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Moody’s has downgraded India’s outlook to negative. Is it be a big cause of concern?
It is not surprising because we have seen downgrades to economic growth from various different agencies. We are in a growth slowdown environment which has become entrenched and a recovery is unlikely to be a V-shaped one. It will possibly be a long drawn-out and slow recovery because many of the factors that have contributed to this slowdown are difficult to mitigate in a short span of time. The most recent economic measures that we have seen from the government are supply side measures which are targeted at addressing the investment side. For the consumption-oriented measures to come through we still have to wait and watch for further economic measures. Much of this consumption slowdown has happened because of income uncertainty. We could possibly see a bit of a recovery in the January-March quarter, purely on a low base. It will take a while longer for a lasting recovery to come through.
Will the downgrade affect foreign flows into India?
Flows over the past one month have improved both in debt and equity. The reasons that have been cited by the global credit rating agencies have not really been unknown to the investor base. If they have been investing in the Indian bond market in debt and equity, it’s not got anything to do with the previous credit rating that India had. This influx of inflows into emerging markets as a whole is not specific to India. We have seen this in the entire emerging market complex. Global central banks have turned more benign in their monetary policy outlook over the past one month as the growth slowdown has become entrenched, notwithstanding how the Fed (US Federal Reserve) sounded a few days ago. They have sort of raised the possibility that the Fed may stop for a while. I don’t think the market really believes that right now. We are also seeing some of the global traderelated worries subsiding, at least temporarily. We are seeing the possibility of a no-deal Brexit being avoided. Despite some of the major geopolitical issues in the Middle East, some of the key variables like oil prices haven’t really fluctuated. The market is leaping, at least temporarily, over the big wall of worry, that had been created over the past two or three quarters. This kind of a situation would possibly last over the next two to three months.
What is your preference list within emerging markets?
We have an overweight on India compared to the benchmark rate of about 10-10.5%. We are 14-15% overweight in India. We are also overweight on China, Indonesia and Thailand. If we look at the so-called sustainability of earnings growth, then the Indian market and many Indian stocks actually fall in that bracket. India provides a combination of relatively high earnings growth in the 8-10% range and quite low earnings variability. It is this sustainability or relative certainty of earnings growth, which really attracts the investor base to the Indian market. We may have stepped away from that trend over the past few quarters but for the investors base who are looking at India, it’s really the long term that matters.
Do you think the government will be able to stick to the fiscal deficit targets?
That is possibly the biggest concern now. The corporate tax rate cut basically was about ?1.45 trillion. Even if part of that is neutralised by an increase in the divestment programme, it could lead to some degree of expansion of the budgeted borrowing program or the budgeted fiscal deficit, which is what the bond market is also telling us. This is something we have to wait and watch out for. If we get a sense that the government is able to neutralise that through asset sales, that is possibly the most positive outcome of this whole pack of policy measures that they have adopted.
Equities are hitting record highs, while global bond yields are pointing to a sharp downturn. How will investors deal with this?
If one looks at developed market bond yields and the Indian or Asian bond yields, there is a gulf of a difference and that is encouraging this flow of money into this region. The hunt for yield is actually forcing investors to look at emerging markets. If the risk of earnings disappointments or the risk of defaults is possibly contained then this significant surge in flows that we have seen towards emerging market bonds and equity will possibly last for a while.
What is your outlook for the rupee?
The rupee in the foreseeable time horizon, the next two quarters or so, would possibly remain in the current range, between 70 to 71.5. Our official forecast by the end of 2020 is 70.5, which is pretty much where the rupee is now.
Are earnings downgrades for Indian corporates over?
Estimates for FY20 are pretty much in line now. The earnings growth consensus earnings growth estimate is only about 5-6% which seems okay. I don’t think there’s much of a scope for that to be downgraded, partly because there are pockets of the Indian corporate base which are doing reasonably well, like the retail lending private sector banks. Even consumer staples have not done badly. Next year still presents a bit of a concern. The consensus earnings growth for FY21is about 23%. There is still some more scope for that to get downgraded, particularly in certain sectors. There are high growth expectations in banks, the asset quality risk may not have been fully factored in there. I still see significantly high growth estimates being factored in consumer discretionary. But the bulk of the downgrades are possibly behind us.
Which are your top sector picks?
Our stock picks are concentrated in three or four sectors. We like the private sector banks, particularly the retail-focused ones. We also like insurance. Some of the stocks in the energy or utility space offer not only stability but they are also a play on high dividend yields. We have seen reasonably good growth from the frontline companies in consumer staples. The only problem is they are over-owned. Frontline companies are trading at 35-40 times PE so one has to be a bit selective there. There are pockets in IT that we like. So that’s, that has been one of the best currency hedges as far as India is concerned.
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