Disinflation worrying investors; buy on India: Macquarie

Below is the transcript of Viktor Shvets interview with Sonia Shenoy & Anuj Singhal on CNBC-TV18.Anuj: Your call on the equity market setup. It looks like a bit of a risk off right now; do you think emerging markets will go through a tough time?A: I think most of the equity markets might go through a tough time and the reason being very simple – a rise in deflationary pressures on the global basis - that’s been building for at least the last six months and it is continuing into the first quarter of 2015. Emerging markets are on a cutting edge of that but that applies certain negative undertone to pretty much all equity markets globally.

Sonia: How does an investor approach 2015? What do you do in the first half, do you sell into this downtick that we are seeing or do you use it as an opportunity to buy into certain markets, for example emerging markets like India?A: From my perspective the key question is not so much whether disinflation is real; it is real. It is little bit like a default condition for the world. If the central banks do not do anything, global economy will have a significant period of deflation. So I am saying we should have had back in 2007-2008 but collectively we decided we do not want to have that. So the key question is not whether we have disinflation. The key question is what central banks can do about it. Some people suggest that central banks run out of capability of impacting the outcomes. I disagree with that. I think central banks still have a capability and therefore what I expect to happen through the balance of 2015 is that the disinflationary pressure should become less pronounced and as it becomes less pronounced it is easier to grow nominal gross domestic product (GDP) and hence it will become far better for equities rather than bonds. Therefore, a strong deflationary environment is very good for bonds and cash, so that’s what we are seeing. We might still see 10-year money going down below 2 percent in the US easily but as we progress through the year the question is whether liquidity will come through.

I still believe that Bank of Japan (BoJ) will stay the course potentially even double down more towards the end of the year. I still believe that People’s Bank of China (PBoC) will stimulate, they have already started. I think more to come through and finally I do believe that European Central Bank (ECB) will embark some time in next quarter or two on asset purchases - that should create over the next 18 months to two years at least USD 3 trillion of surplus liquidity that in-turn will start impacting commodity prices and that in-turn will start injecting a little bit more liquidity to reduce the disinflationary pressures.

Anuj: What is your call on India now? Do you think it is a buy opportunity or after the outperformance in 2014 maybe the market need to take a breather in 2015?A: The same way as you cannot make an argument on inflation, you cannot make a strong stance on whether it is Indian equity market or any other equity market because only 12 months ago we were worrying about inflation and now we are worrying about deflation.

In the past 10-15 years ago the difference in time between the two cycles would have been at least 10 years. Today the difference between two cycles is less than six months. So the question then becomes – do you think this cycle will improve in terms of lower degree of disinflation, faster nominal GDP growth rates. If the answer is yes then liquidity will become more abundant as you progress forward which means India will be the net beneficiary. So India benefits couple of ways; low commodity prices is a benefit, potentially if US dollar continues going up lower gold prices but on the other side of the coin for India, India need to cyclicality, usually India is so uncompetitive and inefficient domestically but the only way to start growing is to have a kick start from external sources or external cyclicality. One of the things that you can see now externally cyclicality will not come to the help of India this year or for that matter probably even next year.

The other negative is that India needs capital and whenever you have a high volatility in a currency market and in fixed income market, capital tends to dry up. So, you do have plus and minuses working in India but from my perspective pluses outweigh the minuses so long as I am right that central banks will not allow disinflation to continue beyond the next several months. So we are still bias of India as indeed we are bias of China and we are bias of the Philippines.

Sonia: Do you believe that at least for the first half of 2015 emerging markets could outperform developed markets?A: Again it comes back to the same issue. If you have disinflation increasing that implies, US dollar continues to climb, volatility for emerging markets will increase substantially, emerging markets will not be able to outperform, in fact they will potentially significantly underperform. On the other hand if I am right that that will not be a scenario that is acceptable to anybody then emerging markets after period of underperformance will perform inline if not better than developed markets later in the year and that is pretty much our position but you got to go back to the basics; it’s nothing to do with earnings per share, its nothing to do with anything other than global liquidity versus deflation which force is going to get stronger – that’s the driver. The same applies to commodity prices; commodity prices are no longer driven by demand and supply, they have not been quite sometime. Commodity prices are driven by liquidity, so it’s more financial instruments against commodities then the demand from the underlying commodities in the real economy. What drives it is liquidity and if I am right that liquidity will come through, commodities stabilise, may go up quite a bit potentially but at the same time you have less disinflation, more nominal GDP growth rates in global economy, more demand and better environment. So that’s our base case scenario as we progress through the year.