 "Sustained high real interest rates would be bad for economy: Jonathan Garner")
Morgan Stanley has made it a habit not to go with the consensus view. Its research team chose not to upgrade India even as other foreign brokerages were Modi-fying their view. Morgan Stanley upgraded India last month in the midst of a market meltdown. Jonathan Garner, chief Asia and emerging markets equity strategist, Morgan Stanley, in conversation with Malini Bhupta on the sidelines of the 17th Morgan Stanley India Summit, explains why he has become bullish on India. Edited excerpts:
How do you rate the first year of the Modi government?
Last year, there was a degree of euphoria among clients on what was achievable in the near term, which I thought was somewhat unrealistic. A lot of what's been achieved sets the groundwork for improvement of the Indian economy over the medium term. Running a better fiscal position is a positive and government subsidy spending is being cut back significantly. There are signs that suggest corporate capex is improving and auto sales are picking up, which is in sharp contrast to what is happening in some other emerging economies. We do not expect the rupee to weaken the way we expect other emerging market currencies to weaken in the face of a strong dollar. We must give credit to Mr Modi and RBI Governor Raghuram Rajan for improved macro-economic stability.
If you look at earnings revisions, then every emerging market, except Taiwan, has seen downward revisions. There is the absolute where Indian earnings growth expectations have been falling and then there is the relative to other emerging markets, which is a more positive story. If you look at the earnings growth for MSCI India in the quarter gone by, it was about one per cent, which is well below estimates. But it has happened because of tightening fiscal policy. If you look out to March 2017, my colleague Ridham Desai (head of Indian equity research) believes corporate earnings can grow at 20 per cent per annum for two years in a row from here. Now that may seem quite bullish, but if you see the operational gearing in corporate India to an improving economy and with lower interest rates, then you could have an upside in earnings growth.
A year ago, Morgan Stanley was not overweight on India even as other foreign investors were betting on India but you have upgraded India now. What led to the change?
I am getting a lot more bullish on India now than I was a year ago. Overweight for us means preferred among a group of emerging countries. At that time, our overweight was China, as it was very cheap. Now China has hugely outperformed other emerging markets. About one month ago, we downgraded China and that allowed us to upgrade India. So effectively, the relative multiple has moved in favour of India after China's outperformance. So India's forward price/earnings multiple is now at a 30 per cent premium to the rest of the emerging markets and that is the cheapest India has been since the end of 2013. So there has been no unwinding of last year's Modi premium. In fact, we have gone back to the pre-2013 valuation premium.
Also, some of the overweight position has come off. Last year, global funds were 800 basis points overweight on India, which is double the benchmark weight. Now that is down to 600 basis points overweight as FII flows have reversed to normal levels.
How do foreign clients view India?
Most of our foreign clients are not as bullish as we are on corporate earnings or the growth and inflation mix. Chetan Ahya (co-head of global economics and chief Asia economist at Morgan Stanley) expects inflation at 4.75 per cent by March 2016 and several more interest rate cuts. With improvement in growth, we believe India's corporate earnings would pick-up.
Chetan Ahya believes the risk to the economy comes from sustained high real interest rates. What is your view?
We believe that the RBI will cut rates further. What Chetan Ahya is saying is that you need to be aware that if the interest rate cuts happen too slowly and real rates remain elevated for long, it would be bad for the economy. India is in a better position than other emerging markets as far as inflation is concerned. Brazil is in a three-year recession and yet inflationary pressures are still very strong. They are raising rates even in a recession.
How do you rate the first year of the Modi government?
Last year, there was a degree of euphoria among clients on what was achievable in the near term, which I thought was somewhat unrealistic. A lot of what's been achieved sets the groundwork for improvement of the Indian economy over the medium term. Running a better fiscal position is a positive and government subsidy spending is being cut back significantly. There are signs that suggest corporate capex is improving and auto sales are picking up, which is in sharp contrast to what is happening in some other emerging economies. We do not expect the rupee to weaken the way we expect other emerging market currencies to weaken in the face of a strong dollar. We must give credit to Mr Modi and RBI Governor Raghuram Rajan for improved macro-economic stability.
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Are foreign investors coming to terms with the new reality that a pick-up in earnings will only be gradual?
If you look at earnings revisions, then every emerging market, except Taiwan, has seen downward revisions. There is the absolute where Indian earnings growth expectations have been falling and then there is the relative to other emerging markets, which is a more positive story. If you look at the earnings growth for MSCI India in the quarter gone by, it was about one per cent, which is well below estimates. But it has happened because of tightening fiscal policy. If you look out to March 2017, my colleague Ridham Desai (head of Indian equity research) believes corporate earnings can grow at 20 per cent per annum for two years in a row from here. Now that may seem quite bullish, but if you see the operational gearing in corporate India to an improving economy and with lower interest rates, then you could have an upside in earnings growth.
A year ago, Morgan Stanley was not overweight on India even as other foreign investors were betting on India but you have upgraded India now. What led to the change?
I am getting a lot more bullish on India now than I was a year ago. Overweight for us means preferred among a group of emerging countries. At that time, our overweight was China, as it was very cheap. Now China has hugely outperformed other emerging markets. About one month ago, we downgraded China and that allowed us to upgrade India. So effectively, the relative multiple has moved in favour of India after China's outperformance. So India's forward price/earnings multiple is now at a 30 per cent premium to the rest of the emerging markets and that is the cheapest India has been since the end of 2013. So there has been no unwinding of last year's Modi premium. In fact, we have gone back to the pre-2013 valuation premium.
Also, some of the overweight position has come off. Last year, global funds were 800 basis points overweight on India, which is double the benchmark weight. Now that is down to 600 basis points overweight as FII flows have reversed to normal levels.
How do foreign clients view India?
Most of our foreign clients are not as bullish as we are on corporate earnings or the growth and inflation mix. Chetan Ahya (co-head of global economics and chief Asia economist at Morgan Stanley) expects inflation at 4.75 per cent by March 2016 and several more interest rate cuts. With improvement in growth, we believe India's corporate earnings would pick-up.
Chetan Ahya believes the risk to the economy comes from sustained high real interest rates. What is your view?
We believe that the RBI will cut rates further. What Chetan Ahya is saying is that you need to be aware that if the interest rate cuts happen too slowly and real rates remain elevated for long, it would be bad for the economy. India is in a better position than other emerging markets as far as inflation is concerned. Brazil is in a three-year recession and yet inflationary pressures are still very strong. They are raising rates even in a recession.