Foreign brokerages are asking the government to urgently address the concerns surrounding the proposals of General Anti Avoidance Rule (GAAR) or face disorderly unwinding of FII holdings.
Foreign brokerages are asking the government to urgently address the concerns surrounding the proposals of General Anti Avoidance Rule (GAAR) or face disorderly unwinding of FII holdings. GAAR issues and indirect transfer norms in the Finance Bill 2012 have Foreign Institutional Investors (FIIs) worried about their Indian investments.
Adrian Mowat of JPMorgan says the bigger question that needs to be addressed is why it has been necessary for foreign investors to go through routes such as Mauritius to get into India when they are not required to do that in any of the other emerging markets or developed markets.
JPMorgan is currently neutral India. On the macro side he sees a relatively weak economy but the RBI’s 50 basis point rate cut has eased expectations. But Mowat says a very high event risk is the debate around GAAR both in terms of people's perception of retrospective policy in India and then there is also the direct impact on the capital markets of some uncertainty in the taxation of FIIs.
Below is an edited transcript. Watch the accompanying video for more.
Q: What is the mood on India in the light of all this confusion on GAAR? Have things settled down or do you still hear a lot of confusion and concern on that score?
A: I would actually like people to look at the bigger picture here and address why its been necessary for foreign investors to go through routes such as Mauritius to get into India when they are not required to do that in any of the other emerging markets (EM) or come to that the developed markets (DM) that I look at. India should review its tax treaties with the major investing economies so that wholesale investors, institutional investors can opt to pay the local tax rate that’s appropriate for them which typically is a zero tax rate whether it’s an Indian mutual fund, pension fund or a British pension or mutual fund. That would be the best longer-term solution.
Short-term we need clarification that the current tax treaties will be respected and that investors that have made decision based upon those tax treaties will have the letter of the law upheld rather than retrospective changes in tax legislation. With regards to GAAR, yes, other countries have it but you will find it difficult to find countries that have imposed it retrospectively. Remember that’s a big story here in India.
Q: How are you approaching India as a market right now? How do you weigh in the pros and cons as you see them for this market?
A: We are currently neutral India. On the macro side what we see is a relatively weak economy but the other side of that story is that the RBI has been easing more than expectations. Really, that is what investors should focus on in terms of you got to pick up in economic activity as you go into the second half and we would also assume that profits would go from disappointing to perhaps being revised up as we go towards the end of 2012.
So that’s the upside story but we do have a very high event risk with this debate around GAAR both in terms of people's perception of policy in India in terms of retrospective policy and then there is also the direct impact on the capital markets of some uncertainty in the taxation of FIIs.
Q: What's been extremely steady though is the performance of the US markets which has hardly blinked through this year. How have you read that?
A: We have a big call for this year that it’s going to be different versus 2010 and 2011 in that US consumer will have real income growth throughout the year rather than having real income growth choked off by inflation which was particularly a big issue last year when I would argue you had stagflation. The oil price has peaked and is now coming off. The gasoline price in the US is coming off and that was really the only inflationary pressure out there.
We do have job creation in US, maybe in March it wasn’t as fast as we have seen prior but it was still job creation. So the US economy does better than expectations and that the middle of the year actually turns out to be one where data points are higher than people were expecting and there is sort of consensus on ‘sell in May’ might be proved to be wrong.
With regards to Europe, the political newsflow is very heavy at the moment. What the Dutch coalition government was trying to do was to reduce the deficit much faster than was required and that has fallen foul with some coalition partners. We don’t see that as too big a threat. We see the noise around Spain just being a normal political noise. We keep on coming back to the fact that the ECB is doing an excellent job in ensuring that there is liquidity in the European financial system.
So this tail risk fear that you get a major dislocation event in the European financial markets we believe is still over estimated and we are not as concerned as the market. With regards to India, if India can clarify the policy risk around taxation and we continue to get the easing in policy then perhaps the outlook for India is a bit more optimistic than the current consensus.
Q: Despite the negative newsflow of the last few weeks, do you still think it can be a positive year for equities in India and we could even start inching towards new highs by the time the year is out?
A: When I get asked questions about relative returns then we need to have a debate about what is going on in so many other markets. I am optimistic that we make positive returns out of the market. I don’t know if we will be hitting an all time high because that will be extremely large return from current levels. I would highlight a very important issue here that we have with regards to EMs, the strongest market globally is the US market. That’s where you are seeing fundamental surprising more to the positive side consistently and so there is a bit of a challenge out there in trying to persuade US based investors to look at EMs at this point in time.
Q: How much of a tailwind will the RBI policy be during the course of the year? In the context of what's going on with other EMs how do you place the action from the RBI?
A: We have got a situation in India and also I would highlight a similar situation in Brazil where the central bank is cutting more than the market expectations. That is consistent with our view of both the economies that they are weaker than the official data and therefore you do need more stimulus. There is a chance that this weak data pushes the RBI for further stimulus.
The other side of the argument is obviously what’s happening with inflation and inflation prints in India are still uncomfortably high at this point. It’s definitely an interesting debate but on the feedback we get from companies on weak demand etc, I think some further favorable policy is likely out of India.
It is worth saying that this trade with regards to inflation coming off and interest rates coming down is reasonably mature and there is potential for upside surprises probably more modest. If you look at the performance of auto companies in India, some of the banks that use wholesale funding, they are partly discounting these moves.
Q: There has been some concern over here about how the currency has moved and whether that is impacting flows and sentiment as well. How big a deal is this fall in the rupee for Indian investors?
A: We have seen the rupee touching 55, in the quarter before last at the end of 2011, so it’s certainly within the range. What I feel is if we can resolve this issue with GAAR the chances of outflows from India relatively modest. If GAAR is not resolved satisfactorily then there is a risk of FII outflows. So trying to predict where the rupee is going to go with that event risk is difficult. If GAAR is resolved in a satisfactory way then I would expect to see a resumption of modest inflows which could help support the rupee. I am not in the camp that sees a meaningful devaluation.
With regards to sectors that are doing well, there are a number of Indian companies with large export earnings, either because they have big operations abroad or because they are in the IT space. Those are the beneficiaries of a weaker rupee. But as we have been highlighting in the IT space, stock selection is very important as there is a dispersion in performance.
Q: Given a neutral stance on India, what kind of data points over the next few weeks would you be watching in order to be able to review that investment stance?
A: There is a short-term impact which is that certain institutional investors will decide that on a risk adjusted basis, the return that they can get out of India becomes unattractive because of this tax liability and they will move capital to other countries. You will see an ongoing decline in derivative flows, the stock market volumes will decline further which adds to the risk element of investing in India. GAAR being imposed on FIIs could take one or two PE points off this market as investors adjust for a different environment.
Medium-term, you need to think about India’s current account deficit, the need to attract international capital both FII and FDI capital and if I am making a FDI in India, I want to know that the terms in which I am making that investment will be consistent over the longer-term because I am making a very long-term commitment to the country.
The problem with GAAR is not GAAR in itself; it’s the retrospective nature of the way the legislation is expressed at the moment. So when I start to think about investing in countries, if I have got a country where there is a president for retrospective change of the terms of investment then that will make me more circumspect about investing in that country.
We need to keep on coming back to the fact that unfortunately India does run a current account deficit, it does make you reliant on other people's savings and those savings would like to be respected in that they have made a decision on a playing field that is not going to change.