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Last Updated : Feb 25, 2016 04:02 PM IST | Source: CNBC-TV18

Portfolio repositioning not China dragging India lower: JPMorgan

As far as China is concerned, Adrian Mowat of JPMorgan feels the situation is becoming less precarious and the pressure on the Chinese currency (yuan) is easing now. He does not see China dragging India lower, instead feels it is the repositioning of portfolios that has dragged the country lower

Equity markets around the globe saw sharp corrections at the beginning of the year and this has resulted in clients going into a risk-off mode, says Adrian Mowat of JPMorgan.

However, as far as India is concerned, it has strong fundamentals. Though, it has its own set of problems — frustrating tax situation, rumours about changes being made to the definition (tenure) of long-term capital gains and also some confusion on what markets and economists alike want from the Budget, says Mowat.

He says the current vulnerability in the Indian markets is on the back of bullish positioning seen earlier.

As far as China is concerned, Mowat feels the situation is becoming less precarious and the pressure on the Chinese currency (yuan) is easing now. He does not see China dragging India lower, instead feels it is the repositioning of portfolios that has dragged the country lower.

On the upcoming Budget, he does not want to see current spending increased beyond what is already out on the 7th Pay Commission. At the same time, he wants to see larger spending on investments in the Budget.

As far as fiscal deficit and missing the target to push growth is concerned, Mowat says there are fears of the Reserve Bank (RBI) not being accommodative if there is a fiscal stimulus in the Budget.

Below is the verbatim transcript of Adrian Mowat's interview with Latha Venkatesh, Sonia Shenoy & Anuj Singhal on CNBC-TV18.

Latha: Indian markets are looking like underperforming, month-to-date it is an underperforming market vis-à-vis other emerging markets vis-à-vis other Asian markets. Is it standout boy no longer all that outstanding?

A: I think it is important to understand how technical markets are. What we saw as we came into the year was quite sharp corrections in equity markets, clients have generally been taking risk off. India has strong fundamentals which have led it to be a consensus overweight market and it has proven to be more vulnerable because positioning was more bullish in India.

I also think there are other India specific factors that have maybe resulted in less investor confidence; we do have talk about re-imposition of long-term capital gains tax and international investors are somewhat frustrated by the whole tax situation in India.

There is also a degree of confusion about what we want from the Budget. There is a view that we should get a nice big fiscal stimulus that gets this economy going but then there is always talk around fiscal consolidation and a fear that if there is a too bigger stimulus then you won't get a help from Reserve Bank of India (RBI) with lower interest rates.

Sonia: When we spoke to you in the month of January you had indicated that the Nifty is likely to retest the lows of 6,300 if the Chinese situation worsens. Are we headed there in the near term?

A: I think the situation in China has become less precarious. There is significant structural issue there. The renminbi is actually up a bit year-to-date and if you look at the offshore renminbi to CNH, I think the pressure on the currency is easing. It is part of the end of the bull market is helping currencies throughout emerging markets (EMs) but notably renminbi, where you would have seen much of capital flow pressure, we had a better Purchasing Managers’ Index (PMI) particularly for service sector and services now is the large part of the economy and where people are concerned that they continue to see growth.

The auto numbers and the real estate numbers have also been encouraging. I do not see China dragging India lower. I think we are in a period of time where you have got repositioning of client portfolios and that is a bit of a drag on the Indian story.

Latha: What don't you want to see in the Budget?

A: We do not want to see current spending increasing beyond what you have got for the Pay Commission but what we would like to see is large spending on investment in order to provide that demand impetus to the economy to help it accelerate. I think we got to be careful also when we discuss fiscal deficit relative to gross domestic product (GDP). The reason I bring this up is, we are seeing around the world that the deflative to GDP numbers is much lower than trend -- you see this in India with Wholesale Price Index (WPI) deflation and so the fact that the fiscal deficit is higher than forecast relative to the economy. I think a lot of that is to do with the fact that nominal GDP growth is suppressed by the decline in commodity prices that we have seen.

Anuj: Indian market has always enjoyed a premium to its peers. Do you think there is a case for that premium to come down a bit considering that we haven't seen earnings growth? We have seen earnings growth getting pushed every quarter by two or three quarters. So is there a case for downgrading the Indian market premium a bit?

A: I think there is because as you highlight there has been a failure to deliver on this, so there is a risk that you do get a derating. I think that is going on in the banking space and to some extent that is a bit of a global story. When we look at this on a medium to long-term view, it is much easier to construct high potential GDP growth in countries like India and Indonesia where you have very good demographics. So yes, it deserves a premium but the failure to deliver earnings growth is wearying on investors' nerves.


Latha: How much bad does it get for valuations? It's a premium but premium can erase by how much you think?

A: I do not have a scientific answer to that. I think the risk is that the valuation moves lower. 

Latha: Are you looking at the recent low in the Nifty around 6,850 mark as a potential support level. Is that a spot where you would move some cash into stocks?

A: It clearly is the support level. You wouldn't want to make a new low particularly when other emerging markets seem to have rallied nicely of the January lows and there is a major change going on in the global economy and global macro dynamic. The dollar bull market to us appears to have come to an end; investors aren't willing to increase their short positions in both yen and euro which means that these currencies are now being driven by the current account surplus. The dollar bull market has been a major headache for emerging markets particularly for asset allocators. The end of that is terrific news but what it is making people do is to look at some of the higher risk, higher beta market in a more favourable light because those have been more vulnerable than India have been to the dollar strength.

Sonia: We were making a point yesterday that many of these banks like State Bank of India (SBI), Bank of Baroda are still trading at more than one time price to book despite adjusting for their slippages from many of the restructured assets. Do you think there is more derating in some of these public sector undertaking (PSU) banks or even some of the private banks that have high exposures to stressed assets. Is there more derating on the cards?

A: Entirely dependent on what the RBI does. If the RBI comes with a cut and signals that we are at the start of a more significant easing cycle to try and bring down real interest rates then the equity market will view nonperforming assets is telling us about history, not about future performance and this will not be an important factor when looking at the banks' valuation and performance. So it's up to RBI, if it continues to run higher real rates in India than asset quality will remain stressed and you would probably accumulate more nonperforming loans.

I have talked to clients about the asset quality issues in India. They tend to be very well informed about them, you are clustering in sectors such as infrastructure, energy particularly coal related names, steel; these are bad debts, they are not going to get any better, they are quite well documented. It really becomes a debate about how the government get more capital into the PSU banks. 

Latha: What is that recapitalisation number that will make you feel this is enough?

A: It will be bank by bank basis, so I do not have that number to give you. This is going to be focused in the PSU banks. It is not going to be in a place where there is a big international investors' exposure to them.     

Latha: The government's timetable was Rs 700 billion over three or four years and by that timetable the Budget recapitalisation number will be something like Rs 200-250 billion. If that is announced, will that lead to more selling of PSU banks, should they frontload and give a bigger number in the Budget?

A: I don't know, to be honest, and partly because when I talk to my clients, they don't own these things, so it's not particularly important to them in terms of international investors' exposure. I think where they are more anxious is maybe beyond the top tier private sector banks where people have discovered that the exposure to non-performing assets was higher than they were expecting.

Anuj: Last year was about a lot of domestic money chasing markets and we have seen domestic ownership of stock markets at multi quarter highs. With crunching bear market scenario that we have seen, is there a risk that domestic liquidity also abandoning the market now?

A: If you have got dependency on retail flows. We know that retail flows do tend to lag performance, so it is going to be a bit more challenging to sell those with the market backdrop that we have got at the moment. In contrast in quite a few other emerging markets, we are beginning to see a better dynamic in the equity market performance as rates grind lower in places like Korea bond yields are below 2 percent, Thailand below 3 percent and quite a lot of emerging Asia is below 4 percent, saving pool is looking more equities. The delta in the Indian story in terms of domestic savings is probably less interesting than I am seeing in some of the markets.

Sonia: What should the asset allocation strategy be now, from now until the end of the year, how would you approach equities?

A: This is going to be credibly dependent on monetary policy in India. If we get the RBI moving into an easing cycle that is more convincing than the current one then India will perform well. India's issues around nonperforming loans will diminish and you will be back to talking about a country with a very high potential growth rate. If we can reinforce that with lots of announcements in terms of railway projects, metro schemes, a fiscal outcome that's about getting infrastructure going then India's performance will be good. So as we run into this Budget and we run into a potential decision from the RBI, it is going to be an important inflection point for the Indian market.

Latha: In the last two or three days we have seen the Chinese yuan fixing lower and lower with each day. It was 6.51 on Monday, 6.52 and change on Tuesday, today it is 6.53 and change. Should the markets worry about this?

A: No. I think the market overly worry about the renminbi. We have got a central bank that is looking at a basket and so will be influenced by the moves that we are seeing in yen and euro. We had CNH basically flat year-to-date. I think we spend too much time looking at these fixing.

Sonia: Give us a couple of ballpark numbers. How high is the possibility of post Budget selloff if the market doesn't get what it wants and if that takes place along with weak global cues then what could the downside for this market be?

A: If the market disappoints, it's going to selloff. Positioning is still overweight in India, so maybe we go down and test the year lows. It is difficult to assess at the moment. I remember looking at the world when the Nikkei moved 8 percent in a day, so the correction could be quite painful if we get disappointed.

On the other side of this if you get a credible Budget and the RBI gives you 50 bps cut then the market will rally on the back of that. So it is going to be a very interesting couple of days as we watch the outcome of this. It is always difficult to say how much the market is going to correct by because it is usually more of a guess than a scientific analysis.

(Interview transcribed by Mitali Mohite)

First Published on Feb 24, 2016 10:04 am
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