India well-placed to attract emerging market flows: Jonathan Garner

Jonathan Garner, chief Asia and emerging market strategist, Morgan Stanley
Favourable election outcome, relative immunity to global trade tensions and uncertain environment in China have directed foreign flows in favour of India in recent months. In an interaction with Jash Kriplani, Jonathan Garner, chief Asia and emerging market strategist, Morgan Stanley, elaborates on the triggers that could give further impetus to foreign inflows. Edited excerpts:

What has been foreign investors' stance on India?

For India, we have recommended a 150 basis points-overweight stance (against the MSCI Emerging Market Index weights), which is our largest overweight alongside Brazil. While clients are overweight on India, their overweight is much lower than what it has been on an average over the last five years. It reached a peak about six months after the Modi-government was elected for its first term. Since then, foreigners have been steadily reducing their exposure to India, albeit they remain somewhat overweight. They have been building up exposure to China. Currently we are recommending them to reverse this allocation strategy. At the margin, we are recommending clients to shift out of China, Korea and Taiwan, and build up exposures in India, Brazil and Indonesia. We are most bullish on India and Brazil.

What makes you bullish on India and Brazil?

If you look at sum of imports and exports, relative to gross domestic product, both Brazil and India's economies are not very open economies. Whereas Korea, Taiwan or China got much more to lose from interruption in global trade. Both Brazil and India have historically done well in environments where the US Fed is cutting interest rates, which is what we are seeing right now. Conversely, these economies don't do well when US Fed is raising interest rates. This is because both tend to have structural deficits on fiscal and current account, which are more difficult to fund when US Fed is raising rates. For India, the other positive is the falling oil prices. India can also benefit from supply-chain relocation out of China.

Are Indian markets attractively valued at this point?

In terms of price-to-book, the valuations are okay on a relative basis. In terms of price-to-earnings, they are somewhat expensive in relation to other emerging market peers. This is indicative of the fact that earnings are depressed and so it is very important that Modi-government solves the financial sector problems in its second term. The re-capitalisation of public sector banks is important. Also, addressing issues related to the shadow banks is important to get growth going again. India's earnings growth is running at two to three per cent and overall economic growth rate has been quite weak.

How do you see foreign flows moving into India?

Overall, emerging market is experiencing outflows at the moment. However, India has been getting inflows in year-to-date, in contrast to the general situation. We are optimistic that these inflows should continue due to the various factors that are favouring India currently.

How has election outcome helped investor sentiments?

There has generally been reduced uncertainty after election results. Key positions like finance ministry have got filled in. At the same time, uncertainty is increasing in the case of China. There are concerns over the trajectory of the Chinese economy and the trade and tariff tensions. India is not as significantly impacted by the trade worries as China.

How much of a concern are issues in non-banking financial companies? 

It is not a systemic worry, but it is important for improving economy's growth. Sectors that use credit from these shadow banks like two-wheelers have had weak sales. So, there is a need to find a solution to the concerns around shadow bank institutions. The financing of these entities needs to be put on a sounder footing.

When do you see the private capex cycle reviving in India?

According to our economist, it will happen in second half from a very low base. Historically, lack of private capex has been a problem in India. In the government's first term, we saw healthy foreign direct investment, and also some infrastructure delivery. But, private capex spending in sectors such as real estate or power has been very weak. We will monitor how the capex cycle shapes up in future.

Do you see interest rates continuing to ease in India?

We see two more rate cuts in this calendar year. But, financial transmission mechanism needs to be fixed. This is a good time for the government, the new finance minister and the Reserve Bank of India to jointly address this issue. India's foreign exchange reserves are quite strong. So, that can offer a solution to re-capitalise public sector banks and re-orient them. But, the public sector banks need to be put on a sounder footing. They need to be re-oriented in terms of their management and their goals should be made more clear.

Which are the sectors that you are bullish on?

We are overweight on financial institutions, private sector banks, consumer discretionary and industrials. We are underweight on utilities and communication services (telecom space). We are also underweight on the pharma sector, but that is due to margin pressure from a relatively strong rupee and regulatory concerns.

What are economic reforms that new government could focus on? 

Further efforts on infrastructure and foreign direct investment are needed. We would like to see more divestments of non-core assets by the government to welcome foreign capital more into the country. It is important that credit growth comes in an appropriate manner. That will allow funding of business investment, also private and consumption spending, especially in real-estate related activities. Whether it is public sector banks or shadow bank institutions, it is important that the credit growth is appropriate; in the sense that it doesn't lead to non-performing loans or liquidity problems.

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