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Stock market investors have been a happy lot. The S&P 500 at the global level and the S&P BSE Sensex back home have been gaining ground and touching new highs in the recent months.
The key challenge for India and the new government that completed 100 days in power on Monday, however, has been managing the economic challenges amid upbeat investor sentiment.
Australia-based Richard Gibbs (below left), global head of economics, Macquarie, tells Puneet Wadhwa that as regards India, the current run of high frequency economic data indicates inflation pressures continue to be the biggest macro-stability issue facing the economy. Excerpts:
Let’s start with India. How does it fare among emerging markets (EMs)? Do you think FIIs (foreign institutional investors) could now look at places like China and Japan to park money since the India story has already played out?
India remains attractive for FIIs, as the economy is possessed of a reboot and expanding domestic demand base and relative to China and Japan is likely to experience less speculative surges in financial asset valuations.
EMs that appear more attractive than India in the next 6-12 months include Singapore, Vietnam, the Philippines and Indonesia in SE Asia; in Latin America, we favour Chile and Mexico.
For all these economies, the growth dynamics and structural positions appear relatively stronger than India at this point in the business cycle.
Like India, all these economies have the scope to implement monetary stimulus measures, via measured reductions in interest rates.
Also, electoral cycles have now run their course in most of the economies and elections have resulted in pro-business and pro-reform leaderships.
How do you evaluate the 100 days of the Narendra Modi government in terms of policy initiatives in the backdrop of challenging macros?
On the economic policy front, there is no doubt that economic growth and improving the ease of doing business in India remaining the key focus areas.
We note that special emphasis on infrastructure projects was visible in the Budget; funding norms have eased; FDI (foreign direct investment) has been liberalised and ‘Make in India’ (manufacturing) is the new mantra.
The reforms being pushed in Rajasthan on labour, land and subsidies do make a strong start. What fell short of expectations was the delay in the gas price hike, no commitment on a timeline for the GST (Goods and Services Tax) and half measures on FDI in defence.
On foreign policy, calling Saarc leaders for the swearing-in ceremony was a masterstroke, and it was followed by a visit to Nepal, Bhutan and Myanmar to underscore the good relationship with neighbouring countries.
...And the disappointments?
One notable source of disappointment was non-passage of the insurance Bill, which sought to raise the FDI limit to 49 per cent in the Rajya Sabha, where the BJP (Bharatiya Janata Party) does not enjoy a majority.
We note that this disappointed markets, as it raised doubts about how the government would manage the passage of other Bills through a hostile Rajya Sabha for the next couple of years.
Now that the elections and the Budget are behind us, what are the likely triggers for the Indian markets?
In the near term, two key factors are the outcome of the monsoon season in respect to cropping yields; and the correction in the crude oil price.
Both of these factors have the potential to assist or hamper progress in addressing India’s twin-deficits problem, which continues to be seen as a high profile structural issue for India’s economy.
In addition, early success in pursuing the structural reform agenda likely increases the prospects of monetary stimulus via cuts to official interest rates as the Reserve Bank of India (RBI)’s confidence that supply-side reforms will be successful in combating underlying inflationary pressures.
Against this background, we continue to believe the FII (foreign institutional investor) will remain supportive of Indian asset markets for the foreseeable future.
What is your interpretation of the key economy-related data like inflation, index of industrial production (IIP), monsoon, etc.?
The current run of high frequency economic data indicates that inflation pressures continue to be the biggest macro-stability issue facing the Indian economy.
Underlying inflation pressures have eased somewhat, but it remains to be seen if this will be sustained, particularly in the December quarter when a combination of adverse base effects and improving activity levels impact price levels.
Industrial production continues to recover, but a key will be whether we see the hoped for recovery in business investment spending in the later part of 2014.
Finally, the progress of the monsoon season will be crucial in determining the outlook for food prices, which in recent times have driven a spike in headline inflation in India.
How far is RBI from making its first moves on lowering interest rates? How do you see the rupee and bond yields panning out over the next 12 months?
RBI is not expected to cut the repo rate until June 2015, once there are consistent and unambiguous signs of decelerating inflation pressures.
In this circumstance, we expect that the rupee will remain range-bound around the $/INR 60.00 level for much of the next six–nine months, prior to some modest appreciation towards the end of 2015. Indian bonds are expected to be supported by the renewed interest of global investors in high-yielding assets and the confirmation by the RBI of a continuing firm stance of monetary policy.
What is your analysis of how corporate earnings have panned out in the recently concluded quarter and the road ahead?
The sectors with high growth in profitability were autos, telecom, IT (information technology) and health care, while Infrastructure/Capital Goods, Real Estate, Metals and Media showed a decline.
We note that the margin-led earnings growth is similar to previous recoveries.
Margins have been supportive as core inflation has remained low and fairly stable on the back of stable crude prices and currency. Cost control efforts by companies, too, have helped push up margins.
Lower interest expense growth has also supported earnings due to favourable base effect from last year. Looking forward, investors will be seeking growth strategies and comfort from firms that they have plans to rekindle investment spending.
What is your portfolio strategy then in this backdrop?
Our portfolio strategy maintains a strongly overweight position in financials, supported by overweight positions in industrials, energy and telecom services.
This reflects our favourable view towards the government’s supply–side and governance reform agendas and early process on liberalisation of FDI norms in several sectors, notably real estate.
We maintain underweight positions in consumer staples, health care, utilities and information technology reflecting some ongoing uncertainties about regulatory regimes and the recent deceleration in rural wage growth.
Overwhelmingly, the key investment themes we are focused on in the next 12 months are business efficiency, investment spending, de-regulation and liberalisation, particularly in respect to FDI flows. As the government progresses its structural reform agenda, we believe that FDI money will be attracted in many more assets in the Indian economy.
Where would you place your bets between the developed markets and the emerging markets from 12–18-month perspective?
Our global portfolio allocation strategy still favours developed markets over the next 12-18 months, as financial conditions are expected to remain highly favourable.
On balance, we expect that both the European Central Bank (ECB) and Bank of Japan (BOJ) to expand and extend their monetary stimulus measures.
In the US, we expect that the inevitable normalisation of interest rates will be a very gradual and punctuated process, so as to safeguard system liquidity.
As a group, emerging markets continue to confront difficult structural reform agendas and this is giving way to a greater degree of differentiation across these economies.
