The Hindu Business Line : `Backdrop for emerging markets still favourable'

Mr Adrian Mowat, Chief Asian & EM Equity Strategist at JP Morgan, believes that short-term regulatory issues are unlikely to curtail the flow of funds into emerging markets. He adds that lack of earnings growth in the developed world would drive money into these markets.

Excerpts from the interview by moneycontrol

Where do you see India and emerging markets' position with respect to the developed markets and the direction of fund flows from hereon?

I think the backdrop for emerging markets still remains very favourable. We have got the Fed at 4.5 per cent, ECB at 4 per cent, and the developed world, where we are likely to see relatively low earnings growth. This is pushing international investors to look at emerging market equities, where they are seeing a high level of growth.

That is true with the Indian environment and we expect Indian earnings growth over the next couple of years at around 20 per cent. Combine that with a strong rupee and you will see international money flowing into this market, even if there are some short-term regulatory issues like the P-Notes or other policies that are designed to slow down the flow of capital.

Given the continuing flow of funds, is the P-note regulation bothering investors at all?

FIIs are getting on with registering directly, although there will be few funds where the administrative costs will be too high. Maybe their money will not flow into India. But, we have seen these issues coming up in the past and this has being going on ever since the FIIs investment opened up in 1993. The market tends to deal with it pretty quickly and if people are still seeing an at tractive investment story, the money continues to flow in.

Earnings growth has been decent but does it not throw up some valuations concerns at the current index level?

India's relative emerging market valuations have come down quite a bit and we recently put out a 22,500-index target for December 2008. We upgraded this market from underweight to neutral because the growth outlook suggests that India's valuations are acceptable as against other emerging markets. A lack of earnings growth in the developed world drives more money to where the growth is and that will push up valuations.

We have just had a CRR hike, with no changes in the repo and reverse repo rates. But there is definite concern on the liquidity front. What are you factoring- in in terms of policy action from hereon?

I think that is a very good question. We saw a major move in the market interest. rates in the first quarter of this year, particularly the prime lending rates, which wiped out much of the reduction that we saw in this decade. That had an impact on the consumption sector, particularly if you look at two-wheeler and auto sales.

I think the economy, the consumers and the banks have now got used to this situation, and you are going to begin to see a recovery in consumption in these larger ticket items. So, looking forward, we think monetary issues are going to be less of a factor for this market than they have been over the last couple of quarters.

Definitely, the Reserve Bank of India will remain focused on inflation. You are likely to see the rupee continuing to appreciate. But we do not think that there will be a major move in market interest rates.

How do you expect interest rates to pan out globally? What does that essentially entail for emerging markets specifically for India over the next six-12 months?

Our base case is a soft landing in the US - the Fed with interest rates at 4.5 per cent and the ECB to stick to 4 per cent. The risk to the growth outlook is on the downside.

We are concerned that perhaps the credit crunch is going to be felt more in the mainstream than it has until now, and there is a possibility of weaker consumer demand in the US and slower growth.

If that occurs, then the Fed has made it clear that they will be willing to cut interest rates, particularly if employment data deteriorates. The shortterm impact of that maybe negative, as people respond to the US economic data. But I think the medium to longterm impact will actually be quite favourable since the emerging economies are growing rapidly and much of that growth is sustained by domestic consumption and business investment.

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