Adrian Mowat, Chief Asian and Emerging Equity Strategist, JPMorgan agrees that the Reserve Bank of India will further tighten rates to rein in inflation. Headline inflation rose to 9.06% in May from 8.66% in April on the back of rising prices of manufactured products and petrol.
Reserve Bank ups repo, reverse repo rates by 25 bps each“High inflation is something that India will have to live with but our outlook on India is more constructive than the consensus at present,” says Mowat. The RBI has already hiked key policy rates nine times since March, 2010 to curb demand and tame inflation.
On the global front, the newsflow hasn’t been positive either. Greece’s debt woes cast a shadow over the eurozone which saw investors back out of European stocks. The pan-European Stoxx 600 index closed down 1.1% at 267.96. Weak manufacturing data from the US also added to negative investor sentiment. According to Mowat, developed markets (DMs) will continue to face pressure on growth on Europe’s sovereign issues.
India has been underperforming its emerging market (EM) peers till early March. However, Mowat says India has been performing very much inline with EMs. “As the correction matures, India has a good chance of outperforming EMs later in the year.”
Below is a verbatim transcript of his interview with CNBC-TV18's Latha Venkatesh and Sonia Shenoy. For complete details watch the accompanying videos.
Q: We have a big cue today - the monetary policy. Do you think there will be more rate tightening and against the backdrop of a pessimistic macro environment what is your outlook on India now?
A: Yes we do think there will be more tightening. The inflation data that came out at the beginning of the week was showing a sequential increase in core inflation. So we would expect a reaction from the Reserve Bank. My outlook on India is probably more constructive than the consensus at the moment.
We do see that headline inflation will begin to come off in India. The monsoon has arrived earlier. We hope we are not going to get the disruption we saw in 2010 and then there was a disruption of too much rains in 2011 which hit the price of onions, etc.
India is just going to have to live with higher inflation. Part of this issue with high core inflation is the degree of pricing power for businesses. When we get a little bit more political certainty, business capex should remain reasonably healthy. Interest rates are going up but interest rates in real terms in India still look quite attractive.
Q: Do you think after the underperformance that India has seen in the first half of the year, perhaps a lot of it is already priced in and the situation could improve in the second half of 2011?
A: India significantly underperformed emerging markets from November through into early March. Now it’s sort of time when the yield curve became very inverted. Monetary conditions were particularly tightened plus we had the corruption scandals and a government that was unable to really make any decisions.
Since then, India has been performing very much inline with emerging markets. As the correction matures, India has a good chance of outperforming emerging markets. For now, I remain bearish and we have been bearish on markets for three months now. Markets are falling for the things that we were concerned about and quite simply global growth is weak.
There is stagflation in developed economies with inflation in the US above 3% when household income growth is only 1%. That’s why the economy is weak. People don’t have the money to drive demand. There are similar stories in Europe. What is happening in the emerging world is a simpler and a very normal cyclical story.
We have been fighting inflation. Central banks have tightened policy. The idea there is to slowdown growth, reduce demand and eventually the inflationary pressures diminish. So markets were too high and they are correcting lower. This correction will continue but at least we are facing up to the fact that growth is weak.
Q: What is the earnings growth you are working with and how much do you think is priced in by way of an earnings downgrade?
A: There is never anyway of answering that question on how much is priced in with an earnings downgrade because you can’t back these things out. It is an absolute given - its Economics 101 - if governments’ are tightening monetary policy that you are going to get less growth, that will cause a negative effect on operating leverage and earnings will be revised down.
We are recommending that investors are very underweight cyclical sectors at this point in emerging markets, very underweight to commodity and energy stocks. What actually happens in stock markets is - the reason they are falling at the moment is that they are trying to price in lower earnings growth. The analysts typically downgrade earnings after the market has bottomed rather than pre-empting it that the market is already factoring that in.
I look at MSCI (Morgan Stanley Capital International) India and I tend to look at it over the calendar year so I can compare it with my other markets. We are currently going for just over 20% growth in this market which is a number too high. Where you need to think about the downside risk, it would be an area such as building materials, metals, the auto industry, particularly, with the capacity that’s coming on-stream, these are the areas where you have your cyclical risks.
In contrast, maybe some of the engineering and construction companies probably have less earnings risk to them so they tend to be much more to do with order backlog. If you look at the IT businesses, they will see lower earnings but they tend to have a track record of being able to manage adverse situations. When you then look at where you would like to be - India has got a lot of FMCG companies which should do reasonably well in this environment.
I also think that banks will tend to react much more to perceptions of change in monetary policy rather than necessary to earnings. We would expect that as India puts through maybe a couple of more rate rises, you begin to see headline inflation coming off that banks could rally at that point as the fear of further monetary tightening diminishes.
Q: What in your worldview would happen to commodity prices in the next couple of quarters and in that would also be your assumption of whether the US will go in for QE3. How are you seeing commodity prices pan out from here on?
A: I am not the commodity specialist at JPMorgan. This is a personal view. What I see is the information that’s changing is demand is weaker, that has to be negative for commodities. We have been doing a lot of demographic work on China. China has a dramatic change in its demographics which means it needs a lot less jobs pouring concretes and building iPads. It needs to create more service sector jobs for the graduates that it produces.
Its demand for commodities is going to be reducing relative to its increase in GDP. That isn't factored in by the commodity bulls. So I am a bear on commodities and I sincerely hope commodity prices come down, particularly, the energy price because if they don’t, stagflation stays in the Western world and that’s going to be very negative for global capital markets.
It is going to be very negative for dealing with these macro issues such as the Greek debt restructuring, Ireland, Portugal, sorting out the 11% fiscal deficit in the United States. Let us all pray for lower commodity and energy prices.
Q: After seeing such a nervous summer that global equities and markets like ours have gone through, do you think the prudent strategy would be to perhaps sit on cash or do you think deploying the money into the downtrend would be a good thing to do?
A: For now, cash is a very nice thing to hold...
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