India at high risk of downgrade; rupee may gain: CLSA

Unlike earlier, rupee's fall this time is mainly due to strengthening US dollar than Indian specific factors, says Christopher Wood of CLSA. There is no evidence of Indian investment cycle picking up soon, also the current account deficit remains too high, which is adding to the pressure, he told CNBC-TV18 in an interview.

The US dollar index could hit 90 level if global markets continue to worry about rollback of quantitative easing. Among the EM currency basket, Wood is looking to buy currencies of Singapore, Malaysia and Philippines. He added that the India currency could gain futher from current level. Meanwhile, CLSA is overweight on India on a relative basis and sees a high risk of sovereign downgrade. Also read: RBI inaction pushed rupee to 60; can hit 62 now: HDFC Bank Below is the edited transcript of Wood’s interview to CNBC-TV18. Q: The big talking point in India right now is the currency and the way the rupee breached 60. What have you made of this current fall and what is does to India’s macro? A: I think the difference between rupee’s decline to 60 between this time and the last time we had real pressure on the Indian currency, is that this time this is less India specific move and more a strong dollar move which has seen the dollar rally clearly against all emerging market (EM) currencies. However, the rupee is particularly vulnerable just like all EM currencies are which have current account deficits (CAD). The secondary problem for the rupee is that we still don't have evidence of a new accelerating investment cycle in India which means if one hasn’t got an investment cycle going, the growth stories are not strong and therefore there is more risk aversion when you have a risk of trade globally. However, this time around it is less of India specific move than a global move. Q: In that context how much do you think the dollar can strengthen against all other emerging market currencies and where do you see the rupee stabilising against the dollar in the near term? A: So long as we have this normalisation scare running globally where markets are worrying about the Federal Reserve (Fed) commencing tapering off, the markets are worried about ongoing tapering off leading to end of QE and therefore renewed monetary tightening, I am looking at a US dollar index which could trade up to the 90 level. However, my fundamental view is that markets have been overreacting to what Bernanke said because all he said that if US economy improves based on the Fed's forecast, then they will start to taper off towards the end of the year. But obviously, the whole thing is data dependent. So, if the data doesn’t improve in the US, then one won't have any tapering off. And if the data gets worse, then the Fed could actually increase its asset purchases. Right now it is still doing USD 85 billion of asset purchases a month. _PAGEBREAK_ I think the markets have overreacted to what Bernanke said. Why did the markets over-react? What the market action says is that there has been a lot of leverage put on, a lot of carry trades put on following the Fed's forward guidance when it said it wouldn't raise rates to 2015. And when Fed said that a year and a half ago, that encouraged everyone to put carry trade. So, what is happening is that people are starting to take of these trade at the first sign of Fed's monetary policy could be changing. Q: How would you tactically approach EM equities and bonds now because there has been a lot of sell off in both bond and equity? A: The EM bonds have become far more over-valued than EM equities but the currencies I favour in EM are those currencies which have current account surpluses. So, in Asian context if one had to buy 3 currencies today and hold it for the rest of the year, I would be buying Singapore dollar, Malaysian ringgit and Phillipines Pesos. These countries all have still current account surpluses and decent domestic stories. Those are the Asian currencies I would own. I am still overweight ASEAN markets in Asia. I am overweight India on a relative basis not because globally it is great. It is because I believe on a relative basis rupee has declined a lot. I think the rupee is basically cheap here and could get cheaper based on global risk aversion. The central bank has clearly commenced an easing cycle. The big sell off we have seen in commodities triggered by concerns in China is relatively positive for India. However, I am underweight in Asia, I am underweight China, very underweight Australia and in EM area I would remain underweight on China related commodity plays. But what I would need to see to really get overweight India is evidence that the investment cycle is resuming and that evidence is not yet forthcoming. So, in my stock portfolio selection, I am sticking with primary quality Indian name which have already outperformed in recent years, not the high beta names geared to the investment cycle. One other potential positive point about this headline move back to 60 on the rupee is that hopefully it will be a reminder to Delhi that they can’t afford to indulge in blatant populism in the run up to general elections because otherwise India clearly risks getting downgraded at the sovereign level. Q: What to your mind might remain the focal point of any risk aversion or risk off through the course of the next few months and what do you see happening with some other global threats like the Eurozone, for example, has that stabilized any? A: No, I think the risk off being driven right now is by the back up in US treasury bond yields which is being driven more by unwinding of carry trade positions than fundamentals because I don't believe the US economy is accelerating that much. However, I do believe that there is a risk of a risk off movement coming from the Eurozone because while people are getting very relaxed in the Eurozone, the reality is that the economy is continuing to weaken. We have not made concrete progress toward banking or fiscal union. Hence, all these problems that existed last year are still there. The one positive is that a lot of the eurozone periphery is moving into current ac surplus, so that is good news. The reason they have moved into surplus is not because their exports are booming, it is because their domestic demands have collapsed. So, I think the fore line in the eurozone remains politics more than economics. But everybody in the eurozone establishment wants to keep everything superficially calm until the German election. They don't want to do anything to upset Merkel’s chances of being re-elected.