See 30% returns from India post EMs sell-off: Wells Fargo

India, though had started its year with great expectations with Modi government taking the reins, anticipated reforms have either taken a backburner or the growth rate has slowed down, says Brian Jacobsen of Wells Fargo Asset Management. However, Jacobsen is confident that the reforms will come through with time. Speaking to CNBC-TV18’s Latha Venkatesh, he says that in the upcoming Budget on February 29, all eyes will be on fiscal deficit as well as key infrastructure investment by the government. Jacobsen says that some improvement is needed in fiscal deficit numbers and says it should be close to 2-3 percent instead of 3.7 percent currently. However, he adds that “a miss on deficit can be forgiven if spending is done in productive ways.” There is a risk of high deficit pushing interest rates up, he adds. On the stressed asset situation of public sector banks, Jacobsen says the magnitude of the issue is much larger than of China and both recapitalization and reforms are needed to improve the conditions of banks. This matter must be on the Budget, he says adding that if it does not find place in the upcoming Budget, then achieving long term goals will become difficult for the country. Jacobsen also believes that Reserve Bank Governor must continue to push for more freedom for the Central bank. Any move to curb its freedom, will prove to be harmful, he adds. Jaconsen says that if emerging market sell-off is coming to an end, as believed by some experts, then one could see repricing. Over the next year, EMs could yield 20 percent returns or 30 percent in case of India, he says. Below it the verbatim transcript of the interview..Q: As you know India's 2016 Budget is just a few days away but before I get to your expectations from the Budget can you just rate the India growth story. Is India living up to that big reform expectation?A: I would say that India we started with some great expectations with the Modi government anticipating that there would be some significant reforms. Sadly some of those reforms seem to be put on the back burner or weren't coming forward as rapidly as a lot of us were hoping. However I do think that a lot of those reforms will be forthcoming. It is just a matter of being patient to wait for them to be actually implemented. So, the release of the Budget is always a very important thing for not just domestic investors in India but also foreign investors to watch to see what the budgetary priorities are of the government.So, some of the things that I will be really looking for are to see whether or not there is going to be significant progress made as far as with infrastructure investment for example which is one of the thing which would be some of the low hanging fruit so to speak for the government to pursue.Q: In India opinion is deeply divided with respect to the fiscal deficit. There are some economist who want it pinned to the preordained timetable of 3.5 percent. That is the original deficit reduction time table. Others want the fisc to spend. What is the deficit number that you will be comfortable with?A: For the fiscal deficit I would like to see some improvements there instead of being close to four percent, I would prefer it to be closer to something like three percent or even two percent but over the next year a deficit in one year isn't necessarily a bad thing if it is being used to finance high productivity assets or to make significant improvements with structural reforms. So, in a way a miss on the deficit target can be forgiven if the spending is used in productive ways.But I do think there would be an adverse reaction in the markets if we saw that there wasn't progress on the deficit front and that it wasn't coupled with decent spending as far as with social programs or with infrastructure spending. So, it really is a find balancing act that the government has to walk here.Q: I don't know if you advice investors into the debt markets in India but the Indian debt market is more wary of the deficit because even with 125 bps rate cut from the reserve bank in 2015 yields did not fall at all. So, would you worry that a larger deficit could push up bond yields?A: There is a distinct risk that a high deficit would push up interest rates even further. One of the reasons why people have been somewhat shunning Indian debt it really has to deal with sort of the story related to most emerging market debt which is anticipating of declines in the currency. So, while the yields might be very attractive just on a nominal basis when it is translated then into a hard currency basis like let us say in US dollars or in Euros it might be less attractive if it is viewed that the currency might depreciate. That has over the last year made people more hesitant in holding some of the debt.However a lot of those concerns might be abating where we have seen declines in emerging markets (EM) currencies and it appears as though some of those worries might be coming more towards an end.Q: Government owned banks have seen a lot of bad loans because of their exposure to say, steel companies and other infrastructure loans. Would the amount of capital set aside for government banks be something that you will watch out for in the Budget?A: Oh yes, that is a very fare point about looking at recapitalisation of the banks. Just for some context if you think about the non performing loans or the bad loans on a lot of the government sector banks in India being at 6-7 percent contrast that to say in China where it is about 1.6 percent. So, it is an order of magnitude higher for Indian banks and they are in quite need of not just reform but recapitalisation. So, a big question is how much do they need and then what sort of steps will they take as far as trying to fill that hole. There is something that should be in the Budget and if it is not it appears as though it is going to continue to weigh on the progress towards meeting some of the longer term developing goals in India. It is very difficult to grow the economy rapidly if you don't have well capitalised banks or banks that are willing to extend credit to finance that growth.Q: How would you assess the Reserve Bank's performance in handling macros like inflation and the rupee?A: I have been a very big fan of the Reserve Bank. It has a very competent head of the Reserve Bank. I have been a big fan of his work for many years. He is very well known on the international stage. I believe he has gotten in front of some significant issues that many EM economies have had to rustle with. Talking about coordinating policy between the EM central banks and the developed market central banks. So, he has done a very good job. It has been a challenging job for certain and I really hope that over the next year and over the next couple of years he continues to push for more independence for the Reserve Bank. Over the last year there was talk about whether or not the government itself should have some sort of voting right or vito power over setting monetary policy. And if that were to come to pass that would be a significant step backwards for the financial development of India. Having a strong independent central banks is a cornerstone to taming inflation and developing your financial system.Q: What kind of returns do you expect from India in say, 12 or 24 months, in Indian equities that is?A: Assuming that I am right about the EM to sell off coming to an end here we could actually have a significant reprising across all of the EM space. For EM as a whole I am anticipating that over the next year we could probably see close to about 20 percent return. India though we could see something close to 30 percent. Again there is a lot of air around that because of the uncertainty around that forecast but if we do end this sell off in the EM and begin this reprising India is the one that could actually stand out in terms of the total return over both the next one year and over the next three years as well.