returns be strong in next one year?I think you should not look at one year. I think you should definitely look at the longer term.Have you been a buyer in the recent fall?Yes. In a fall, there are two types of activities. One is position yourself in your portfolio pre-demonetisation on basis of seven assumptions which of course worked well for the last so many number of years and you get that marginally corrected that is one. Of course, what all portfolio managers do is take into account the impact of demonetisation.. There are stocks actually which have fallen by about 30%, 40% and there are stocks that have fallen anywhere between 10% and 15%. Then, look at them, actually go back and revisit them from the point of view of fundamentals. At the end of the day what we have seen that while the broad market is bound to be volatile, there are many sectors which are doing well.Give me an example. Let us say on 7th November, before demonetisation was announced, what was the flavour of your portfolio and today because of demonetisation which is a big structural reset, what has changed in your portfolio positioning?Are there some sectors where you said you are going to get out because there are some sectors and stocks which you are buying with the view that you may lose 5% but in next two-three years you will make 15%, 20%, 25%.I think clearly one of the segments where we were relatively overweight on the basis consumption theme rising, is in the NBFC space. We have also been bullish on private sector banks but at the same time we are little large overweight on NBFCs which has done excellently well last almost for three-year period. But post demonetisation, we have to of course take some bit of course corrections and then make portfolio changes. And the other sector is commodity sector. Today with returning stability, profitability may improve for the that sector. We have also gone a bit overweight on commodities as a sector more as a tactical call and also the oil marketing companies.: Bala which was the first stock you bought in your life?: Of course, that was the time of my when I started building my career in companies like Reliance Industries which used to come with an IPO and…: You actually bought the Reliance IPO?Yes. Even my father had made investments in Reliance Industries not as Reliance Industries but in Vimal…