Rupee fall hurting debt market: Morgan Stanley

Sanjay Shah of Morgan Stanley told CNBC-TV18 that liquidity in the Indian market will improve in the next half of this year (FY14). But pace of growth remains a concern for the foreign institutional investors' community.

Speaking on the declining rupee, he said that the currency was weakening due to the increasing dollar strength, which has been affecting other Asian currencies too. Shah says the debt market has been particularly impacted; it has seen about USD 2 billion of outflows in last few days because of the rupee depreciation. The Indian currency has breached 57 on Thursday.
Commenting on global investors' outlook of the Indian market, he said that global emerging markets (GEMs) were curious about Indian economy and its actions over the next few quarters. He believes that, among the BRIC nations, India was in a good position to attract investments.
Speaking on investor sentiment in the upcoming elections, he said that they (investors) were basing their calculations on the either of the two major political parties forming a coalition government. Also read: Equity funds drop while debt funds gain in volatile market Below is the edited transcript of his interview to CNBC-TV18. Q: How are you mapping the second half of the year? Do you think liquidity is genuinely on a downturn or a downtrend for the next six months?
A: Global liquidity is going to remain benign and do not really see a big threat out here. The US Fed and the Japanese central bank will continue to maintain an environment of easy liquidity.
There have been some talks about Ben Bernanke lifting liquidity earlier than what most people expected, but that is really not what we think. We are very positive on the prospects of liquidity overall over the next two quarters or so. Q: The rupee is the big talking point in India flirting with an all-time low. There is so much concern about a huge balance of payments (BoP) crisis etc. that economists are worried about. How are global investors approaching India because of the weakness that we have seen in the currency? What impact it could have on equities?
A: The rupee is not the only currency in the emerging markets which is depreciating against the dollar. Almost all the emerging market currencies are weakening against the dollar because it is dollar strength story that we are going through at this point in time.
If you look at rupee on a real effective exchange rate (REER) basis taking consumer price index (CPI) inflation, it would be somewhere in the region of 56. So we are not too far away from there and since we do not have capital account convertibility in India it will be easier for Reserve Bank of India (RBI) to engineer a slow depreciation of the currency.
We do not see untoward panic because of the rupee in the equity markets, but it is fair to say that the debt markets are a little bit more volatile because of that. We have already seen about USD 2 billion of outflows in last few days because of the rupee depreciation in the debt markets.
On equity market investors, so long as it is a dollar strength story and rupee not the only currency weakening against the dollar, they are fairly comfortable. Q: The big reason this market has even stayed afloat in the first six months is because of the amount of liquidity we have pulled from the foreign institutional investors (FII). Domestics are out of the market and for this point or by the end of last month people were actually losing positions in India in dollar terms. Might they remain quite as generous with India in terms of inflows you think if this kind of depreciation continues?
A: If the rate of depreciation continues at the same pace there would be some worries with the overseas investors, because at the end of the day they would look at the dollarised return on their investments.
We do not think that the rupee is going to depreciate significantly from here and so long as it is an emerging markets currency depreciation story, it is not something that people are panicking about. Q: What the mood is like at your conference? How are people feeling about India and what is the prime risk for India?
A: The mood has to be compared to last year. Last year mood was very despondent with almost everything that you could think about from the global markets to Indian conditions were going wrong. This year the mood is that of cautious optimism.
Corporates are focusing on asset turnover. There is not much fresh capex happening and investors are focusing on the sectors and the companies within each sector which have dominant share and a strong balance sheet. The mood is that of curiosity.
We have seen significant number of new investors coming to India, especially from the North American region and other parts. Global emerging markets (GEM) mandates are focusing on what is happening in India.
So, definitely there is more curiosity about India. What is going to happen over the next few quarters? Have corporate earnings bottomed out and will growth pick up?
_PAGEBREAK_ Q: Generally is it about deciding whether or not to commit fresh capital to India or is it good place to still keep your money going? The anecdotal evidence suggests that a lot of funds are actually full up on India, overweight positions for many.
A: There is a huge pool of GEM money which is just discovering India. They have been investing over the last couple of years, but there is significant scope for them to increase their positions and their weightage in India.
India within the context of EMs, within the Brazil, Russia, India and China (BRIC) countries looks fairly attractive. The one big market, China, is a market that people have been avoiding this year.
By default and design, India looks fairly decent from a positioning perspective and that is the reason why we think that flows on the equity side will continue to come into the country.
There are some headwinds and you spoke about one or two of them including the rupee. If the rupee depreciates, we might see some kind of a pause, but if you take a slightly more medium-term view we think that given the positioning of India within the emerging markets, within BRIC, it will continue to attract more inflows. Q: Any concern about the narrowness of the market so far? Any relative strength we have seen is basically courtesy just a clutch of stocks and most of them are large cap oriented. Are people a bit nervous about how narrow the rally has been for the market so far?
A: The mood generally is that people are not getting paid to take liquidity risk or to go down below the top 20 or 25 companies at this point in time. The economic growth needs to accelerate for people to take more risk on the liquidity curve, on the market-cap curve and to get involved in the mid-market cap companies and into smaller companies.
The focus is much more on the large companies in each sector which have got dominant shares and strong balance sheets. So the breadth in the market is an area of concern. Unfortunately, till we see the growth reaccelerate again that is going to remain status quo. Q: I believe you all did have a discussion surrounding elections and politics. How big a deal is that for potential investors?
A: Based on the discussions that have happened in the last two and half days, the school of thought is as follows. Either one of the two major parties will be able to form a coalition government when the elections takes place and that is the basic premise upon which investors are basing their investment decisions.
If that does not happen and if we suddenly see coalition of smaller parties come in without having strong leadership then there is a concern that we might see a sell-off.
But at this point in time it seems that people are basing that premise on one of the two main parties coming to power with a coalition. So politics remains a very important topic of debate and people continue to monitor that. Q: What is your own sense of how the next month or so will pan out where there will be important liquidity announcements by the Fed and otherwise? Do you think people are holding onto commitments because of that or are they still going ahead and investing in markets they like?
A: It is a tale of two cities. On the debt side people are getting more wary because the currency directly impacts the bond yields and the bond returns. On the equity side though they continue to monitor what is happening on the macro side I do not see any signals from any of the investors if they are going to go slow on investment in the market and in the companies or the sectors that they like.
So I would not worry as much about equity market inflows. The concern on the rupee is very valid and that might just cause some volatility in flows, bunching up of flows or some outflows, but if you really take next few weeks or the next couple of months I do not think that is really such a big concern.