Syria woes not alike Iraq war; rupee undervalued: JPMorgan

Though the world is in the throes of a war with the way the Syria crisis is panning out, it would not be right to draw parallels with the Iraq war, says Sunil Garg of JPMorgan Securities. During the Iraq war, interest rates were falling and the markets rebounded almost as soon as the war started, he told CNBC-TV18.

As far as the affected Asian economies are concerned, a lot of the problems are local and country specific. Most investors in India have been rather long on risks to economic growth and also earnings growth, Garg added. "This essentially means earnings are still elevated and equities may see more downside."

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He feels the Indian currency right now is undervalued. But rising oil prices and risks to portfolio outflows could lead to further depreciation of the already undervalued rupee, he elaborated.

Below is the verbatim transcript of Sunil Garg's interview on CNBC-TV18

Q: Not many of us have been through the Iraq war. Can you tell us whether you were around at that time and how bad things got at that time, gold and crude in particular?

A: I guess I was around but I think interest rates had also been falling for a long time then and markets did rebound pretty quickly after the war started. So I am not sure if I want to draw a direct comparison here. I think there are a lot of local and country specific issues that are dominating at least the Asian markets right now.

Q: How is the Indian market in that case looking to you, perhaps we have been underperformers in the emerging market (EM) basket, how bad can things get?

A: If you look at two markets in Asia - India and Indonesia - which have been racing each other to the bottom, both in terms of currency depreciation and also erosion in equity values. Both have country-specific issues, markets are jittery about the current account deficit (CAD) and portfolio flows in India have been much more equity dominated, in Indonesia much more bond dominated, there is a fear of outflows hurting sentiment across all asset classes. These are very country-specific issues and not necessarily only driven by global factors.

If we talk about India specifically, we started to see a little bit of capitulation coming in some of the better quality defensive blue-chip names only over the last couple of days. Now, if you look at investor positioning, it still is quite long on India and the risk to economic growth and therefore earnings growth is still very elevated and that effectively means that equities still have more downside. We would still be very cautious on the equities in India.

Q: I am drawing the comparison with the Iraq war, primarily because we capitulated very quickly into a Balance of Payments (BoP) crisis because of the way crude moved. Of course situation is very different now. We had hardly 7 days of imports worth of cover at that time and now we have like 7 months, so the comparison is not correct in that sense. The way rupee has hurtled towards 66 and probably 67 today and the way crude has moved, do you think that CAD could begin to look like a BoP problem; therefore what are your levels on the rupee?

A: I think the risk that we get into a Iraq-Kuwait situation is definitely there and as you rightly pointed out there is a lot more import cover, so it is not as much of a BoP crisis at the moment. The upward movement on Brent is clearly not happening and the confidence level in the currency has eroded sharply, the dollar-rupee is almost in uncharted territory.

I think on fundamental valuation basis there are many arguments out there that the rupee is now undervalued, but the risk that you have from both rising oil prices as well as risk of portfolio outflows means that you can continue this overshoot and we could see some further depreciation despite what looks like an undervalued currency.

The pressure point here is going to be very simply on economic growth which is what leads me back to the risk on Indian equities, because that is one asset class that has not fallen as much as the currency and that is where the downside risk is probably maximum.

Q: That was my next question, when does value emerge in the Indian equity markets? For a long-term investor, does he wait for another 10-15 percent downside before accumulating or do you think the cut could be restricted to less than that?

A: If you take a 12-18 months period, you are looking at a period where you probably would have some clarity on the political front as well post election. So yes, we are getting to at least on an individual stock and sector basis, some value beginning to emerge.

My only question is, is there a reason to rush into this market just as yet? A good 8-10 percent downside from here and revisiting 4,800 levels on the Nifty, which is what a 10 percent downside gets us to is not unthinkable.

Clearly at this point in time, one needs to be thinking about where are the earnings that are defensible, where are the earnings that are visible and companies and industries that benefit from currency depreciation clearly are the easy picks from here.

However, we recently turned positive on some of the beaten down metals and mining names and a lot of these companies have businesses overseas. So they are net beneficiaries from currency depreciation in a deep cyclical sector. So that becomes a little bit of a contrarion value seeking opportunity and also at the same time benefiting from rupee depreciation. So there are some pockets of value but I don’t think there is a rush to go into this market just as yet.