See 10-15% upside for India in dollar terms: Morgan Stanley

Will it be the European Central Bank (ECB) taking fresh easing action in the form of a Long-Term Refinancing Option (LTRO) later in the day to calm market jitters? Or will it US Federal Reserve chairman Ben Bernanke's testimony before a Congressional panel on Thursday?

Also Read: Only technical bounce, see mkts heading south: Julius Baer

In an exclusive interview to CNBC-TV18, Gerard Minack, global cross asset strategist at Morgan Stanley says his US counterpart believes there is an 80% chance that we will get a further quantitative easing when the FOMC (Federal Open Market Committee) meet. The focus is also on the outcome of the June 17 Greek election , he adds.

Looking at the emerging market (EM) space, Jonathan Garner, chief Asian and emerging market strategist at Morgan Stanley says for nearly eight straight weeks EMs witnessed FII outflows. There was dollar strength which impacted EM currencies during this risk aversion phase.

Garner feels that any quantitative easing (QE) would be helpful in relation to reversing some of the dollar strength. However, Morgan Stanley is also looking for some policy response from within the emerging world to help boost markets back up. “The upcoming China data package this Saturday is really vital particularly in relation to inflation. That’s a very important degree of self-help from within the emerging market space,” adds Garner.

On India, he says our inability on the supply side to keep pace with aggregate demand growth is why we see particularly stubborn inflation as well as slowing growth and a widening current account deficit. "I think the Indian market will underperform during any rally and will likely maybe we are looking at plus 10%, plus 15% as a price target for India in dollar terms whereas we will be looking at substantially more than that for the overall asset class in the EMs," he says.

Below is an edited transcript of their interview to CNBC-TV18. Watch the accompanying videos for more.

Q: What are the key events for global markets in the near-term?

Minack: Europe is still dominating but I don’t think it is a European story alone anymore. Certainly, a month ago we were talking about global stress being very euro centric, but what changed through the course of May was this morphed into a global growth concern and that’s all broad based losses in risk assets. So there are really two strands now running. There are euro specific events and central to that is the Greek election, but now the market concerns are far broader now looking for policy response in the face of this global growth slowdown and that’s what we think you will get.

The big debate will be how effective it is, but one of the key events we are looking for is also the FOMC where my colleague Vincent Reinhart in the US believes there is an 80% chance that we will get a further quantitative easing. So looking at the two aspects, what’s happening in Europe and the risk events there and the policy response elsewhere in the face of this global growth scare.

Q: That’s a pretty high probability in terms of more quantitative easing from the Fed. Do you think that will be the likely solution by the end of June that the Fed will blink first and there will be a liquidity gush that enters the system?

Minack: Yes, we think it’s the base case. There is a debate about how effective that will be. I think most of us on the team, they are relatively skeptical about QE’s effectiveness as a macro stimulant. The problems from the Fed’s point of view is that it’s the only lever it can pull, so it will pull it but I think even some people on the Fed are doubtful that it is going to make a big difference to the macro outlook.

The other big debate is the impact on risk assets. Of course the precedent of QE2 was quite promising. My own view is that QE2 was an overrated factor for markets. What was decisive about the QE2 rally was that actually the macro data picked up and if the macro data do not pick up then any QE3 rally would last hours or days but not weeks or months.

Part of the issue there is as soon as we lift our gaze beyond QE and look at the end of the year we have this fiscal cliff issue in the US, this very dramatic tightening of fiscal policy that’s due to arrive on January 1, 2013. If policymakers in the US don’t change course then it’s almost inevitable that you will have a US recession next year regardless of what the Fed does with QE later this month.

Q: What kind of immediate impact would you expect to see of this kind of liquidity measure for emerging markets because going into this month, opinion was, there is going to be a flux of outflows and emerging markets may continue to underperform the developed market space. Are you changing that strategy around given your expectations on QE?

Garner: We certainly had outflows; we had eight straight weeks of outflows from the emerging market space and we had dollar strength which has impacted emerging market currencies during this risk aversion phase. QE would be helpful in relation to reversing some of the dollar strength but what we are also looking for is policy response from within the emerging world.

Here the upcoming China data package this Saturday is really important particularly in relation to inflation. Our expectation is that China is also going to join the party in terms of monetary ease either in June or July with the first rate cut that it will make in this cycle. That’s a very important degree of self-help from within the emerging market space.

Q: Given the amount emerging markets have underperformed already, what are the base and the bear case scenario for the second half? Are you expecting to see much sharper price falls or do you think EMs will generally muddle through; it will be a flat kind of second half performance?

Garner: We haven’t actually underperformed either euro stocks or Japan. We have only underperformed the S&P but it’s true that if you go back to the peak and performance relative, it is a long way back to September 2010 versus the S&P. But we are trading around our bear case. We have to get back to 2004 to find our markets as cheap as they are now to the S&P.

I think the catalyst comes both externally in relation to global monetary ease but also internally. We are expecting earnings growth particularly in the more cyclical sectors that are China influenced to reaccelerate at some point during the second half. On our numbers, we are trading below 1.5 times price to book for the overall asset class which has been good entry point in the past. So having downgraded tactically in mid-February we are looking to redeploy that cash back into the market but we have not chosen to do so yet.

Q: The second half of the puzzle is the problems in Europe specific to Greece. At this point, would you say markets have priced in the potential impact of a Greek exit and how deep might that impact be you think for global equities?

Minack: I am not sure they have although it is true that the only exceptionally cheap equity markets I can find tend to be European equity markets. Greece was to leave - is the serious contagion risk. We see it in a sense analogous to the shock that we saw after Lehman’s failed and then after the Greek default, both those events triggered important contagion effects. We think a Greek exit would in a sense change the nature of money in Europe and in a sense an intensified flight to the centre which would put enormous stress on the periphery. We are not convinced yet that policymakers have the tools in place to stop that getting out of hand.

I would also have to say in the medium-term view, perhaps the biggest risk for Europe is not that Greece leaves and has a deep recession, the biggest risk is that Greek leaves and then in a year or two it’s growing. So you got for example, for the other members of the euro zone struggling under austerity but if you do leave it’s a light at the end of the tunnel where that would be a very bearish medium-term outcome for Europe.

But for this year our view is what we need to see to stabilise things is a move to a greater fiscal integration, the possible introduction of euro bonds, a Europe wide deposit insurance scheme and effectively the individual countries giving up a degree of fiscal sovereignty. That is a chance as an endgame. Our only point is we think you need to see a bigger crisis to get the policymakers to agree to that sort of solution.

It’s been a whole pattern of the European crisis over the last two or three years where policymakers have only responded when the crisis has got big enough. I don’t think we have got a big enough crisis yet to get to that fiscal integration which would settle Europe down for sometime.

Q: What form and shape do you think a crisis of that size could take? Would it be a belly-up situation like we saw during the Lehman crises for a couple of the European banks? Do you think it will be a sovereign issue again?