`Valuations in India are now at a significant premium to the region and to the US and global markets'

Morgan Stanley has gone further underweight on India and according to Asia-Pacific Strategist at Morgan Stanley, Mr Malcolm Wood, this is due to Indian valuations, tightening global liquidity, and unsustainable fund inflows into India.

He adds that, India should increase FDI, and the privatisation programme could lend help.

Excerpts from CNBC-TV18's exclusive interview with Mr Malcolm Wood:

You remain underweight on India but the market continues to move up, what do you do now?

We have gone further underweight over the last week or so. Our reasons for that are; we think Asian markets will do well this year and we are looking for further 10 per cent returns from Asian markets, that will give us 15 per cent for the full year.

So we are positive on Asia and when we look at India in that context, then we notice that valuations in India are now at a significant premium to the region and to the US and global markets.

Second, liquidity in India is tightening and we look at rising short-rates in India and a sharp increase in loan to deposit ratio in the banking system and we also see global liquidity conditions tightening, which is not positive for liquidity-driven markets like India. We also look at factors like the outlook for equity supply and we see that pipelines are building quite rapidly in India as supply could rise 50 per cent this year to over $20 billion.

We will also look at factors like the macro-fundamentals in India. We have noticed that the current account deficit continues to widen and foreign exchange accumulation is slow. Putting all these things together there are reasons for going underweight on India.

Do you think the balance of power is shifting in terms of liquidity both domestic and global wherein domestic gets a little bit higher now?

I think that is a fair risk to our viewpoint. When we look at the international liquidity position we are expecting the Fed to raise rates further by 75 basis points this year and now, even Bank of Japan will end its zero interest rate policy in the fourth quarter of this year.

Therefore, from a global perspective liquidity conditions will be normalising or tightening further and when one thinks of that particular picture against what we have seen in terms of risk taking in fund flows into emerging markets, then in the last five months we have had equivalent inflows into emerging markets of the last 10 years.

When one looks at the domestic picture in India, according to our data, the inflows into equity mutual funds in India over the last 12 months are greater than the inflows in the entire history of mutual funds in India.

Therefore on both the international and domestic front, we argue that fund flows are at extremely higher levels already and it is difficult to envisage it going another leg higher.

Do you think there could be any policy related triggers, which could insulate India from any large exodus of capital?

I think the announcements over the weekend are positive and that is good for India over the medium-term.

Apart from this, it is appropriate to emphasise that the medium term story in India looks very good. So our concerns are more cyclical in nature and more short term in nature rather than structural concerns.

When you look at the direct foreign investments in India compared to China, then India should be looking at increasing direct foreign investments significantly and one easy way to do that would be to accelerate its privatisation programme, which has really lagged that of other countries globally.

You have a sell on Hindustan Lever, what makes you skittish about that?

I would like to emphasise that I have taken Hindustan Lever out of my model portfolio, our analysts are still quite positive on that stock. My concern is the valuations for some of the consumers and some of the domestic focussed stocks in India.

Some stocks like consumer names, some of the industrial names, capital goods etc have now got extremely high multiples. We think you need to have a valuation discipline as to how much you are willing to buy, for assets that provide those goods. That was the reason why we specifically took out Hindustan Lever from our model portfolio.

(This article was published in the Business Line print edition dated March 21, 2006)
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