Citi underweight on India; sees FII inflows slowing down

Renewed eurozone fears and domestic headwinds have set back Indian equities by a huge margin the past few weeks. The Nifty was headed towards 5400 early July, but delayed policy action and the growing fear of poor monsoons hit the indices hard, pushing the Nifty substantially.

One factor that hasn’t gone completely against the market yet has been foreign inflows, which have remained strong. However, according to Geoffrey Dennis, global emerging market strategist at Citi, this may not last for too long. In an interview to CNBC-TV18, Dennis says that flows into India from foreign institutional investors will slowdown from here on because Idnia’s outperformace due to weak commodity prices is over. “The biggest period of benefit for India from commodity price decline has already happened, so I would expect to see those FII flows probably begin to slow down from here over the next several months,” he said. He further adds that Indian equities are more expensive than other emerging market equities, and therefore he is underweight India. From an earnings perspective, however, Dennis says India is likely to outperform its peers. Citi expects India Inc to deliver 12% growth this year and 14% in the next. His top sectoral picks are materials, financials, and consumer discretionary. Below is an edited transcript of his interview with Udayan Mukherjee. Q: There has been a lot of excitement in global markets over the last 2-3 days on Mario Draghi’s comments. What is the next course of action you see from the ECB? A: Well we certainly look for another interest rate cut down to just 50 basis points over the next several weeks. We also think that there is a very good chance that the European Central Bank will formally institute a policy of quantitative easing. So given the definition of QE, that does mean that ultimately we would expect the ECB to step back into the markets to buy some bonds to provide some support. I think what the ECB is waiting for or has been waiting for is other initiatives to be put in place, other action by European governments, before they step up and take their own additional action. But we find it inconceivable that the ECB will just stand by and let the euro collapse. We do think that there is more action they will take and we should expect that over the next several weeks and months. Q: This will buy some time, may trigger off some kind of risk on in global markets, but by the end of this year where do you see the situation having evolved to? A: We think what will happen ultimately is that Greece will almost certainly leave the euro. The official view we have is that 50-75% chance that Greece will leave the euro before the end of next year. The most likely scenario is that Greece will leave probably well before that, possibly around the end of this year is a good time frame. Then what happens is that firewalls will be in place to provide the necessary protection to ensure that other countries do not leave. We actually happen to believe that the other members of peripheral Europe such as Spain, Portugal, Ireland and Italy are in significantly better shape than Greece is. Therefore Greece we think can leave without necessarily causing the whole of the euro to collapse. So I think gradually, with the aid of some steps towards banking union, with some aid towards fiscal union as well including potential euro bonds, we will look eventually for the situation to settle down once Greece has left the euro itself. _PAGEBREAK_ Q: But given your expectations in the near term of some more easing from the ECB, may be purchase of bonds, do you think we could have a phase of risk on and a phase supportive to global equities generally for the next few months? A: We have been noticing that you getting very supportive liquidity conditions from the major central banks - the Fed, the ECB the Bank of England, the Bank of Japan. We have also paid a lot of attention recently to the fact that the interest rate trends in EMs have begun to turn lower as you start to see some more support from EM central banks for economies in the face of much lower inflation recently. So we have seen countries that we didn’t previously expect would cut rates stepping up and easing monetary policy, such as Korea and South Africa. So the easing of monetary policy is broadening out within the EMs to a larger range of countries and ultimately we think there is a good close link over time between the level of nominal interest rates in EMs and EM equities. So short of the global economy going back into recession, we would expect this increased easing to contribute to higher equity prices over the long term. Q: What could have mean for India because even in July we saw billion dollar plus inflows from global investors? Do you see flows continuing into India in particular? A: I think it depends on large extent on two things - first the outlook for structural reform, now that the presidential election is out of the way, and also I think the outlook for commodity prices. From a very oversold position, India has bounced very nicely. It has outperformed EMs slightly since the bottom of the markets in the early part of June and I think that’s had a lot to do with the sharp decline in both food and oil prices, both of which are important for India. The benefit of lower oil prices come through with lower inflation, it comes through with potentially reduced need to increase subsidies, so that helps the fiscal deficit. So what investors have been doing is looking around the world for clear beneficiaries of lower commodity prices. India is one, Turkey is another. But our view is that we don’t think commodity prices will go much weaker. We think if the global economy does pick up in second half of the year, you will see commodity stabilize. Oil prices are well off their lows and food prices, especially soft prices, have been rising. So I suspect the biggest period of benefit for India from commodity price decline has already happened. So I would expect to see those FII flows probably begin to slow down from here over the next several months. Q: What is your own positioning on the Indian market? Relative to the EM basket, where is Citi on India right now? A: We are underweight on India within EMs. Our India strategist has a year end target of 18,400 on Sensex which is slightly under 10% from current levels. It’s a little bit below what we are looking for from EMs overall, which is 15-17%. So that comes out as an underweight and that’s for a couple of reasons. One, we feel that the real benefits to India from the drop in commodity price, particularly drop in oil price, has already come through. It has come through partly as increased FII flows into the country, but also because India is still an expensive market compared to EMs overall. It’s trading at 12.5 times forward against 9.5 times forward for EMs so quite a substantial premium. Now the earnings outlook in India is quite good. We have got 12% earnings growth this year, 14% next year which is slightly better than EMs overall. But you are paying a sizable premium for that which is about 30%, so India looks fine. Earnings story will push the market higher against the background of better EMs overall, but we don’t expect it to be an outperformer. In terms of sectors, we turned aggressive in terms of our sector calls in the middle of the year on the view that there would be a pick up in China and markets would do better in the second half of the year. We are overweight in materials, financials, and we are also overweight consumer discretionary. We are underweight in most of defensive sectors like consumer staples, healthcare and telecom. We'd broadly play India the same way. I think the thing to do here is to focus on our EM calls overall, and that’s our preference for materials, financials and consumer discretionary.