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Business News/ Companies / News/  The elections will be the main hurdle for India in 2014: Kelvin Tay
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The elections will be the main hurdle for India in 2014: Kelvin Tay

UBS Wealth Management investment officer Tay says emerging markets will struggle in 2014 as historically they have done well only when the dollar weakens

Kelvin Tay says the markets right now favour the accession of the Bharatiya Janata Party’s prime ministerial candidate Narendra Modi to office.Premium
Kelvin Tay says the markets right now favour the accession of the Bharatiya Janata Party’s prime ministerial candidate Narendra Modi to office.

Singapore: The outcome of the next general election and what the new government does to address India’s current account deficit and inflation will be key to the performance of financial markets in the country, said Kelvin Tay, regional chief investment officer, southern Asia Pacific, UBS Wealth Management. The markets right now favour the accession of the Bharatiya Janata Party’s (BJP’s) prime ministerial candidate Narendra Modi to office, he said in an interview. Edited excerpts:

What are the structural improvements that investors would like to see India undertake in the immediate future? Do you think things will change after the general election? At UBS, what is your view on India?

The main thing is to get the infrastructure up and going. If you look at the number of blackouts the country has, the bureaucratic hurdles and even in the mineral sector, there seems to be no regulatory consistency—that is something that can be changed because a lack of regulatory consistency can scare off investors. A lot of the foreign companies that actually wanted to invest in India have pulled out because the bureaucratic hurdles are too much for them to overcome, and they have gone to other countries instead. These are the things that whoever comes to power in the next government will have to address. These cannot change overnight.

The markets right now favour (Narendra) Modi’s accession to power. As the opinion polls have been rising in favour of Modi, the stock markets, too, have been rising and doing very well—whether that holds true in the next couple of months remains to be seen. If Modi come to be power, does it mean that he will be able to have a majority—we are not too sure about that. Will he get coalition partners —there is a big question mark there. If Modi comes to power, it is a very big assumption that you have to make, that he will do much better than the Congress. The sentiment on the market seems to suggest that.

With regard to our asset allocation, we try not to make a call based on the political scenario. If you look at the Indian stock market—if you look at the valuations, whether it is PE (price-earnings), it is trading at a significant premium to the rest of Asia. On a 12-month PE basis, India is trading at some 14.5 times earnings, while Asia and Japan trade at 10.9 times earnings. So India is trading at a 23.6% premium. Look at earnings growth—India is growing at about 15.6% this year compared with Korea that is growing at 19.5%, which is much higher, but its valuation on a PE basis is 8.3 times, which means it is trading at a significant discount. If you look at the valuations, earnings growth potential, the answer is very very clear—you should be buying Korea and not India.

At UBS, we are underweight on India. India is one of our least preferred countries because the valuations are too high, the political situation is a little too volatile for our liking at this point of time. In comparison with other Asian countries, we think India should be underweight. The Sensex is pretty high right now—above 21,000 points—for example, if something happens during elections, if tapering occurs much faster than expected, or if gold and oil prices shoot up—we do see India as one of the most vulnerable markets in Asia, and we do think that the downside risks are pretty high. We think that India should trade down to about 12.5 to 13 times earnings.

Definitely, it won’t be possible to undertake major reforms before elections. This is not a problem with just India, but with all democracies. Twelve months before elections, you cannot not afford to do anything. You tend to introduce populist measures to get the support of the electorate going. That is a problem with a lot of democracies; you can only set the policies for 3.5 to 4 years maximum—the last year, you have to be populist—whether the populist policies will benefit the economy or not, that is not important. In most cases, populist policies don’t benefit the economy. So you cannot come out with any structural reforms right now unless the government says, “You know what, we are going to lose this elections anyways, and we don’t really care what is implemented right now." But I don’t think any government will think like that.

The elections will be the main hurdle for India in 2014. Then it will be what the next administration will do to solve the current account deficit, how do you solve this problem that is perennially caused by high food inflation. These will be big challenges. The inflation challenge in India is not because of bad or good monsoons, but due to infrastructure bottlenecks.

How do you see the performance of emerging markets, especially India, in 2014? Do you see India growing at more than 5%? Where do you see the rupee in 2014?

The emerging markets will struggle this year—historically, they have done well whenever the dollar is weakening. The dollar has been very resilient over emerging market economies in the last 18 months. Look at the so called “fragile five"—Indonesia, India, Turkey, South Africa and Brazil—these five countries are all going to have elections this year and it will add a certain amount of volatility to their currencies, to the bonds markets as well as the equities markets. If you look at Asia, ex-Japan countries—the Asian Dollar Index—about 40% of this index is the Chinese yuan, which is more or less pegged to the US dollar, and this has been one of the best performing currencies against the US dollar. Look at the other Asian currencies against the US dollar—they have been relatively flat or negative, particularly from the end of June to the end of 2013. Tapering has actually started and you are seeing the US treasury yield rise above 3%—the more the US treasury climbs, the harder it will be for emerging market currencies and emerging market bonds to outperform; this is because when US treasuries climb more than 3%, that means local bond markets in emerging markets or in Asia will have to pay much higher than 3% in order to entice investors to remain in the local government bonds. If the local government bond yields go up, your equity risk premium for this region will have to go up as well. This basically means your equity prices will have to fall—it is going to be a difficult year for Asia and for emerging markets equities and this is why we are still neutral on Asia relative to developed markets equities.

It is tough for India to grow at over 5%; it may likely meet 5%. The good news is that commodity prices have so far remained flat—oil, coal, gas—while gold prices have been weak in the last three months. This is good news for India because 75% of the current account deficit is because of oil and gold imports. The rupee seems to be stabilizing at the current levels, and if the rupee does not weaken any further, it shouldn’t do any further damage to the current account deficit, which means that on a short-term basis, we do expect favourable movement in the current account deficit. The problem for India is food inflation and this will remain high because of the infrastructure bottlenecks. That means inflation is likely to remain in the very high single digit or low double digits, which means India’s interest rates cannot come down. That means, the Indian economy itself will struggle to grow around the 5% mark and it certainly won’t go beyond 5.3%.

We think that the rupee will stabilize at this level unless oil prices shoot up tremendously. Any level between here and 65 will be a pretty good shot. Do notice that the Indian rupee has not recovered significantly—it had hit a low level of 68 and has now gone to 62 (to the dollar), but this is way below the levels it was trading at before all the tapering talks started in May last year. That should tell you something that the indexes are quite concerned about the Indian current account. As long as the Sensex does not see any further weakness from here, then we don’t see the rupee actually weakening, because the rupee is impacted by the outflows.

What will be the top trends that will define Asia in 2014?

North Asia will be doing much better than South Asia. If we look at South Asia, you have elections in Indonesia and India; you may not have election on 2 February in Thailand, and may instead have a military coup there. Developing Asia is a challenge. Developed Asia, which is a net exporter, is likely to do better.

The main thing there is your exports picture must improve significantly—we know that the US economy is improving pretty well. We think that the US economy will grow at 3.4% this year and that will be the main engine for global growth for 2014.

In this level, where Asian exports are concerned, the only game changer is Europe. If Europe improves significantly—our consensus has Europe growing at 1%—but if Europe comes in higher, at say 1.5%, that will be the game changer for Asian exports to move up sharply. We think one should be in North Asia. What are the countries you should be in North Asia? China and South Korea—these are the two countries you want to be in, because in the top-down or bottom-up perspective, these are the most attractive markets. Taiwan’s valuations are high—on the bottom-up basis, there is nothing really comparative about—but on a top-down basis, things look good. Singapore, both top-down and bottom-up, are a little bit shaky. Only thing that is good with Singapore is that we expect its currency to appreciate against the US dollar because of the fact that inflation in Singapore is still sticky.

At this point, I don’t think that foreign direct investment into India will slow down to a trickle or fall off the cliff dramatically because of the fact that on a medium- to long-term basis, this is the region you want to be—its population is young, because the consumer class is there, and the middle class is still growing. On a short-term basis, Asia can’t sell more goods to the US and Europe—with oil and coal prices remaining where they are, inflation is not going to be an issue for Asia because Asia as a whole is a net importer of energy. Inflation is going to be okay, which means that interest rates can be eased to help the economies here. For India and Indonesia, the problem is that they need to keep their currencies stable—if the currency is not stable, you can say goodbye to investors. No one wants to invest $100 and then suddenly find that at the end of the year they are down to $50 just because the currency has been extremely volatile.

What is your view on the linkages between growth and demographics—both for the developed world and emerging countries like India? Is the era of Asia having a demographic edge over the developed countries over?

For demographics to have a big impact, you need to assume a couple of things here—for a developed country, they mostly have full employment and the skill force has actually reached a level where the productivity levels are pretty high. Then they have a declining population. Ageing population will have a tremendous impact because you cannot increase your productivity levels anymore and you don’t have enough young people coming in to replace the old ones who are retiring. For a lot of these countries, coincidently, the debt levels are pretty high and, for example, if you look at Japan, its gross public debt amounts to close to 240% of GDP, and the rest of the Euro zone is not that much better off as well.

So, for each of (developed) country, they have the burden of higher pension payment and higher health care payment coming through. If you have a smaller population, then where are you going to have the tax revenue coming from to pay for all these services? If that is the case, then your ability to borrow in the bonds market will be impacted by the fact that your interest rates will be much higher than what you have now, in order for you to attract investors to actually fund your payments going forward. For developed countries, this is actually a crucial problem that needs to be addressed in the next 10-15 years as their populations get smaller and older. If you look at the emerging market countries, the difference is actually quite stark—we can look at two countries here—China and India. For China, the argument has been that the demographic dividend that the country currently enjoys is going to disappear over the next 10-15 years given the fact that the population is also getting smaller. I am a little bit sceptical on this because for that to actually hurt China, you should assume that China is at full employment now and that its productivity levels are also very, very high. We know that is not the case as China still has some 600 million people living in the countryside that can be tapped on to provide further labour for its industries, for its manufacturing sector. The demographic argument that China will be losing out since its population is getting smaller and older does not hold much water, when compared with countries such as Japan and Germany because of the differences in the productivity levels, literacy levels and in the number of people living in the countryside. If you look at India, it is the country where you have the world’s biggest pool of poorly paid workers waiting to be tapped upon. Unfortunately for India, the country does not attract too much manufacturing and, therefore, it has a big pool of low skilled and poorly paid workers—whether the population gets smaller or bigger has no impact on India and on its growth. So the linkage between demographics and growth is not even as strong as China. We are making a huge assumption here, but if suddenly Modi comes to power, it will attract MNCs to tap into this pool of workers, and then India will benefit significantly as its people in rural areas can move to cities in search of jobs, and that means they are producing something for exports in the developing countries.

The era of Asia having the edge when it comes to demographics is not over. A lot of people assume that Asia is just China and India. You have Myanmar with 65 million people—more than the population of France—then you have the Philippines, with about 100 million people and then Indonesia at 240 million people. The potential there is huge. Some of the infrastructure issues, some of the bottleneck issues, some of the political problems and if some of the other problems are resolved, and if some political stability comes in, the potential is huge as these are the countries that are remaining to be tapped. Asia can be divided into three: the developed part—Hong Kong, Taiwan, Korea and Singapore—and then you have the developing part—China, India, Malaysia, the Philippines, Thailand and Indonesia—and the frontier markets—Myanmar, Laos, Cambodia, Vietnam. So the whole Asian continent is huge and there is a lot of potential to be tapped.

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Published: 10 Jan 2014, 12:08 AM IST
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