Despite the notion that India’s outperformance maybe curbed in near-term, Manishi Raychaudhuri, Asia Pacific Equity Strategist at BNP Paribas retains his overweight stance on Indian equities, as he sees no reason to scale it down.
Although India remains one of the best games in town amongst emerging markets (EMs), incremental outflows can be seen flowing into north Asia, specifically China and Korea in near-term, he says in an interview to CNBC-TV18.
According to him, as valuations are becoming worrisome, India may consolidate at current levels having outperformed so sharply. Moreover, given the current scenario, the Reserve Bank of India may not cut rates on December 2, he adds.
From the private banking space, he remains most upbeat on HDFC Bank and ICICI Bank. On the flipside, he advises investors to avoid PSU banks barring State Bank of India and Bank of Baroda.
Furthermore, he is positive on consumer discretionary, auto sector and oil refining companies. He also expects Indian IT space to pick up on the back of US demand recovery.
Below is the edited transcript of the interview:
Q: You go to Hong Kong and you force the People's Bank of China (PBOC) to cut rates, what does all this mean for EMs? In particular, will the pecking order within EMs change to China taking away most of the money?
A: Let us focus on this from two angles – First, the fundamentals and the divergent direction of monetary policy that Asia and entire EMs are likely to witness going forward. If you look at the entire EM complex particularly the Asian EMs, they are currently on widely divergent path as far as inflation trajectory is concerned. Large parts of North Asia are in a disinflationary or downright deflationary mode. If you look at China producer price index (PPI) for example, that has been in negative territory for about 33 months now.
So in a sense and faced with very significant degree of acceleration in quantitative expansion by Japan, I think large parts of North Asia including China and Korea, would have no alternative but to embark on this rate reduction programme for a considerable period. This is the first step from China, we have seen such steps from Korea earlier in the year, couple of months ago and we believe that this is likely to continue for some more time.
Now in case of China, there is another domestic imperative as well. They need to desperately boost domestic demand particularly in property and we must remember that land sales constitutes a significant degree, almost 35-40 percent of the revenue of the local governments there. Until and unless they are able to balance their budget, they are unable to invest more in the infrastructure programs which in turn boosts Chinese GDP. So this is another attempt by China to boost domestic demand and also to generate some inflation.
Having said this, the impact on the rest of the emerging markets would be twofold. Number one, as soon as we saw this China rate reduction over the weekend, commodity prices shot-up. We saw oil futures, gold futures, those things move up pretty significantly over the weekend and that actually has some impact on India as well. To some extent, there could be two effects, the commodity importer universe within EMs could suffer over the near term and there could also be some movement of fund flows into China which would deprive the other part of emerging markets from what they were getting historically.
Q: So do you think India’s outperformance will now be a thing of the past?
A: Not over a very long-term. I think the extensive outperformance that India has had could be curbed in the near term. Firstly, valuations if you look at India in relation to rest of Asia, it is almost at one standard deviation higher, in fact slightly higher than that compared to the longer term average premium that India always trades at. So that is bit of a concern but there are genuine fundamental reasons behind that. I personally think looking at what is happening in the rest of Asia, India would likely consolidate at the current levels. Two reasons behind that, as I just now highlighted that there could be some incremental flows into North Asia and secondly the valuation premium particularly for the companies that investors would like to invest in, the large cap frontline companies in many of the sectors, that is appearing slightly egregious. So some degree of time correction would possibly be warranted.
I would not really say that India looks risky over the medium term at this point. I think India despite all this remains one of the best games in town as far as emerging markets and Asia are concerned. The overweight positions on India by EM investors are unlikely to be wound down significantly as a consequence of this. But obviously the market having outperformed so sharply, may consolidate at the current levels. In our Asia model portfolio, we still retain overweight on India. I don’t see any reason for winding down or moving away from that position significantly at the present point of time.
Q: Does a rate cut as well as the ECB bond buying significantly change the nature of fund flows globally?
A: If you look at last few months, EM flows for the months of September, October, November have been mixed. September, October, till about middle of October was pretty strong for them. Then from late October will late November where we are now, EMs began to lose funds again. And this was true of EM funds, this was true of Asia ex-Japan funds and the funds that have secularly gained in terms of fund inflows, the money inflows, or the north American funds and the global funds. So this has been story of second half of 2014.
At the present point in time, there are certain segments of EMs that would possibly continue to gain. In the near term, I would see some money flowing into China and Korea. Similar would be the fate of Taiwan as well. Taiwan is gaining because of the buoyancy or recovery in demand in the US, ship makers, the semi-conductor component makers. They are obviously linked to the Smartphone handset chain, that business is growing pretty rapidly.
I think the gainers in first half of 2014 like Indonesia had got lot of flows, that is likely to move away slightly because I think in the near term Indonesian inflation would increase as a consequence of the fuel price hike that we saw. India would possibly continue to hang in there for a while. The kind of fund flows that we have seen may ebb slightly at this point. But all and all it is going to be quite a mixed picture. At the present point, I would think that over the next couple of months till the end of the year, the emerging market flows would possibly stay pretty much flat at the current levels.
Q: Does the China rate cut put pressure on Governor Rajan to cut rates on December 2 policy?
A: That is the million-dollar question. Honestly, I don’t think so because as I said the trajectory of inflation and the consequent trajectory of policy rates are quite divergent now and I think central bankers have come to realise that this is likely to be the case. Remember that China cut rates, Korea cut rates about a month ago and in the same breadth, we saw the Bank of Indonesia raising rates by about 25 bps last week. So central bankers understand now that it is likely to be divergent across different parts of the same emerging market complex.
For Reserve Bank of India, it’s the inflationary expectations that are more important than the immediate short-term trajectory of inflation. We have no doubt seen CPI trending below 6 percent in recent months. Not everyone understands that that is because of high base effect that we are seeing right now and that base effect would vanish by early 2015. So we are not yet pencilling in any rate cut right now.
Q: What about stock churn in India itself under the new situation of rate cuts, what will be your lead stocks for instance in the Nifty?
A: I would just point you certain sectors within India. We still remain positive on the private sector banks and we are still quite cautious on the public sector banks except for a few may be like Bank of Baroda etc. But on the private sector banking complex, the likes of HDFC Bank or ICICI Bank etc, we still remain quite positive despite the outperformance that they have had.
I am also quite positive on the consumer discretionary like autos, which have outperformed but there are still some pockets of reasonable valuations in there.
I am also quite positive on Indian IT. I think it is a gainer as consequence of US demand recovery. There is a lead indicator that I always refer to which is the Philly Fed Survey which bottomed out in October 2012 and that is a survey of capex intentions by the US companies and that has been moving up consistently over past two years. I think the biggest beneficiary of that would be the tech universe within Asia, the Taiwanese ship makers, the Korean manufacturers or the Indian IT service providers.
Finally, I would think that very selectively some commodity companies like the oil refining and marketing companies, they would also continue to gain particularly those which have kind of moved away from purely being refiners. Also very selectively some engineering companies, I would not yet look at the second or third tier engineering companies but if we do get a boost to the investment cycle possibly from mid 2015 onwards then the large front line companies would clearly be the biggest beneficiary of that. So those are at the present point of time our sector preferences within India.
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