Budget 2012-13: India must attract FDI to deal with deficit, says Rabobank

“However, the regulatory environment within India is possibly not as friendly as it could be to foreign direct investment which is a strategic challenge for the government there,” he adds.

Below is an edited transcript of his interview. Watch the accompanying video for more.

Q: We have seen some strong performance coming in from some of the global markets notably on Wall Street as well today some of the Asian markets. How do you see the risk appetite progressing? Do you see equities as a favoured class for some more time?

A: I do think investors more generally in 2011 were extremely negative. There were the systemic risks coming out of the eurozone, the US economy looked pretty lacklustre and with some highlighting the risk of a relapse into recession. Following the LTRO liquidity provision from the ECB, it has clearly brought government policymakers time to implement austerity in a relatively calm financial market environment.

That has really emboldened investors and of course the signs coming out of the US economy in the last couple of months have all tended to be on the positive side of the ledger rather than negative. Investors clearly have had some catch up to play. That best describes the fairly rapid ascent of most of the major bourses over the last couple of months. We are probably still in that phase, perhaps some of the more embedded bears still have to throw in the towel and get reinvested in equity markets.

But it’s pretty clear that the main bounce at the end of last year’s troubled time is beyond us. Equity markets really moved in one direction for a long period of time, so you should expect some periodic falls but the global environment now argues very strongly in favour of periodic falls representing buying opportunities rather than renewed downturns across global markets.

Q: Moody’s has termed the Budget as a credit negative for the sovereign. From an investment point of view how do investors perceive Indian equities? Is there a likelihood that India might underperform couple of its other Asian peers, something that we are seeing in today’s trade?

A: I wouldn’t like to over extrapolate a couple of days trade. You have recently had the Indian Budget. It seemed to me there are not too many red flags that are waving as a result of that Budget but similarly the absence of any particularly strong upbeat messages coming out of that. It is pretty much business as usual on the government front is my read of the Budget.

With rating agencies it’s interesting because it’s hard to argue that they had been ahead of the curve. When we look at some of the European downgrades we have seen in the last couple of months, I am not sure that they really picked up anything particularly significant in India that was going to cause global investors any particular concern.

The issue I think India faces is with an external current account deficit. We are in a relatively more austere financial market environment now. Portfolio capital is a bit harder to come by. India needs to be attracting foreign direct investment is my take to fund that external deficit but the regulatory environment within India is possibly not as friendly as it could be to foreign direct investment. That’s a strategic challenge for the government there.

Q: What are you expecting in terms of assets that smart money would chase in the next quarter or so? Would it be developed market equities? What would your top three picks be?

A: I do think the environment will be more likely positive than negative. I think this global growth story yet has a bit further to run and a rising tide will lift all boats. The underlying fundamentals in the US are still pretty supportive of equities. Of course, equities there only got back to mid-2008 levels so there is a bit more upside there. In Europe we are still in a period were the ECB liquidity significantly calms nerves, significantly calms funding markets. I am not an equity analysts per se, so my thoughts there are very much macro driven.

Q: You spoke about how one should adopt a buy on dips approach for the equity markets. What’s the kind of correction we can expect? Which should one actually buy into so they don’t miss the bus?

A: It’s very dangerous setting firm benchmarks in advance. I do think periodic selloffs are more likely to represent buying opportunities. Perhaps a critical element when these periodic selloffs come along and I look at the global liquidity environment which is still very, very generous, that makes me think we are still in a period of over-emphasized moves downside and upside because of that liquidity backdrop.

It’s important that when you do see periodic selloffs in the market just re-benchmark your thoughts and make a reassessment of the global outlook. My sense is that the global outlook will still remain relatively firm and that’s going to be the signal to dip in the water rather than a 3-4% move per se as providing the signal.

Q: How long will this peace that the LTRO has bought in Europe last? When will the next red flag or eruption happen you think?

A: It’s certainly a risk. It’s one that people should be keeping their eyes on. I am sure a lot of people are keeping their eyes on it. It’s hard to imagine that there is a trillion euro odd of liquidity pumped into the system, less if you make some adjustments of some of the previous liquidity measures but it’s still a very generous liquidity backdrop. It can only buy time for governments, governments need to tighten up.

The critical factor to watch is just the progress in tightening up budget deficits. Spain slipped a little bit in the last month or so but I don’t think Spain is at a level which is sending warning signals directly but I do think across the gamut of these troubled or challenged countries in Europe, we need to see some firm measures tightening up fiscal policy. That’s going to be a signal that politicians are putting this bought time to good use.