Oil prices, not 2019 election key risk for Indian market: CLSA's Chris Wood

Christopher Wood
Despite the headwinds in the form of oil prices, monetary tightening, state and general elections, Indian equities face over the next one year, CHRISTOPHER WOOD, managing director and equity strategist at CLSA tells Puneet Wadhwa at their 21st India Forum that he is not altering his allocation to Indian equities just yet. The Narendra Modi government, he says, is right in complaining about the RBI's tight monetary policy given the inflation data. Edited excerpts:

What’s your view on how the equity markets across the globe have played out over the past few months?

The correction in the Asian markets on account of monetary tightening in the US has been overdone. In the case of China, the correction has been driven by deleveraging and not trade war fears. What we saw in October was monetary tightening finally hitting the US market. So long as this tightening continues, there is a downside risk to the global equity markets. That said, there are chances of a rally as we go into the New Year, if there is a trade deal between the US and China. This rally will clearly led by Asia. My base case is that he will do a deal with China before the next wave of sanctions come in.

What about India?

India is more of a domestic news story. While the rest of Asian markets will react to this development, India will not be impacted much. In India, there will be a huge noise around the state election, which in my view, are not relevant for the general elections as they will be contested on local issues. The state elections are much more important for the opposition parties than for the Bharatiya Janata Party (BJP). The Congress needs to prove that it can demonstrate an electoral challenge to the Narendra Modi – led BJP. There will be a lot of volatility in the Indian markets till the general election outcome is known. The key data point, however, to watch is the bond fund inflows given what we saw in September.

Have the recent developments prompted you to change your allocation to Indian equities?

No, I am not changing my India allocation just yet. I reduced the stance from triple overweight to double overweight at the start of calendar year 2018 (CY18). Exposure to energy stocks is a must for those who want to be overweight India now. The biggest risk for India is if oil prices go up. My opinion is that Saudis do not have as big oil reserves as they claim. As a result, I don’t think they have the ability to raise production. 

So, what will make you rejig your allocation to India?

I will increase my allocation if I see evidence of a pick-up in investment cycle, which I expect next year now. By 2019, there will be a pick up in the investment cycle, which means that India will become contra-cyclical at that point in time. But in the meantime, we have the risk that oil-related risk.

The other issue that has caused some concern is the tussle between the Indian government and the Reserve Bank of India (RBI). How do you interpret this?

The monetary policy in India is too tight, and I do agree with the government on this. The real rates are very high relative to headline inflation. The core inflation, on the other hand, is higher. But, the RBI’s monetary policy is based on headline inflation. So, the monetary policy is too tight. If the RBI is also tracking the core CPI (consumer price inflation), they should say so explicitly to the market. Personally, I am sympathetic to some of the criticism. The biggest risk to inflation and rupee is the externalities of the US dollar. I hope the tightening by the US Federal Reserve (US Fed) will end next year, in which case the dollar pressure will ease. 

How have an exposure to banks and non-bank finance companies (NBFCs) in your Asia ex-Japan portfolio. Have the recent developments nudged you to trim this?

The development was a disaster. Up till August – end, my portfolio was performing well despite 2018 being a bad year. But this single event has clearly trashed these stocks, particularly on a one-month view. I still have an open mind on what to do with the bank and NBFC stocks in India. 

The government has strengthened norms for credit rating agencies as well post the development. Your thoughts here?

Yes, the bigger issue in all this is about the credit agencies. Investors will not take them seriously. It is a big deal that a triple-A rated company defaulted on the bond payment. This coincided with the announcement the tenure of a particular bank’s chairman not being renewed. This was a double-whammy for the Indian financial sector. It is not only about the rating agencies, but about the Indian government as well. That apart, where were the regulators amid all this? This is a legitimate criticism of the regulators from the government. 

So, will investors pull out money from banks and NBFCs now?

If investors stop trusting the credit rating agencies, they will look at the parentage of the companies, or the lack of it. Amid all this, one thing that is being missed is that the government has put in place a strong bankruptcy law in place. Contrary to expectations, new people are coming in to buy stressed assets. This is a positive development. 

Your views on the Indian economic growth?

The overall economic growth in India will slow. Loans to developers, too, will slow. That said, the overall property market in India is in the early stages of recovery. The realty sector has seen an extended downturn. This is a good time for investors to add stocks from the affordable housing sector to their portfolio. 

What is the biggest risk for the Indian markets?

The biggest risk for the financial sector is another skeleton (like IL&FS) going ahead. For the Indian market as a whole, the key risk is oil and the key positive from a 12-month view is evidence of capex picking up. I do not see the general election as a key risk to the Indian markets. My base case is that the BJP will form the next government, but with a smaller majority. 

Which regions look cheap / attractive to you now?

Russia does, so do China and Pakistan. Indian markets do not appear cheap at the current levels. India has always been a growth market, but never cheap.

How do you rate the progress on policies / reform agenda of the government over these four years?

On a scale of 1 to 10, I rate the Modi government’s progress on policies 8. The big mistake made by the Modi government was not to address the banking problems immediately. They should have done this in the first month they took over, as they knew this existed. The Modi government inherited this from the earlier government. The reason they probably did not address this issue was that the government would have had to bring their shareholding in banks to below 50 per cent.

How do you see the US bond markets play out going ahead?

Inflation in the US is just about peaking. My base case is that the bonds will rally and the equity markets will correct in the US.  

Crude oil prices have slipped below the $70 per barrel mark. Is the worst behind us now?

Oil prices can hit $150 a barrel in case we get politically driven supply disruptions. The Indian government should not assume that oil has peaked. The Americans did a U-turn on the Iranian issue. Two months ago, the world was assuming that the US will force the sanctions aggressively, India would stop buying Iranian oil and were threatening secondary sanctions. Suddenly, Donald Trump realised that oil prices could go parabolic when he was to face the mid-term elections. The rise in oil prices started to become a liability for him. He also started to doubt the ability of the Saudis to control the tall oil price claims they had, as they claimed to be the swing producer. As a result, the oil hawks backed down and resulted in the prices softening. The fall in oil prices has presented investors with an opportunity to buy oil stocks. The fundamental dynamic on oil is that the demand stays strong led by emerging markets and the supply remains constrained. 

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