India got into the S&P’s bad books albeit with just a warning. The credit ratings agency lowered India to negative from neutral, with a warning that in two years if there is no improvement in the fiscal situation and if the political climate continues to worsen, a downgrade could be on the cards.
Shane Oliver, head investment strategy & chief economist, AMP Capital Investors agrees with the S&P that India really needs to move a bit faster to get its fiscal and current account deficit under control and needs to see more effort to reform the economy.
Below is an edited transcript of his interview to CNBC-TV18. Watch the accompanying video for more.
Q: India saw a hiccup with the change in outlook from S&P. How big a deal is it in the minds of foreign investors? Are people talking about that as a serious negative for India?
A: Not a lot. It’s certainly been a factor. It’s well known that India has a relatively high budget deficit and its public debt by emerging standards is relatively high and it needs to get them under control. I tend to think that as always with these ratings agency changes they tell everyone that a place has got a problem long after the events. It’s been well known that India has those issues.
Where I would agree with the S&P is that India really needs to move a bit faster to get its deficit under control and we need to see more effort to reform the economy. One of the concerns about India is the pace of economic reform. In recent years, under the current government it has slowed down.
It doesn’t detract from the longer-term growth potential of the Indian economy and India is not in any situation like many European countries are because its debt level ultimately is quite serviceable given the strong growth in India and the strong demographics. Nevertheless, compared to other emerging countries, it would be desirable to see India get those issues under control.
Q: The fear globally seems to be that the eurozone worries have come back to the fore and within that, that a market like India could get impacted more adversely. How have you read the news flow coming out from the eurozone? Do you think it’s going to precipitate a big risk off in the system?
A: I hope not. There is no doubt that Europe is still an issue. We went through a relatively calm phase from December through to most of March. Then of course since then it’s become a bit messier in Europe, first with the problems in Spain which they themselves drew attention too by saying they won’t meet their previously committed to deficit targets and then worries that if Spain is in trouble then that might flow onto Italy. So bond yields in those countries have increased.
We have also had the election in France which raises question marks about their commitment to the fiscal compact and of course the Dutch government, the coalition falling apart. All of those things have sort of reminded investors that Europe is still an issue and the economic data coming out of Europe is consistent with a recession. Flipside though is when you look at that economic data; it’s all consistent with a mild recession.
I know Spain, to a lesser degree Italy but certainly Greece, they are going through something a lot deeper. It’s certainly not a mild recession. But if you look at the eurozone on average, our assessment is that economic growth this year will be about minus 1%, much better than the minus 6% or 7% that occurred back in 2009. The economic data so far is not consistent with a serious recession; it’s consistent with a mild recession out of Europe.
Likewise, there is no sign of an imminent banking crisis. The European Central Bank has provided plenty of funding to European banks. Therefore, the risk of a banking crisis in Europe triggering a global credit crunch like we saw through the GFC is relatively low. The bottomline is Europe still remains a risk, but I don’t think it’s as big a threat as was the case last year.
Q: Tactically, how do you approach global equities this month? A lot of people have been calling for a haircut through the months of April and May. Do you think May, may turn out to be as volatile or as weak as people fear?
A: Well, there is certainly a pattern there. If you look at the last two years, share markets had strong starts to the year in 2010 and 2011 and then the US shares and the global shares generally peaked roughly around April and then had sharp falls in the middle of 2010 and then into September-October in the case of 2011. Those falls were of the order of 15-20% depending on the market and depending which year you look at.
The last two years don’t provide a lot of confidence given that we followed a similar pattern. Therefore I think investors do need to be a bit more cautious. Now, the easy gains are behind us. The big run-up we saw from the lows back in September-October last year, that’s behind us and the news out of Europe is getting a bit messier and the economic data coming out of the US has been a little less favorable.
I think this rough patch that we have started to go through, through April, could continue for a little bit longer, but if I was to put a number on the size of any correction, I would say 5-10% as opposed to the 15-20% corrections we saw in the last two years. The other thing to note is that share markets globally are cheaper than they were this time a year ago. Price earnings multiples tend to be lower, bond yields are certainly a lot lower so on a relative basis shows a much better value.
The other thing to note is that central banks around the world are easing. The Indian central bank was one of the last ones to cut interest rates. Today, we saw the Bank of Japan expand by one-third its quantitative easing (QE) program or asset buying program. The Europeans eased late last year and ultimately, I think the Europeans will have to ease more and of course the Fed stands ready to do more whereas a year ago some central banks were actually tightening. Big inflation worries in India and China and elsewhere and the ECB had been raising rates.
For all those reasons, any correction in markets will be a lot milder than what we have seen over the last couple of years. So it’s the time to sort of wind back the overweight’s a little bit but look for buying opportunities on any weakness we see over the next couple of months, because shares will end the year a lot higher than they are right now.