Dollar nearing peak but oil remains a headwind: Morgan Stanley's Garner

Jonathan Garner, chief Asia and emerging market (EM) equity strategist, Morgan Stanley
Morgan Stanley forecasts oil price to move beyond $90 a barrel. Jonathan Garner, chief Asia and emerging market (EM) equity strategist, Morgan Stanley, tells Jash Kriplani the dollar could be nearing its peak but oil remains a headwind for India and that the country loses out to other EMs on metrics such as dividend yield and valuations. Edited excerpts:

Morgan Stanley has drastically cut its overweight position on India in the past one year. Why?
We are still overweight on India but less. One of the things we have been looking at is the sensitivity to oil. It is also one of the reasons for the recent rate hike (by the RBI).

India has the third-highest oil to GDP ratio among the countries in our universe. We have recently revised our oil price forecast. Last year, we had forecast that oil price would hover around $75 a barrel and we now think oil would move around the mid 90s. So, oil remains one of the headwinds for India.  We do not think it as a strong enough headwind that would derail India’s earnings story, but it has certainly tempered our bullishness.

Do you think the ruling BJP’s defeat will be a big setback?
We are going through a very busy period of politics for emerging markets and there have been some unexpected changes. Whoever forms the next government, for foreign investors it would be important that we do not see a significant expansion in fiscal deficit because that would lead to high inflation. 

One of the achievements of last few years has been the participation in financial markets from domestic investors. However, that process would slow down considerably if you start to have inflationary pressures resurfacing. This would reduce financial savings. So, fiscal discipline would a key monitorable from foreign investors’ point of view.

What is causing the rupee to weaken against the dollar?
The dollar has been strong against most currencies. It again boils down to the current account position and oil sensitivity. We think the dollar is nearing the peak of its cycle right now, but the oil price will continue to be a headwind. Hopefully, it would be a manageable headwind for India.

You see foreign flows into India getting affected due to a weak rupee?
We have seen large inflows into EMs peak in early January. Since then, they have moderated and now turned negative.  One of the reasons we became cautious on EMs was we thought the strong inflows were unsustainable as valuations were overstretched. Now, India is also seeing investors reducing their positions. Investors were running an exceptionally high overweight position around three years back. In early 2015, they were double-weighted versus the benchmark. Now, they have moderated to a five-year low.

How do India’s macro fundamentals look compared to other EMs and Asian peers? 
Our India growth outlook looking forward is the strongest within the EM. We expect 7.5 per cent GDP growth this year. India’s fiscal adjustment has been promising compared to its own track record. The inflation reduction is quite impressive, but there is still a long way to go in terms of exports from the manufacturing sector, generating sustained infrastructure improvement and formal sector employment. Another factor that could work against India is low dividend payout. One of the features of a volatile market condition is a shift from growth investing to value investing where dividend income becomes an attractive feature for investors. In a volatile environment, the return from dividend is quite attractive for investors. Dividend payout is quite low in India compared to its peers in the EM space. Markets like Thailand and Singapore which are our top picks have a much higher dividend yield. 

In terms of valuations, India is not much undervalued. On the one-year forward basis, India is trading about a 30 per cent price to earnings premium to emerging market, which is a similar premium when India’s one-year forward estimated ROEs (returns on equities) are compared to its EM peers.

Lastly, what has been your takeaway from the RBI’s recent rate hike?
The rate hike taken by the RBI was a pre-emptive decision and it was the right thing to do. Rising oil prices is one of the reasons for taking this decision. It is good to see equity markets reacting positively instead of in a knee-jerk reaction.

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