Europe has fundamental issues but is on right path: AMP Cap

In an interview to CNBC-TV18, Shane Oliver, head investment strategy & chief economist, AMP Capital Investors says all the positive noises coming from the EU summit will cap the downside in the near-term. While the euro zone is far from solving its fundamental issues, the need of the hour is faster progress on a European fiscal union.

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

Q: Is the market justified in the optimism that’s come through from the EU Summit or do you think it’s an overreaction?

A: It’s probably a good result. The markets were very nervous going into the summit and I don’t think the markets were expecting much at all. The fact that we have seen quite decisive action to remove the seniority in terms of the bailout funds relative to other lenders to Spain in terms of the Spanish Bank bailout, the fact that they have freed up the bailout funds to invest in Spanish and Italian bonds and also the fact that they are moving towards some sort of single supervision of European banks hopefully by the end of the year, all of those things have to be seen as pretty positive. Europe is still a long way from solving its problems, but the summit does go some way to sort of making sure that it doesn’t go off the abyss in the short-term.

Q: The observations from the summit dialogue also seemed to suggest that Angela Merkel has had to retreat quite a bit. Would you say that things may have gone to the extent of working out some kind of rough map for combined bonds or euro bonds or would that be stretching it?

A: That will probably be stretching it. If you read the statement there is no reference to that at all. That’s still something to be worked out over time. In an ideal world that’s what they should be doing. They should be agreeing on a fiscal union, on a banking union in return for some sort of common issuance of bonds or at least a redemption fund concept the Germans themselves have proposed. But a lot of those issues weren’t even in the final statement.

The fact is those issues; particularly the fiscal union issue is yet to be resolved. It is still something which is going to be down the track. At the end of the day, even if they had agreed to do all of that, it would have taken a long time before they could actually do it. Even if we did get a statement on that it would probably be sort of rolling out over the next few years rather than anything that would provide immediate relief for markets.

I think what they have done is the best they could probably have been hopeful for given the circumstances. The only nagging doubt I have is that the 500 billion euro left in their bailout fund may not be enough to do the job. It’s still a relatively small amount compared to the total I think 2.4 trillion of debt on issue from Spain and Italy.

Q: What would be the fair way to read this - that this is a liquidity backstop which has been put on European banks for now, enabling the use of the ESM funds and that kicks the can down the road for a few weeks, maybe a few months and again we revisit the problems?

A: Yes, that’s probably the best assessment that it has provided a bit of a backstop for European banks. We are moving in the direction of some sort of common banking system across Europe which is a good move. But it’s probably not going to stop the ongoing recession we are seeing in Europe. There was an earlier agreement to have a sort of a growth pact of 120 billion euro which is a positive sign, but it’s probably not enough to stop the ongoing recession in Europe.

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I suspect that a few months down the track, maybe six-nine months we will be back at the same issues again. Greece is still a potential source of risk. Spain is struggling very badly, but the whole story over the last two or three years has been just that that we have occasional flare-ups, we get some sort of action by the authorities, things calm down for a while, share markets rally and then six-12 down the track we are back with the same issues again and I think that probably continues.

I tend to view this with a somewhat optimistic approach. You would probably say glass half full rather than half empty, but every summit they have has moved them a little bit further in the right direction. We now have bailout funds. Three years ago, Europe didn’t even have bailout funds. They are now moving towards common supervision of European banks that wasn’t even being talked about three years ago and of course the European Central Bank has jumped in with assistance for banks in terms of liquidity.

So there have been a number of moves put in place over the last few years out of these summits which have taken Europe closer to a solution. But you characterise it more as a muddling through than providing a comprehensive solution. That’s where the volatility continues, but at least we have avoided falling into some sort of abyss that some had feared till today.

Q: Would you say the events and the flashes that we have been seeing from the EU summit might actually lead to an extension of that? What kind of a potential rally in markets could we be looking at on the back of this event?

A: The reality is that share markets have had a pretty tough June quarter. Most markets are down from where they were a year ago. The valuations for shares are now actually quite attractive and combined with a very negative sentiment suggests there is plenty of scope for markets to rise from here. My only uncertainty is whether we go through a continued base building process in terms of global share markets or whether we have actually seen the lows. It’s too early to say with certainty that that’s the case.

But I do see markets being substantially higher by year end. In 12 months time, I wouldn’t be surprised if markets are up somewhere between 15-20% by this time next year. A lot of volatility on the way and lot of issues to work through, obviously the global economy has been slowing down. There are issues not just in Europe but also China, the US, Brazil and India, all these major countries around the world has seen their economies slowdown.

So I think the problems globally are much more than just Europe. We need to see more monetary stimulus, but I tend to think we probably will see more monetary stimulus. So therefore in 12 months time I think markets will be quite higher.

Q: India has not been the favourite market for many global investors, but in the last week or so we have heard some positive news from Delhi politicians. Are you getting a bit more hopeful on India as well in the midst of this global risk-on?

A: That’s true. India has sort of fallen out of favour because the Indian government has sort of slowed the process of reform. India was seen as following in China’s footsteps, but in the last few years the whole reform process in India seems to have slowed to a crawl. The budget deficit has been allowed to stay relatively high and there has also now been a chronic inflation problem.

Even though you have got industrial production growth on an annual basis near 0%, inflation measures are still up around 8-10% depending on which measure you look at which suggests that the growth inflation trade-off has deteriorated quite dramatically. Hopefully, the Indian government is getting the message that it needs to speed up the process of reform and that could put India back onto that sort of favoured states that it was about a few years ago.

In the meantime, you could argue that Indian shares have reasonably good value at this point. So if there is any return to confidence in terms of global share markets i.e. it goes beyond today’s rally continuing through the second half of the year, then Indian shares would be a key beneficiary of that, particularly if we see more monetary easing by the Reserve Bank of India.