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Last Updated : Jun 02, 2016 08:21 AM IST | Source: CNBC-TV18

Worst not over for emerging markets; India safe: Morgan Stanley

India is more resilient to global factors like Fed rate hike now, says Jonathan Garner, Chief Asia & EM Equity Strategist at Morgan Stanley.

Accelerating gross domestic product (GDP) and earnings upmove has made India more attractive, says Jonathan Garner, Chief Asia & EM Equity Strategist at Morgan Stanley.

The brokerage house had upped its outlook on India to ‘overweight’ from ‘equal weight’ last week. India has risen to number three position among 27 countries that Morgan Stanley reviews on monthly basis.

Garners expects earnings to grow at 9 percent this year and will be in mid-teens in FY18.

While the Emerging Markets (EMs) are likely to decline, Garner says that “India will stay where it, if not rise.” However, worst is not over yet for EMs on back of slowdown in China, lower commodity prices and strengthening dollar.

“India has de-risked itself from EMs,” he says adding that it country is not longer vulnerable to global risks like Federal Reserve expected rate hike.

Garner expects a 50 basis point rate cut by the Reserve Bank of India by end of FY18.

Below is the transcript of Jonathan Garner’s interview with Anuj Singhal on CNBC-TV18.

Q: Great timing. You upgraded Indian market and we have seen a 5 percent rally. What drives your tactical overweight stance on India now from here on?

A: It is actually a call that we make in the context of a monthly model we run. And India has risen to number three out of 27 countries that we assess on a monthly basis. So, if I were to summarise the reasons why, it is really that we see a gross domestic product (GDP) growth acceleration that is unfolding now and we see an earnings growth acceleration.

So in the most recent quarter, Indian companies had a net income beat of around 6 percent whereas emerging markets overall were still missing earnings by about 2 percent. In terms of that GDP growth acceleration, we have seen the numbers today, 7.9 percent for the most recent quarter. That means India is by far the most rapidly growing country in emerging markets.

Q: And do you think the earnings growth will follow now for India because this quarter it looked like we had some green shoots. The second half of earnings season was not as bad as people had feared. Do you see the start of an earnings up cycle which your colleague Ridham Desai, of course mentioned yesterday as well.

A: Yes, we do. If you look at the numbers that Ridham and the team have in mind we are looking at something like 9 percent earnings growth for Sensex this year accelerating to mid teens earnings growth next year.

And that in dollar terms will translate to positive dollar earnings per share (EPS) growth which again is in contrast with what we see for the broader emerging markets universe.

Q: I was going through your last strategy note and what stood out for me was that, you see India is a low beta market. You see absolute downside for emerging markets. So, in that context, are you saying that Indian market may also fall, but may fall less than the emerging market. Or do you see in absolute number, an outperformance for Indian market.

A: So yes, we do expect emerging markets overall to decline because of that earnings fall we are projecting. For India it is reasonable to assume it can at least stay where it is in that context, if not rise. And that point about low beta is an important one. The beta is about 0.8 to the emerging index. It used to be well above one.

India has de-risked itself from the rest of the emerging markets. And if you were to summarise why it is probably around the much improved current account balance and fiscal balance situation. So India is no longer as vulnerable to global risk-off environment when the Fed may be raising interest rates, the dollar may strengthen and so, 2013, you would have not had that same kind of low beta reaction.

Q: So, let us put it in numbers because we know that India is trading at a premium to emerging market peers. That premium of course has come down from 56 percent to 36 percent as you mentioned in your note. Do you think it can go back to 56 percent in current environment or do you think it will go back to somewhere around 45-46 percent. Is there any number that you worked right now?

A: If you take 40 percent and that is quite close to where we are now, that is the long run average valuation premium for India going back 15 years. And we think that is warranted by the superior return on equity (ROE) that Indian corporates have demonstrated over the cycle.

In terms of the peak valuation premium which we saw around 70 percent, I doubt that we are going to go back to that. That was probably excessive in the early days of the Modi administration. But certainly is a pretty comfortable valuation set up right now.

Q: The other point that you also mention is the foreign institutional investor (FII) ownership or the FII positioning. The global fund positioning for India, that has clearly come down from what it used to be. The last round of market rally was led by domestic flows. Not as much foreign flows. Do you see foreign flows picking up in the second half of this year for India and do you see disproportionate amount of foreign flows into Indian markets?

A: If you look at flows in relation to emerging markets and Asian equities generally, we are actually getting outflows again right now. There was a brief period of inflows in the March-April timeframe. But as Chinese economy slows, as we are getting weakening of commodity prices again and as the Fed interest rate pike looms, you are getting that traditional outflow from emerging markets.

But we think India will suffer less from that than the other countries because of this divergent GDP growth and earnings growth environment that we just talked about.

Q: In that context, how do you look at the domestic fund flows into India because which really has been a pillar of strength all through the month of May when all the emerging markets fell 4-5 percent, but India actually rallied 5 percent?

A: The key to the long run development of the market remains local mutual fund and institutional flows into equities and if you look at one of the catalysts for that, it will be this sustained improvement in the fiscal deficit which unlocks the potential for lower interest rates and lower government bond yields.

And again, we are pretty constructive on that. We see that the RBI is able to make another 50 basis point rate reduction at some point for the remainder of the year and that will help drive this process.

Q: 50 basis point rate cut for the next calendar year or fiscal year?

A: Out to the end of the next fiscal year.

Q: That would be great news for the market. In fact since we are talking about the rate cut, just a word on how global investors are viewing the current situation about the RBI governor, the fact that his term is up for renewal. But there is some bit of debate on whether that should be done or not. Would that be a material negative for Indian market if Raghuram Rajan is not re-elected as the RBI governor?

A: There are many positives behind the India story at the moment, multiple positives. But I do think the Central Bank governor deserves a lot of credit for the action he took early on in his term in terms of doing the hard work of monetary policy when India’s macro position was more unstable and so global investors view him as one of the higher performing central bank governors in emerging markets.

Q: I know it will be unfair to compare from a particular point, but over the last 8-10 years, long-term investors have not made too much money in India in dollar terms. Do you think that will impact some of the long-term flows in Indian market?

A: Versus the rest of the emerging markets, India has actually been a trend outperformer, but with a lot of volatility which has been the result of the macro balance being somewhat more adverse in the past than it is actually today. So, come back to that low beta point.

If India is low beta to emerging markets, but also delivering higher GDP growth and higher earnings growth and if the starting point in valuations is reasonable, then you can really get quite excited about this market and that is why we are overweight.

Q: One confusion which prevails in the market right now is the Morgan Stanley Capital International adjustment that will take place on June 14 regarding China American Depository Receipts (ADR). If China ADRs are included, does that impact India’s fate and other emerging markets fate? In that case does it impact the flows or are we reading too much into that right now?

A: This is the second phase of the ADR inclusions. They come in two phases, as you said, last year and then again next month. And then there is also the debate about the Asia index inclusion where we may get an announcement, not that they would be included this year, that would actually happen next year. But you have to bear in mind that the Chinese ADRs, already very widely held by global investors, is an off index bet.

So, we do not think there will be very significant fresh money buying of those ADRs just to do with the index inclusion. And indeed, on the Asia side of things, we think it is 50-50 whether they will be announced for inclusion. But even if they are, it will come in at a very low inclusion factor, round about 5 percent of the free floats.

That means that the Asia will most account for about 1 percent of the emerging market index pro forma going forward. That is only going to have a really marginal impact on India’s share in the emerging market equity index. And in any case, active fund managers have often deviated from the bench mark in relation to India.

At the moment, they are close to 10-year average degree of overweight on India. But we actually think that overweight will probably build going forward.

Q: Do you get a sense that the emerging markets have put the worst behind with the February low? Do you think the MSCI emerging market index or MSCI Asia ex-Japan even though your call is that emerging markets will fall from here? Do you get a sense that the worst is behind and what we may see is a bit of a correction of the recent gains?

A: Our target is 755 for the emerging market index. That is down around 5 percent from where we are now on a 12 month forward basis. So no, we do not think the worst is over.

We think we go back down again, not all the way to the lows we saw at the low where we were sub-700 on the index, but we think there is a headwind in relation to China’s growth outlook for the second half in relation to what we think commodity prices are going to be doing.

And that has already started in May and dollar strength which again, has reasserted itself in May. So, what is interesting is that India has managed to decouple in terms of performance, since you mentioned at the start of this interview doing very well in May and that is something that is quite striking.

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First Published on Jun 1, 2016 10:43 am
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