The Hindu Business Line : `India to perform well despite high valuations'

The Managing Director of Morgan Stanley, Mr Daniel Hegglin, believes that liquidity conditions across the world are fairly benign. In his view, India will continue to do well despite high valuations. According to him, Bank of Japan may leave rates unchanged due to political compulsions. Mr Hegglin mentions that the Fed rate hike is likely to create danger for emerging markets. Moreover, he feels that emerging markets will outperform both on the upside and downside.

Excerpts from CNBC-TV18's exclusive interview with Mr Daniel Hegglin:

It is not just India, even Korea, Taiwan, Thailand have all seen reasonable flows in the last three to four days after a lull. Do you get the sense that emerging market flows are picking up again?

Actually, January wasn't that bad either because whilst the markets didn't do a lot, there was lot of sector trading going on; different sectors performed well, autos have retreated and I think we have built up quite a good base here. If you look at the flows in the month of February, I think a lot of it was driven by the attempt in S&P in New York to push through the 1440 levels, and then through the 1450 level, which I think has given people confidence.

Even so, do you think anything has changed by way of risk appetite at this point in emerging markets like ours? Can we expect to see more by way of flows from the next two months onwards?

This is the time of our ninth Investor Conference here in Mumbai and we seem to have the knack of having this conference whenever the market is doing particularly well. I think, even in this period, with a relatively expensive market with forward PEs of nearly at 20, India will continue to do well because what we have seen over the last few years is that whilst the market traded theoretically expensively, we have seen lot of upside surprises in the earnings, which then with hindsight make past prices looked quite cheap.

What is the sense you get from the US given what the Fed or the FOMC has been saying for the last couple of meetings? Do you think it points to fairly benign liquidity conditions across emerging markets or do you think a process of tightening may ensue soon?

I think the liquidity conditions across the world are fairly benign, notwithstanding that particular European Central Bank is still on a tightening mode. But let us just take a step back. A year ago, when Mr Bernanke came on as the Fed Chairman, he made a couple of mis-steps probably; he needed to regain the confidence of the financial world. I think he has done a very good job over the last 12 months.

What about the other key source liquidity - Japan? What do you see happening in terms of interest rates and fresh money coming from that market?

Everybody talks about the carry trade and whilst no doubt that Japanese interest rates at a quarter off the percentage and with inflation 0.3 per cent continuing to be negative, I do think that the Bank of Japan has got the bias to tightening, but probably has not got the political strength in front of the Diet elections in September to really do anything about it. I think Prime Minister thinks it is in his interest to leave interest rates where they are for the time being.

What do you expect to see from the emerging market space in 2007? Do you think it will be another year of out performance after all, or do you think the issues of the developed market or uncertainties will prevent out performance this year?

If we look back over history, there have been only three cycles so far that S&P in the US, over a period of 107 years, has closed in positive territory for five years in a row. We have just closed our fourth year in a row of positive return and are at the beginning of our fifth.

I think markets are priced for perfection; we are in Goldilocks scenario, as liquidity is extremely deep and confidence is high. I think the more important point is, whether markets will close up or not because in a continuous positive scenario, I do think the emerging markets will outperform because there is lot more growth here than in the West. But the more important point is we need to look for danger zones.

My scenario is that emerging markets will continue to outperform but I think they will outperform on both sides, either they will go up faster than what we see in the West but they will also come down faster.

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