In a special coverage of the UBS India Conference, CNBC-TV18’s Anuj Singhal spoke to Geoffrey Dennis, Head-Global Emerging Markets, UBS Investment Bank, Gautam Chhaochharia, ED & Head-India Research, UBS and Tanvee Gupta Jain, Chief India Economist, UBS Investment Bank.
Dennis is of the belief that India is a buzzing economy and a classic emerging market story.
In September the dollar stopped falling and that led to inevitable pressure on certain countries, which have weaker fundamentals, weaker currencies – there was a selloff in Latin America, Turkey and South Africa but Asia has continued to do well.
Dennis is not overly bothered by the recent pull back as it has been fairly small. The emerging market story is a definitely a buy for the long-term, he said but one of the things that need to be absorbed is that the Chinese economy will slow down next year because this year it was stronger than expected, which drove emerging markets in 2017.
Going head the forecast is for a slowdown in Chinese economy to 6.4 percent from 6.8 percent and the recent pull back in global markets was on back of soft China economic data, said Dennis.
However, the house is still constructive on EM equities for next year, said Dennis adding that they still remain overweight on India.
Looking at the long-term, India is still the best growth story in EM index, said Dennis.
Talking on the Indian economy, Jain said 2017 saw a period of unprecedented reforms in India – reforms like GST, PSU bank recapitalization plan and demonetisation, a move towards digitization.
The house is at 6.6 percent GDP growth for FY18 and expect growth to recover to 7.4 percent in FY19, said Jain, adding that most of the disruption in economic activities is behind us.
However, the key is not whether the growth will pick up from 6.5 to 7 percent but key is whether 7 will go to 7.5 percent and higher and for that the most important factors remains recovery in investment cycle.
Below is the verbatim transcript of the interview.
Q: Any difference this time when you landed in Mumbai compared to your last visit?
Dennis: Busy as ever, some suggestion of slightly worse pollution, it is a little bit cloudier and darker but I think what you get when you come to India is the buzz of an economy that is growing and growing pretty strongly.
Also I think it is a classic emerging market story because you are coming from a very low base in terms income per head, so lot of activity but I have been here many times before, very similar to what we have seen in the past.
Q: There has been a bit of a smog in market as well for emerging markets, what would you attribute that to or is it just that because you have been spoiled so much by markets going up, you have forgotten that markets can correct as well?
Dennis: I think it is both, markets have gone up a lot this year of course and US has gone up a lot since the election, almost exactly a year ago but the point that we have made to people is that in early September, the dollar stopped falling, it began to rally a little bit and that has led to the inevitable pressure on certain countries which are perceived to have weaker fundamentals, weaker currencies. So we have seen a lot of selling in Latin America, a lot of selling in parts of Turkey and South Africa but at the same time what has been very interesting is Asia has continued to do well. I know you have seen a little bit of weakness in the rupee over that period but Asia has done continuously well.
So it is almost like the technology sector which has been the big driver in emerging markets this year and markets like China and Korea have kept going, whereas you have seen some risk taken off the table in some of these other emerging markets.
So what matters from here is, what is the general trend of global growth, what is the general trend of earnings growth going forward but also we as a house think that the dollar is going to start to go down again eventually over the medium-term to long-term and I think that will bring that liquidity back into EM. So we are not particularly bothered by this pullback because it has been fairly small.
Q: There has been some concern about what is happening in China as well. The US bond yield is something that we have looked at over the last couple of days, at what point do you think the emerging markets story will be a buy story again, is it already there or do you think maybe some more correction?
Dennis: I think it is definitely a buy for the long-term. I wouldn’t try to be clever enough to try to pick the actual buying point on a shorter-term basis. I think that one of the things that we have to absorb which is going to be a challenge for emerging markets as we go forward is that the Chinese economy will slow down next year. One of the interesting things about this year is that the Chinese economy is being considerably stronger than we all thought it would be 12 months ago and this has been a very big driver of emerging markets in 2017.
Going forward, we have that slowdown forecast again, 6.8 to 6.4 percent and the pullback just in the last couple of days has been frankly because of the Chinese data. Most recent data has been on the softer side.
So I think as long as the slowdown in China is modest which is what our forecast would indicate and as long as US bond yields stay within a manageable range which again is the houseview, we don’t see bond yields in the US going any higher than 2.7 percent by the end of next year, I think it will just be a question of when you start to see the buying coming back in. We are certainly optimistic for EM equities next year although I don’t think we are going to have another 30 percent year, it feels to us more like 10 percent year next year but we are definitely constructive.
Q: Where would India rank in your pecking order right now?
Dennis: We are still overweight. I think the way to look at it frankly is that and Gautam Chhaochharia will talk about this, you have seen some local liquidity helping to drive the markets. We think that global emerging market investors are beginning to reduce their overweights in India and I think it is a question of stacking up the short-term pressure on growth which is clearly there and will recover which is what we think will happen. How challenged the short-term economy is compared to the longer-term story which is still very good, if you look at it over the long-term India is still the best growth story in the emerging market index. That is where people are looking at, they are wondering at what point do you start to eventually come back into the market but frankly it is pretty expensive right now. But we are still long-term overweight.
Q: What is your sense of where we are right now in terms of economy? You have recently released a note as well, what kind of growth do you see once this near-term GST overhang is over?
Jain: If you look at the way we are looking at Indian economy right now, we believe that 2017 and at least over the last 12 months have been a period of unprecedented reforms. We saw GST getting implemented, which is the biggest tax reform in India on indirect side, we saw demonetisation, which is a move towards digitalisation and formalisation of the economy and finally we saw steps taken to try to resolve the stressed asset situation of the banking system so deleveraging is continuing.
So we are at 6.6 percent gross domestic product (GDP) growth for this year which is FY18. However, we think that most of the disruption in economic activity is now behind us. We are expecting growth to pick up or recover to 7.4 percent in FY19. So we are quite optimistic on the overall growth front. I think the key is not whether the GDP growth will recover from 6.5 percent to 7 percent. The key is whether the 7 will go to 7.5 percent and higher and I think for that the most important thing which I need to see is investment cycle recovery.
Q: Do you think there are upside risks to your GDP target instead of downside risk?
Jain: As of now looking at where the oil is, we have oil at USD 55 per barrel for the full year average in our forecast, if oil sustains at a higher level where we are seeing it right now then there are more downside than upside risks at the moment. So, that is for FY19.
Q: In terms of oil how big is that risk for the Indian market, we have seen USD 64 per barrel and now it has cooled off a bit. If it starts to go above USD 70, in that case would you be cutting your estimates?
Jain: If oil remains around USD 60 per barrel my macro stability risk will widen – be it inflation, current account deficit, fiscal deficit but I won’t be as much concerned as I would be. However if oil crosses USD 70 per barrel I think the impact on my macro stability risk will be much higher.
India has been enjoying this high growth, low inflation and was able to do lot of reforms because we were getting a lot of bounty from low oil prices and we are a net oil importer. So, if oil prices sustain higher, we are definitely at a disadvantage.
Q: How is the domestic picture looking because there is this liquidity argument that every month we are seeing Rs 20000 crore, where will this money go and of course there is the foreigner selling as well and India is an expensive market. So, put this altogether for us and tell us your view on the market?
Chhaochharia: The key delta here is two parts, one is whether earnings recover strongly enough in terms of what the markets are pricing in or expecting and secondly whether the local liquidity can sustain at these levels beyond this year.
For the first part - earnings recovery our top down view is we will still see earnings cut. Very simplistically, the current earnings forecast implied 20 percent earnings growth in second half of FY18 which despite the optical base of demonetisation in our view is very difficult to be met because in a way it presumes that we are not talking just about an optical low base but a stronger economic recovery – more than possibly what even Tanvi is forecasting.
Secondly if you look at next year - FY19, Tanvi’s forecast is 7.4 percent but it is very similar to what we saw GDP growth for the last 3-4 years and we all know where earnings growth numbers were at that level of GDP growth forecast.
So, our top down forecast is 13 percent for fiscal year 2019. So, we are building in some earnings recovery, incorporating a soft economic recovery but nothing great, not where the markets are pricing in.
Markets expectations are that next year it will be kind of goldilocks scenario where government will possibly stimulate growth and at the same time not hurt in terms of macro stability or inflation, which is difficult.
Q: So, at index level you are still not a buyer, you would want to wait for some time?
Chhaochharia: The risk reward is definitely not attractive at these levels but the local flow obviously is a strong support.
Q: What would be a good level, where do you think the risk reward would again start turning favourable?
Chhaochharia: We don’t have a formal forecast for next year for Nifty targets but even for calendar year 2017 our upside scenario was 10000 and if you are looking at 10-12 percent earnings growth next year, you would like to buy markets below that upside scenario to give you some comfort in terms of downside, specifically given how interest rates, the 10-year yields have moved which kind of dilutes the entire cost of capital argument for valuations. So, risk reward definitely not here.
Q: Foreigners used to love Indian market. For the last one year, that has not been the case. The heavy lifting has been done by the domestic investors. Is it just India specific because foreigners are getting better emerging markets, for example Brazil or any other market where they are getting more bang for the buck? Why is there so much consistent selling in India for the last one year?
Dennis: Inevitably, with a question like that, it is a bit of both. People do not just sell India because they do not like India. They probably want to put that money somewhere else as well. The drivers of emerging markets this year have primarily been technology and of course, India has got tech, but it has not been the focus of the technology move this year. That has been Chinese internet and the hardware stocks in Korea and Taiwan. And then, you have seen also a period of time, particularly in the third quarter where some of the commodity driven markets did exceptionally well such as Brazil.
So India has, if you like, been a little bit less in the limelight with respect to the foreign investors. However, it is still worth pointing out that India, for a very long time and probably still today, who is the biggest relative overweight of foreign investors. There has always been this great desire to be invested in India. All that is happening is some of that overweight is being reduced now.
But if you look, for example, at what the data would tell you on India versus China, India is still probably an overweight for global emerging markets (GEM) investors and China is probably still an underweight. It is just they have moved closer together, if you like. So you could see more foreign money coming out, depending on obviously what happens on the earnings side, as Gautam has also said and it depends on relative valuations now.
The point we made to investors is that while the cost of capital has been very low, which it clearly is in the US and we expect that to be the case going forward, I think all emerging markets look a little bit expansive, the asset class does, although India looks particularly expensive. So we even have to look at Indian valuations in context of EM overall as opposed to just saying the foreigners think India is expensive and they need to get out. It is a question of what the relative attractions of India are compared to other markets in the EM space.
Q: And in terms of these flows, how important is the next move from the US Fed? Are we now in for a rising rate territory and in that case, would the overall inflows into emerging markets, would that itself be at risk?
Dennis: We think, what the Fed does is not of major importance at this point. We think the markets are being driven by the long end of the curve, not the short end of the curve and we expect long rates to stay, as I said earlier, relatively low, 2.7 at the end of next year. You are probably going to get a Fed move in December, two more moves next year.
So the yield curve is going to flatten and the long end is going to be the big drive. Now, having said all of that, I think the biggest single conventional macro risk, I emphasise the work conventional, macro risk to emerging markets today is that you do get a stronger US economy, you do get a sharp pickup in inflation which makes the Fed get more aggressive and gives you a much weaker bond market.
That is going to pull all of EM down, but if we get the Fed doing what we think the Fed is going to do and the bond market behaving that way as well, I think the Fed is going to be something that it is not going to be that relevant in terms of where the markets go from here. We are going to be driven by bonds and we are going to be driven by the US dollar as always, of course.
Q: Talking about US dollar, what is the house view for the Indian rupee? It has been resilient, but off late, there has been a couple of issues whether there are the macro headwinds or there is this foreigners' selling that we have seen. We have started to see a bit of a move on the currency as well. How are you mapping the moves?
Jain: On the rupee side, if you look at why rupee has been so stable is because our current account deficit was very stable and we came down at a peak of 5 percent of GDP on the deficit front to only 0.7 percent of GDP last year. But if you look at now what is happening, because of oil prices going up and the sensitivity is so high that every USD 10 increase in oil prices increases current account deficit by USD 8 billion which is almost 30 basis point of GDP.
At the same time, your non-oil, non-gold imports have been trending 20 percent plus average growth. Over the last six months all these have been hindering in terms of stability in rupee. And we recently saw FII debt limits were liberalised by USD 6.7 billion. So that kind of supported rupee even with somewhat widening in the current account deficit. But now, everything seems to be mellowing down especially with oil going up.
So our view is that even our base case is still based on USD 55 per barrel oil. It is at USD 65 per barrel for the year end, but if oil remains at the levels where it is, we can easily see 2-3 percent appreciation from the current levels.
Q: Since we are talking about deficit, you must have done some work, once these GST rates were reduced, on what kind of impact will we have on the deficit numbers. Any calculations over there?
Jain: If you look at the recent cut in GST rate which was announced for a number of items, the impact on fiscal deficit will be to the tune of Rs 200 billion which is 0.1 percent of GDP which is not much. The thing is that GST is still a very big indirect tax reform and the government is still trying to make changes.
The only idea is that as long as it improves tax compliance, bringing more people under the tax net, a lower GST is okay. So I think I am more concerned about the risk of fiscal slippages this year partly on GST, partly on excise duty cuts and now, oil going up. And plus, if you look at year-to-date, government deficit is already running at 3.6 percent of GDP. So that is what is more concerning and we are in the run-up to the 2019 elections. The only hope is that we do not go populist way.
Q: Is that a risk for market? We have Gujarat elections just round the corner. That is the first big one and then next year, we have 3-4 really big states.
Chhaochharia: That depends on which investor you talk to because we see two divided camps. The local investors here would actually look forward to a fiscal stimulus because they are more local growth buyers and they think of returns in rupee terms, not dollar terms, while the global investors, the investors Geoffrey talks to, they would worry if we see any change in the stance on macro stability parameters.
But our sense is, we spent some time with government officials also is that they seem to be very clear that fiscal discipline is something which is what they will stick to. There could be slippages here and there depending on macro events, but the broader trajectory is not to look at a massive fiscal stimulus.
Q: The days of populism are over, right?
Chhaochharia: At least that is what this government thinks so and even our work earlier suggested that populism works at a very marginal level. The Indian population has changed and evolved and just freebies will not win you elections.
Q: So, what are your main conference themes? In any market, I know you are bearish or slightly negative on the market, but you still have some bullish bets, right? So what are the main themes for this conference?
Chhaochharia: Again, bearish based on fundamentals. Again, liquidity we all know and the long-term India story still looks very solid. There is no change in that framework. The themes we are looking at is a more topical one so we have themes focused on electric vehicles, how the Indian passenger market will evolve around that, we are looking at gas as a potential energy solution for India, internet, specifically the travel space, consumers, whether the new physical retail is now back to being a reality.
These are the topical themes which are relevant for markets right now and focusing on that. In a way, it reflects the emerging areas of the economy. Even in a company, preference list, stock picks list as well as our attendance list, we are focusing on themes around this.
Q: Since you spoke about IT or technology and we have seen the kind of rallies that companies in US have had, huge market caps being added almost on a daily basis. We have started to see some bit of revival in Indian IT as well. I know you have tracked it in the past. Do you think it is getting its mojo back? Would you want to bet on this story or do you think the heydays of Indian IT are well and truly over?
Dennis: Obviously a little bit beyond what I focus on day-by-day, but I think the way you look at it in context of emerging markets right now is that there is so much of excitement about first of all, the fact that global economy was so much stronger this year than anticipated. We just had a tremendous demand on the hardware side which of course, the Taiwan and the Korean companies have benefitted from. And then you have had this dramatic explosive growth of the Chinese internet companies. In some sense there is a linkage there but they are also slightly different stories.
I think it is perfectly logical to be constructive about Indian IT, but I still think at this point there, if I may say so, it is more of a side show compared to what is going on in other parts of the tech space, whether you are looking of course at the US, with the famous FANG stocks, as they are called now, and also, if you are looking at what is going on in the emerging market side. So if the local conditions are there to nurture these technology companies in India, I think they will benefit long-term from all of this. But frankly right now, the focus, I think, is elsewhere.
Q: You of course, look at them more closely. You have Tata Consultancy Services (TCS) as one of your top picks. IT has had a big rally actually this year. I was looking at Wipro's chart for example, up 27 percent. Is that a theme that you are backing right now?
Chhaochharia: We have been overweight this year on IT. We were underweight for the last three years. But we turned overweight this year primarily because in our view, these structural headwinds from digital transformation was in our view, in analysts' estimates and their valuations. So we expected disappointments to no longer be the case and we have seen while quarterly numbers for them are not great, but they are no longer disappointing. And the upside scenario is basically coming in from if we see a US cyclical recovery in tech spending, then that could be a tailwind for these companies' earnings growth next year.
Q: The other thing that I noticed is that you are backing the consumption play despite the kind of valuations that we have seen. Some of these stocks are trading at 40-50 times. What makes you bullish even at these prices?
Chhaochharia: A couple of points. Longer term, obviously consumption is one of the secular themes in India. So if you are looking at long-term investment, you should look at the theme. But near-term, our preference is more for staples and two-wheelers. Staples reflects also our slightly defensive view on the market as well as the tilt in government policy towards lower income and rural population which should help staples more than discretionary.
And two wheelers, our recent evidence lab work suggested that even urban areas, we see two-wheelers picking up, the demand for bikes picking up this year. Rural we all know. And the valuations are much more reasonable there in the two-wheelers compared to four-wheelers. So it is a mix of these two things. But consumption anyway is a long-term secular theme in India.
Q: Do you think that this market and I am talking about global equity markets, global emerging markets, in a synchronised bull market, it still has to see the best, we could see a bit of a melt-up as we move towards the year-end, December?
Dennis: I doubt you will get a melt-up. We sort of had a melt-up already. We have had a 30 percent move in emerging markets this year. We have started to produce research for 2018 and our initial call is emerging markets add another 10 percent next year. The issue here is that we have had very strong earnings in 2017 coming off a very low base with the global economy surprising to the upside. We expect global growth next year to be flat on this year.
So it is going to be very hard to generate the same sort of earnings growth, 20 percent plus that we have had this year. So we are looking at about an 8-9 percent earnings per share (EPS) growth next year as the first cut. And given that valuations are already pretty stretched, it is hard to see much of a rerating.
So we are bullish, but we are not as bullish as relative to what the markets have done this year. So I think a melt-up is unlikely. But we are pretty sure as well that a melt-down is unlikely as well because, while these global financial conditions are favourable, low cost of capital, dollar probably going down again next year, that is going to continue to move funds towards the emerging markets. The constraint will be what the earnings growth is going to be and what the valuations are.
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