India remains attractive for foreign investors despite the imminent interest rate hike by the US Federal Reserve and UK’s decision to leave the European Union, John Woods, chief investment officer for Asia-Pacific at Credit Suisse Private Banking, said in an interview. Edited excerpts:
In January, you had written that you are neutral about India as ‘the growth and reform potentials are still suppressed by political factors’. Has your view changed since then?
We are cautiously constructive on India from a fundamental perspective. We know it is one of the fastest growing economies among the major economies. We are positive about its valuations. We think capital inflows into India is likely to accelerate as the focus on emerging markets continues. That’s why we are overweight on India within our asset allocation for the Asia-Pacific region and just recently turned overweight on China as well. We are recommending these two markets to our clients.
Some people say the Indian equity market is overvalued.
We were looking at the price earnings ratio for the next year, which is at around 16 times. For us, that is not particularly expensive. It is not particularly cheap either. It is fairly priced. The problem seems to be consumer-related stocks are quite expensive and capital consumption stocks are quite cheap. What we would like to see certainly is greater evidence of growth in the manufacturing and industrial sector, greater evidence of capital expenditure and therefore profitability growth. That would paint a more balanced picture of the choices open to investors.
What are your growth projections for India?
We are looking at GDP growth of 7.8% and 8% for next year. We expect the Sensex to close this year at around 28,500. We got a pretty positive outlook for next year. We are looking at 30,500, equivalent of 10% growth from current level, which would be a record high for the Sensex. We are absolutely positive on the equity story.
What makes you so bullish about India?
It is the fundamental story relative to the rest of Asia that is actually quite attractive. It has a growth rate most economies will die for. It has quite a positive story on consumer spending, which pretty much the rest of Asia is also seeking to expand as well. The reality is we have a positive forecast for a large number of countries in Asia because we think the emerging markets will continue to benefit from the inflows from developed markets. We have seen evidence of some of those inflows already. 2016 has been a great year for a number of emerging markets, particularly based in Asia. Our forecast is a combination of our views on dollar, on commodity prices, on interest rates and domestic factors as well.
So, how will a US Fed interest rate hike change those assumptions?
We think the Fed will hike interest rate in December, but we only anticipate one or two hikes next year. In other words, it is going to be a very shallow trajectory. That is pretty positive for emerging markets. It means dollar is likely to stay soft, liquidity continues to seek yield and carry. They will continue to be attracted towards economies like India, which offers both yield and carry. In May 2013, we saw the taper tantrum and we saw foreign investors attack India because it had quite unmarked external imbalance in terms of its current account deficit. That’s corrected quite dramatically since then. Foreign exchange reserves have improved quite substantially since then. The economy itself has got a much better reputation among foreign investors due to the liberalization programme.
But what are the risks for emerging markets like India?
The risks are focused on unexpected spike in inflation in the US because of rise in commodity prices. Then we have to start repricing the Fed, the US dollar, the term structure of bond yields and that would have quite profound effect because then the US will become the yield and carry story and all the money that were seeking carry and yield in emerging markets will go back. But the important point is we are seeing an end to deflation.
The last two years or so, the global economy was hammered by deflation. China’s latest PPI (producer’s price index) was for the first time positive in five years. As you know people have been accusing China of exporting deflation to the global economy, that has now ended. So we are seeing more signs of positive inflation, which leads to positive sales growth, improved profitability, improved earnings and a healthier stock market. That’s the kind of virtuous cycle that shapes emerging markets such as India.
But do you think Brexit has been priced in completely by the investors?
The positive effect of Brexit has certainly been priced in. As you know there were a lot of dooms day predictors. They have been proven wrong. Unemployment is now extremely low, the PMIs (purchasing price indices) are extremely high, the stock exchange is getting higher and higher, sterling itself is a great shock absorber.
The UK has one of the highest current account deficits among the OECD (Organisation for Economic Co-operation and Development) countries and 20-30% correction in sterling is a very good way of correcting that imbalance. The medium term implications of Brexit are uncertain. But the UK has a huge trade deficit with the EU.
So I can’t see it necessarily why it is in the EU’s interest to burn its bridges with one of its important markets in the world. So I do think there will be mutually beneficial agreement ultimately because both parties want access to each other’s markets.
The government is exploring ways to deal with the bad loans in public sector banks. Do you think a bad bank will be an effective tool in Indian context?
In principle, recapitalizing the banking system through the vehicle of bad bank makes perfect sense. If your banking system is unable to extend credit because it is too focused on repairing its capital adequacy and provisioning for its non-performing loans, then how will the economy grow? How can credit be extended particularly to the manufacturing sector and it is one of the problems facing India right now.
So the idea to create a vehicle to recapitalize the financial sector by taking out the impaired assets and thereby improving the quality of the balance sheet clearly is a very good idea. The devil always is in the detail. How do you actually do that? Who takes the hit? Should shareholders pay up or should the government pay up? In China, for example, that was originally done at face value.
Do you agree with the IMF assessment that credit is growing at a dangerous pace in China and its economy risks an eventual disruptive adjustment?
We don’t think there will be a credit event in China over the next year because there is an extremely important national People’s party congress in October 2017 and it is our view that until that meeting happens, the government will continue to provide support and cushion any downturn in economic growth. We have in fact upgraded China’s economic growth to 6.5% this year and 6.3% in 2017 (from 6% earlier). So not only do we not see a hard-landing, we actually see some evidence of economic acceleration vis-à-vis our previous forecast.
10-India has proposed a BRICS credit rating agency as it thinks the current rating system is quite biased against developing countries. Do you agree? Do you see scope for another rating agency?
I think it is a fantastic idea. Any effort to provide independent, impartial view of an operating environment through the rating of individual companies can only increase transparency of a business environment. The problem that comes up is how impartial this rating will be? Can I trust the quality of the rating and that clearly has to take time.
Initially, there will be some caution and wait and see attitude among investors whether the quality of this credit analysis replicates other rating agencies. But the big problem that I see is when you have a niche rating agency, foreign investors are unable to make a rating assessment at a global level based on a consistent set of rating methodology.