While the world is bracing for yet another tumultuous year, analysts have begun predicting low returns from all asset classes. In an interview to Bloomberg TV India ’s Abha Bakaya and Priyank Lakhia, Morgan Stanley India’s Managing Director and Head of Equity Research Ridham Desai says India will offer better returns even in the low-return world. While WPI deflation has led to convergence of nominal and real GDP growth rates at 6 per cent, and also muted India Inc’s earnings, Desai hopes profit growth to improve going forward.
What a start it has been to 2016! How surprised are you and more importantly, are we somewhere near the bottom out here?
See, globally when we put down the outlook for this year, which was in early December, we essentially opined that it is a low-return world and that equities like a lot of other asset classes will struggle to generate absolute returns. Indeed, 2015 also was a tough year for all asset classes, globally — not just equities, but gold, oil, emerging or developed market, bonds — everything struggled. I think we are still in that low-return world. From India’s perspective, because India has lost its beta versus its peer group, a low-return world basically means India outperforms. So, I cannot say that we were expecting markets to fall off so dramatically in the first week in the context of our low-return outlook. But it has obviously been a very dramatic start and along expected lines, India is outperforming. You can’t draw much solace from it if you are based in India because you still lose absolute value. But this is the template I think for most of 2016 – unless something turns and there is a snap back. And if there is, then India will under-perform albeit absolute share prices in India will go up, which will make domestic investors feel better.
These comments were centered on what has happened over the past few days. If you actually take this conversation to a long-term conversation, the fact is that the world has a problem in terms of high leverage, in terms of demographics and in terms of low growth.
And, indeed a lot of the world is facing disinflation and bordering on the deflation, though we have not reached that. But it is disinflation nonetheless. And, therefore, it is a challenging environment in the long term. India does not have these problems. India does not have a major debt problem, except maybe from some select companies and therefore some corporate leverage in the system but household sector is pretty much under-levered. The government has actually given up debt over the past few years. India has a very attractive demographic picture. So, on a relative basis, long term India stands out. In the short run, what has happened since the 2007-08 period is that India’s correlations have dropped. So the correlations peaked out at 90 per cent in 2008, when for example, only 10 per cent of India’s performance was explained by India-centric factors and 90 per cent of it was explained by what happened outside. Today, India’s correlation is around the 50 per cent mark. So, half of what happens in India is explained by outside factors and half of it is explained by what is happening within. And, the reason for this is because of the way our policymakers managed the macro. Both the central bank and the government have been particularly hawkish in 2013 since the selloff in 2013 following the Fed Taper Tantrum. The RBI has kept real rates in positive territory. The government has engineered a major compression in the fiscal deficit, somewhat helped by falling oil prices.
The fact was that we had to react to it and we reacted correctly, and we are now reaping the benefits. So, as a consequence our relative valuations are sitting near all-time highs. If you look at foreign portfolios, they are overweight India. Those overweight positions have actually grown and they have not shrunk. And even though you are seeing FII outflows over the past two-three days, think about what happened in 2015. Since the beginning of 2015, the emerging markets have experienced nearly $80 billion of outflows. We are still seeing net inflows. So that is the remarkable contrast that is there, whereby investors recognise India’s long term position and also short term policy traction, and has rewarded India accordingly.
There has been talk of removing the ‘I’ from the BRICS grouping, given how India stands out as against other major emerging economies. Is India decoupling? Are we still connected to the EM basket on whatever is happening in terms of redemption pressures, or for that matter the global market?
We cannot be decoupled forever. The world is a relative place. And I keep telling this to a lot of people who think that it is inappropriate for India to deliver negative returns. India is not a frontier market. It is the eighth largest stock market in the world and so cannot be disconnected with the markets around it. India can’t be decoupled forever. A point will come – if we reach that stage – when if there is decouplisation in global equities, India will also fall and will fall dramatically. A lot of the emerging market targets that we have are approaching our 2016 bare case scenario. India is still far from that. It tells us that the worst is still not upon us. It could get diverse from here if it does get. It is hard for me to tell whether it does or not. But I do expect policy response in China to what is going on and if that happens there will be some stability in near term.
You have really taken into account a lot of the risk elements. Talking about domestic factors, what are some of the parameters you will be tracking as there are a lot of near-term triggers like the Budget and earnings?
I think as far as delivery is concerned, you have had a pretty good period of delivery. Two things that hurt the most are the non-passage of the GST Bill and the lack of capital in State-owned banks. [It is] the fact that they are running pretty high non-performing loans (NPLs) and running short of capital. The government has been hesitant to put capital to work because it is trying to force a culture change, which is to get better lending practices. We have seen this story play out in the past. State-owned banks participate in loan booms and then end up burning a lot of capital through NPLs and taxpayer’s money is used to bail them out. But this government is approaching it differently. Indeed, from a long-term prospective it could be quite good for the banks but in the short term it could create a bit of stress.
These are the only two factors that are really worrying. But if we look at infrastructure spend, we have managed to get a 20 per cent growth in the 12-month period and I think we can probably accelerate that in the next 12 months with the Railways leading the way. If you look at the fiscal deficit, the government is way below the target. And it is very preciously conserving the oil gains and not giving it away, which is the right thing to do.
We are hearing some noises of rural package. I think that’s exactly what the doctor has ordered for. Rural India has gone through some pain over the last 18 months and has borne bulk of the correction in the economy in terms of inflation. And now it is probably the time to boost spending. I hear all the right noises from the government – the only thing they can’t control is what happens to the global environment as the trade has collapsed, which is a drag in the economy. The other drag — we have very low CPI inflation and a deflation in WPI, which means nominal and real GDP growth is same at 6 per cent. So nominal GDP growth is half of what it used to be so. If corporate earnings do not recover, it is not surprising because earnings are a nominal number and not real. But I still think this quarter earnings would be better than the last.