On Episode 968 of The Core Report, financial journalist Govindraj Ethiraj talks to Arvind Chari, Chief Investment Strategist at Q India UK (affiliate of Quantum Advisors India) as well as Piyush Pandey, Senior Vice President, Institutional Equity Research (Lead Analyst)-IT, Telecom, Internet and Power at Centrum India.

SHOW NOTES

(00:00) Stories of the Day

(00:50) Indian Markets Reel Under Oil Price Onslaught

(02:31) Rupee Hits A 10-Week Closing High

(04:59) India’s Banking System Will See A Liquidity Overdose Thanks To The $127 Billion Inflows

(17:53) ITC Infotech Is Merging With Ashok Soota’s Happiest Minds. What Signals For India’s IT Sector?

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NOTE: This transcript contains the host's monologue and includes interview transcripts by a machine. Human eyes have gone through the script but there might still be errors in some of the text, so please refer to the audio in case you need to clarify any part. If you want to get in touch regarding any feedback, you can drop us a message on feedback@thecore.in.

Good morning, it's Friday the 4th of September and this is Govindraj Ethiraj broadcasting and streaming weekdays from Mumbai, India's financial capital.

Our top stories and themes…

Indian markets continue to reel under the oil price onslaught.

The rupee hits a 10-week closing high.

India's banking system will see a liquidity overdose thanks to the $127 billion of inflows. What could be the impact?

ITC Infotech is merging with Ashok Sutar's Happiest Minds, one of the largest signals for India's IT sector.

Markets, The Rupee and GDP Numbers

It does appear that there is little way out for Indian equities from the grip of oil prices, which in turn continue to be driven by repeated US attacks on Iran.

There is no sign of the attacks stopping, perhaps for a long time, just as they have not in the case of Russia's invasion of Ukraine, which continues four years on. In the case of the Russia-Ukraine war, hostilities are perhaps at a much higher level now than before with Ukraine, for instance, inflicting real damage on Russia's energy infrastructure, which was not the case earlier. Both situations are putting pressure on global oil prices, which means the rupee and Indian markets will also remain subdued despite everything else, including some positive macro numbers.

On Thursday morning, Brent crude futures were up about $1.7, around $97.39 or just above $97, also erasing the losses that were seen earlier. Not surprisingly, Indian equities were down despite some of those positive macros that we spoke of, including Forex flows via NRI deposits and stronger-than-expected GDP numbers announced earlier in the week. More on that in a moment.

The benchmarks were subdued on Thursday, with the BSE Sensex falling as much as 2.5% during the closing auction, with the index extending losses on weekly derivatives expiry as volatility during the closing auction intensified, according to Reuters, which added that the closing auction session is already reshaping options trading, prompting participants to trim positions and ramp up hedges, as wild swings in the final 15 minutes make closing levels increasingly difficult to call. The Sensex fell 417 points to 76,152 and the Nifty 50 was down 41 points to 23,873. In the broader markets, the Nifty mid-cap and small-cap were also down 0.3 and 1.2% each.

The rupee, however, was strong and closed at a 10-week high on Thursday, thanks to the stronger-than-expected dollar inflows under the NRI deposit scheme, even as, according to Reuters, importers' demand pared some of the currency's earlier gains. The rupee closed about 0.5% higher at Rs 94.48, which is the highest level since June 25. India's dominant services sector accelerated slightly in August, but persistently subdued new business kept overall activity near its weakest in more than four years, according to HSBC's India Services Purchasing Manager's Index, or PMI, compiled by S&P Global, which rose to 54.1 in August from July's 53.3, but was slightly lower than a preliminary estimate of 54.5. Basically, a PMI above 50 signals expansion in activity.

That report was via Reuters. Elsewhere, there have been questions raised about the quality of the latest GDP numbers, including on the GDP deflators of negative 2.5% used, which HSBC economists seem to suggest is low. On the other hand, data that we see and cover frequently, like auto and housing sales, is looking strong.

Which could also mean that, among other contributors, growth is being driven by relatively affluent sections of society, though that's a different problem to address. In the US, by the way, artificial intelligence contributed to anywhere between 36 to 44% of GDP growth contribution for the second quarter of 2026, according to a note from ING Bank. HSBC, in the same report highlighting the deflators, says they use 100 indicators of growth database for India, which seems to be in sync with the latest GDP growth numbers.

Record High For India's Banking System Liquidity Surplus

India's banking system liquidity surplus has jumped to a record high with rupee liquidity surpassing levels seen in the post-COVID-19 days, even as banks raked in way more dollars than expected under the NRI deposit scheme. Banks have raised something like $127 billion through non-resident foreign currency deposits, and most of the amount has already been swapped with the Reserve Bank of India, leading to a sharp spike in rupee liquidity, according to a Reuters report, which added that bank liquidity surplus stood at about 9.7 trillion rupees, that's 970,000 crores or $102 billion, the highest ever recorded surplus, surpassing the 920,000 crores seen in September 2021.

Now, the surplus complicates the Reserve Bank's job of managing liquidity and overnight rates, with Brokinghouse Nomura noting that the Reserve Bank of India is facing a problem of plenty. According to a note written by Nomura's economist and reported by Reuters, they said that while some of the surplus will be offset by higher cash in circulation during the upcoming festive season, maturity of forwards and due to any potential Reserve Bank forex intervention, the Reserve Bank may have to employ a panoply of liquidity absorption tools to mop up this surplus. I reached out to Arvind Chari, Chief Investment Strategist at Q India UK, an affiliate of Quantum Advisors India, to understand what would be the downstream impact of this liquidity and what could be done about it.

INTERVIEW TRANSCRIPT

Arvind Chari: Let's just recap and now that we've ended the scheme, just go back and understand why India did what it did. And of course, we've had precedence of whenever we've had challenges on attracting capital flows, we've opened up the NRI route and we've always got flows. And 1998, 2003, 2013, we had multiple examples.

So of course, this was when RBI decided to do this, the RBI was already running, I think about 50 or $60 billion of net short. So they had sold dollars in the forward market for forward maturities, predominantly because we've had net capital outflows, both from foreign portfolio investors. And as we know from foreign direct investments, when they sold their private equity venture capital stakes, that money went out.

Then of course, as the war broke out, you had a significant increase in oil prices, and that could have impacted current account deficit and further flow. So that was the background in which India decided to do it. Some would argue that we could have done it later.

But also the fact that RBI was intervening very aggressively in the FX market, maybe to protect the psychological level of 100 to the US dollar, I think that played a fairly big part of about how we thought about which options and which to choose. And of course, we went through this FCNR. And this time, because we had experience of 2013, all the previous issues of whether banks can provide leverage, whether banks can issue letters of credit, I think they were all sorted pretty much in the first month.

So banks would go out and create kind of a product where this is your dollar interest rate, this is the leverage that you will take, and hence your return on equity would be X percentage points. And that was all broadcasted very quickly. So that's the background.

And that's where we've ended up by getting a lot more than what we expected. Like my initial estimate was that we need 5000 wealthy Indian NRIs in Dubai and Singapore to give us $100,000 each, which will get leverage 10 times, that's $50 billion. You know, so we could have got easily $50-75 billion.

But the actual amount is much higher, I think about $50-60 billion more than what even RBI expected. So that's where we are. And that's where we are standing.

Govindraj Ethiraj: Got it. So now this is obviously impacting liquidity. I mean, and we've seen a surplus and it's a record.

So what is the implication of that?

Arvind Chari: The first implication is also that if you see off the 20, 125, 127 billion, I would assume about 80 to 100 billion is leverage. And about 25-30 billion is actual flows by non-resident Indians, which also means that foreign banks or Indian offshore bank balance sheets have exposure or in banking balance called India risk of about $100 billion over and above what they had before sitting on their balance sheet. It's not a very, very big number, but it is sizable.

The fact that foreign banks were willing to give loans at 1% spread because they are charging 5 to 5.5% as leverage cost, and the bank's own cost of borrowing would have been about 4% because this is a credit risk-free instrument. It's not an Indian sovereign borrowing, but it is essentially bankrolled by the Indian sovereign in terms of the swap risk and essentially there's effectively very zero credit risk. So the cost of borrowing also would have been that much lesser internally for a bank.

But the fact that they could give $100 billion of Indian exposure to earn 1% spread, maybe they will also have some share on when the Indian banks have borrowed at 6-6.5% and they will lend at 8, 9, 10, 11, 12% and they'll make a spread. Some of that spread might actually go back to the foreign bank balance sheet so that everybody makes good enough money. But this was the other point that India is borrowing at 6-6.5% dollar rate. That has some psychological implication, but in terms of how sentiment and everything. The one aspect is extra India exposure that foreign banks have and whether they have more room to give loans for other normal trade and borrowing, we'll know that. The main part, of course, as you've pointed out is liquidity.

This is a very, very significant increase in liquidity. Even the first thing that the RBI I think should do is to pay off their existing short forward. So as of end July, they still had about $47 billion of net forward short.

So now that they have long dollars for the next three to five years, they should repay that. So after netting of that, we would end up with about, say, $80-90 billion of net new foreign exchange for dollar flows that we have, which is about eight or nine lakh crore, as we call it, or nine trillion rupees. So that's a very significant increase in liquidity.

And because it's way above what RBI themselves expected, this should get sucked out. This has to get removed from the banking system. Now, ironically, these FCNNR deposits did not carry CRR and SLR impingement on them.

So they allowed the bank that your cost of borrowing then remains the same. You don't have to keep anything for CRR and lose money. You don't have to keep anything for SLR and earn lesser rates.

You can actually lend it out. But the fact that the excess liquidity is so high, I think they will have to do some incremental CRR. It kind of defeats some of the purpose of this FCNR, but we've got way more than what we wanted.

I don't think we can do the MSS, which was the market stabilisation scheme bonds, which was introduced in 2007 to suck out excess liquidity from foreign operations. So then the other option for RBI is OMO sales, which is open market operation, selling of government bonds. Again, because the deposit was three to five years in maturity, the lending that the banks or the investment that they make will be three to five years because this has to be repaid.

I think the OMO activity also should be considered in the near term, like the one-year, two-year space where RBI sells. So that's a supply of government bonds, or there could be incremental CRR, or they could come about with some long-term draining, like, you know, long-term, they did long-term repos during COVID. They gave three loans.

They can do something like a long-term reverse repo where they suck out money for about one year, two years. But again, banks have to participate in that and they have to have exit clauses. I tweeted yesterday that, you know, the immediate focus has to move to liquidity management and how RBI does that will be interesting to see in terms of what is the impact on the markets, because on interest rates and on liquidity, and whether they use the incremental CRR approach, which will have some impact on the margins that the banks will make on these loans.

Govindraj Ethiraj: And what happens if they don't do much about it? I mean, what happens conceptually if the liquidity remains as it is?

Arvind Chari: Typically in India, the RBI will define liquidity as a percentage of the NDTL, which is net demand and time liabilities. And in normal times, it will be plus minus 1%. You know, in stress times, you'll allow it to go plus minus 2%.

This is now going to be plus minus 3%, the excess liquidity. As you also said, it's more than what we had during COVID. And COVID was a massive shock to the economy and to the banking system.

We are not in any kind of crisis scenario. So it has to be taken off. And look at the backdrop, Govind.

If you look at global interest rates and global central banks, they're all highlighting or moving or inkling towards interest rate hikes or tightening because there is an inflation pressure. At that time, if you have a situation in India that there is surplus liquidity sloshing around, which can be easily used for carry and some speculative activities, that is not a good condition to be given where global rates are. Of course, we are determined by our inflation targeting and our domestic macro.

But you can't be completely dealing to what is happening in the global world. So some amount of this liquidity will have to get sucked out. I would say about at least half of that liquidity has to be permanently sucked out, like in a durable manner, either a CRR or a long dated instrument.

And the rest you can, of course, RBI has enough liquidity tools on a daily basis to manage this. Understand that this has already gone in the market. So what you see as liquidity is basically liquidity, which is between banks and the RBI.

The banks have already invested or lent out or will invest and lend out whatever they have received.

Govindraj Ethiraj: Right. So obviously, a lot of this money has come quite quickly. And the Reserve Bank did pull back its deadline for the scheme.

My question is, would they have thought through and if so, in what way, from your experience, the whole, let's say, the downstream impact of this additional flows or this big flow that we've seen?

Arvind Chari: See, the one good daunting impact is that credit growth will pick up in the sense that if you've seen over the last seven, eight quarters, there has been net capital outflows, which means India has kind of drained out domestic money. So money going from Indian SIPs into the stock market and then IPOs coming through and, you know, foreign investors selling, that money is essentially moved out of India into the global markets. So that much amount of money is then not available in the domestic market unless RBI then recreates that money and adds that money.

So subject to that. So this is now new money, which is available for the banks and they lent out. You've already seen some increase in credit growth.

It will be for the short period of time because this has been matched by the maturity. But for the short period of time, we've already seen some increase in credit pickup. And you maybe see some more as some of the immediate money would have got parked in government bonds and treasury bills as cash management.

And as banks then figure out, OK, this is my lending opportunity. And you will see that moving away from treasury bills and cash management or cash management into loans and debt. So that is going to be a decent impact, irrespective of what RBI does from the own liquidity perspective or in terms of sucking up the money is available for credit.

The other point would be repayment, right? So this has to be repaid first, like by the loans that people repay and the banks get it. And then the banks will have to deposit that rupees to the RBI, get dollars from the RBI, and then they refund and return back the money.

As we know, most of that is leverage. That is going to be significant. And in 2013, we raised about 26 billion in the FCNR.

By May 2014, especially in the month of May 2014, Raghuram Rajan and RBI bought $22 billion in the forward market, kind of covering the entire FCNR liability in about less than a year, two years before maturity. So the RBI had actually bought back their entire liability and was sitting long forward and used that dollar money to repay when they had eventual repayment time. This is a lot more.

There's $125 billion. And if you look on an average, the net BOP, which is basically the current account deficit surplus capital flows after meeting our current account deficit, which is our imports and exports, it tends to be about $20 to $30 billion. So this is like four years of surplus money we need, same kind of, for RBI to only build back what they have to repay, if they don't want the FX reserves to fall by any manner.

It would actually mean that India needs a phase of extreme bullishness in INR assets, in equities, in FDI, in the bond market, and in debt capital. For excess capital flows to come in, which then RBI kind of buys back and does not allow that dollar to stay in the market, you will not expect INR to appreciate a lot on its own because the RBI will first refill its FX reserves. They have FX reserves, but refill this entire liability so that at the end of the third or the fifth year, we actually do not have any depletion in FX reserves.

So that's going to be one. And eventually, they'll also have to plan out the liquidity because the money has come in. So we have 10 lakh crores of extra liquidity.

When the money goes out, you'll have to pay out more than 10 lakh crores of liquidity will go out. So they're going to plan that. We have time, from what I read, most of the deposits have been five years as compared to three years.

So we have a lot of time to do it. But these are some of the downstream aspects that you have to pick up, especially from the RBI side, they'll have to start covering this FX liability as soon as they can and whenever they can.

Govindraj Ethiraj: Right. Arvind, thank you so much for joining me.

Arvind Chari: Thank you so much, Govind.

What Do ITC Infotech’s recent Moves Indicate?

Earlier this week, Happiest Minds, the second IT services company promoted by industry veteran Ashok Sutar and founded in 2011, said that Sutar, who holds a 32% stake in the company in his personal capacity and Ashok Sutar Medical Research, which holds a roughly 12%, have decided to sell 22% to ITC Infotech, a subsidiary of ITC. The deal will take place in two tranches of 11% and 11% with Happiest Minds merging with ITC Infotech. The combined entity is expected to be listed on Indian exchanges by the second or third quarter of 2027-28 and is expected also to be the 11th largest company in the Indian IT space, according to some reports.

This will also be, by the way, ITC's third listed entity after ITC and ITC Hotels. ITC Infotech was formed in 2000 when ITC, a cigarette and consumer products major, spun off its information technology business into a wholly owned subsidiary and it reported revenues of about 4700 crores last year. However, the markets did see the deal as negative for Happiest Minds whose stock was down sharply on the day after the announcement and subsequently into Thursday as well.

But the question is a little larger. So I reached out to Piyush Pandey, Senior Vice President Institutional Equity Research at Centrum India, who focuses on IT, telecom, internet and power. And I began by asking him what the key takeaway was from the deal from an IT services industry perspective and particularly looking into the future.

INTERVIEW TRANSCRIPT

Piyush Pandey: See, over the last few quarters we have seen that there has been increase in the number of mergers and acquisitions and IT services companies are looking to acquire smaller companies to fill gaps to get into new geographies and primarily it is driven by two facts. First, demand has become slightly weaker IT services companies. They are finding it difficult to grow organically and as a result now they are resorting to small acquisitions to drive growth and as well as fill the gaps in their portfolio.

In this age of AI it is leading to some sort of pricing pressure for the IT services companies and as a result company could say broad-based offerings will be the one that will be able to compete effectively. Now for smaller companies I would say with revenue say less than 1 billion dollar they have certain gaps in their product portfolio, gaps in their geographical mix, vertical wise mix and as a result they are finding it difficult to offer end-to-end solutions to clients and this is where I would say they're coming together especially the recent announced deal by say ITC Infotech and Happiest Minds.

That deal I would say a lot of positives and it will definitely help the company to move up the scale in terms of revenue and can drive cost similarities also.

Govindraj Ethiraj: Right and are you saying that between let's say the large companies and small companies for instance we've also had a situation or we have a situation where a lot of smaller mid-sized IT companies are liked for their sharp focus or their let's say engineering expertise and so on whereas large companies have been at a disadvantage. So are you saying now small companies too are at a disadvantage in general or are they still able to have some edge because of their specific competencies?

Piyush Pandey: See I would say small companies below 1 billion dollar revenue they have certain disadvantages and companies which are like say above 1 billion dollar but less than say 4 billion dollar like say Coforge, Persistent, Amphasis they are doing pretty well because they have the critical size and they have the offerings across verticals and geographies and plus they have lesser mix of legacy I would say managed services contracts. Those managed services contracts are the one where there is more pricing pressure because of AI.

So that's why you are seeing that companies like say TCR, Infosys or Wipro they are sort of guarding for like say low single digit growth for FY27 whereas at the same time we are seeing companies like say Coforge, Persistent and they are growing at more than 10% plus on one way basis because they have lesser mix of legacy contracts and also like many of these AI deals are small in sizes and because these AI deals are small in size they can be done by say even tier 2 companies or also tier 1 companies. So basically now tier 2 companies like say Persistent, Coforge or say Amphasis now they are better able to compete with bigger players because these deals are smaller in sizes. So that helps them to book good amount of PCV and cover to revenue in the subsequent quarters.

I would say there is a sweet spot between say 1 billion dollar plus to say 4 billion dollar. Above that you face the pricing pressure because of AI and below that you are just subscaling. So you lack the I would say that range of offerings, horizontal offerings or like say tight geographical depth to effectively serve your clients.

Govindraj Ethiraj: Right, you did mention that we are seeing a spate of mergers and acquisitions right now and I presume you mean that there will be many more to come. So what has driven apart from the one that we've talked about which is IPC and IPS mines what has driven some of the M&A deals in the past and what could drive them in future?

Piyush Pandey: See some of the M&A deals I can mention like say Coforge acquired Ancora, their Persistent has announced to acquire Nadaro, LTM has announced to acquire their Einstein consulting business and even for the tier 1 players like say TCS is acquiring the posh IT's unit like Amplus, you have like say Infosys has also announced certain acquisitions in healthcare space. So I would say generally like say when in a strong development environment when organic growth is healthy in that environment that generally IT services companies they refrain from doing acquisitions but now I think in the current environment when it is very difficult to I would say drive organic growth. Also like say for many of these say smaller companies with competitions there is some pressure of course on the pricing their promoters might look to exit because now I think with increased competition in this environment some of the promoters of smaller companies might look to exit and this is we are coming together to I would say combine the strengths and then effectively compete with the bigger guys.

Govindraj Ethiraj: Right that's a good note to end on. Piyush thank you so much for joining me.

Piyush Pandey: Thank you.