Neutral on India with positive bias: Morgan Stanley

Indian markets are trading at fair valuations versus its peers, Jonathan Garner, Chief Asian and Emerging Market Equity Strategist, Morgan Stanley and he is neutral on India, with a positive bias.

"The combined fiscal and current account deficit in India is shrinking somewhat. There is still a lot of room for improvement but with the disinflationary trend, I wouldn't anticipate any particular problems in relation to the Indian rupee," he said in an interview to CNBC-TV18.

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Below is the verbatim transcript of his interview on CNBC-TV18

Q: The big fear through yesterday has been the contraction or pulling out of liquidity that has been so ample for equity markets. Is that looking like a real threat in the second half, for equities, across the world?

A: When we look at global equities certainly some of the markets particularly developed markets are quite close to our year-end target price this year. In fact in Japan’s case it hit our target price earlier this week. That said there is still around 15 percent upside to our Asia ex-Japan and yen targets. We don't think liquidity withdrawal is going to be a dramatic and sudden shock to the market and the Federal Reserve would do all it can to avoid that.

So what we are really taking about is the potential for tapering treasury purchase under the current Quantitative Easing (QE) program. Perhaps beginning sometime between September and December but it would be quite a slow and gradual progress there and we are not expecting the 10 year bond yields to go above 2.25 percent at any point this year.

Q: Are you expecting a major risk-off phase in the next couple of months or next few months in global equities for any reason and if it were to come about, what do you think could be the primary driver of such a risk off phase after many months?

A: We are not expecting that because we are not expecting a dramatic back up in bond yields. I suppose if we were wrong about that then a sell-off in equities would become more likely.

Equities are our preferred asset class; they are quite reasonably valued still to history albeit actually close to target prices in developed markets. We are more concerned about a gradual process of rising core government bond yields. There are excesses in financial markets in terms of very tight spreads in the high yield markets in US and Europe and some of the developments in the risky debt markets which are much more fully valued.

Q: What kind of positioning do you see for investors right now particularly in markets like India? Would you say that from the start of the year many investors would have turned overweight on a market like India compared to underweight earlier?

A: Our recommendation is equal weight. We think India is fairly valued versus history and versus peers. What is interesting is the surprise fall in Wholesale Price Index (WPI) inflation, which has taken it to a level which traditionally does allow the relative P/E multiple to rerate and that is getting some attention amongst our foreign clients.

We are neutral on India, but with an upside bias to somewhat more constructive as long as that disinflationary trend is intact.

Q: While the last few weeks have seen a fairly consistent rally across equities in the world, there have been far more disparate moves in currencies for one and commodities the other for instance gold has fallen sharply, and in terms of currencies the dollar has been strong while many others have corrected. Any throwback from what is happening with both those asset classes for equity markets?

A: The most important view that we have on the forex exchange side is that the dollar is becoming globally strong. We do believe there is a genuine economic recovery happening in the US; recovery in housing and that is causing this whole debate about withdrawal of Fed accommodation.

However, we are a long way from that situation in Europe, where the economy is still very weak. The picture in Asia is gradually improving but at a relatively slow pace. So we like dollar strength but we are getting somewhat concerned about some currencies particularly some of the commodity related currencies like Australian dollar. In fact we downgraded Australia, just this morning in our outlook and upgraded Taiwan partly because of currency.

Q: Even if June were to signal the tapering of some of these flows that have been abundant in global equities, what kind of impact would it have on peripheral markets like ours because up until now liquidity has been abundant, would a tapering would imply sucking out some of these peripheral positions first you think or unlikely?

A: I think it has not really been like that in this cycle; certainly was in 2006-07 but the markets including India have not performed very strongly with the exception of Japan, which is the one we are most concerned about from a tactical perspective.

So we don't actually think that we are looking at anything like liquidity withdrawal crisis, it should be quite a gradual affair. I think countries including India that I cover have their house reasonably in order. I particularly like the fact that the combined fiscal and current account deficit in India is shrinking somewhat. There is still a lot of room for improvement but with the disinflationary trend, I wouldn’t anticipate any particular problems in relation to the Indian rupee.