RBI “Being Too Bullish” On Impact Of Demonetisation On Growth, Says Ashburton

I think markets globally, including emerging markets, have been eagerly awaiting this event. You could argue that the market has priced in some sort of interest rate hike, so that won’t be a surprise. From the emerging market perspective, the scale of the rise will be important. We are not expecting anything too dramatic. But how big a rise it is and the commentary that comes with it, is obviously the key part, as is working out the trajectory – how many more hikes etc. So that’s clearly going to be very significant for emerging markets and has implications for emerging market currencies, bond markets etc, depending on interest rate differentials.

I think that’s a very valid question. It’s very difficult for anybody to work out what the outlook could be. When President-elect Trump actually takes over the White House, we need to see what his policies are. It can dramatically alter the U.S. growth trajectory if he does get some of this offshore money back in, and if he does have a policy in place to ensure that the money stays and gets into the real economy, and companies actually spend on new productive facilities etc. That clearly will change the outlook in the medium term for U.S. interest rate policy. There is a huge amount of uncertainty out there. So I would expect conservatism initially from Yellen. We are all grappling with what Trump stands for and what his policy is going to be because it will have an impact on the U.S. and therefore on the globe.

We have seen some breakdown in the relationship of the dollar versus, for example, commodities, versus energy. That’s been changing over the last month or two, ever since Trump’s been elected. And traditionally, as we all know, a strong dollar was never great for emerging markets. Again, if Trump ultimately can get the U.S. economy on a stronger growth trajectory than most analysts or forecasts are predicting, the first conclusion from that would be that it’s great for the emerging markets. Ultimately, particularly for an economy like China, as China needs U.S. domestic consumption to suck up its exports, which is less relevant for India because India does not have the same export structure...exporting goods to the U.S....it’s more of a services function that India has. I think it’s very different. So we are uncertain about the direction of the dollar. Our view remains that the dollar probably has some further room to go but the bulk of the move has happened. But we can easily see quite a shift in trading patterns in the period ahead. Net-net, for us, I think one of the key relationships going forward would be to examine the relationship between China and the U.S. Its quite obvious at the moment, if you look at the changes going on in China, if you look at the growth slowdown going on, the overcapacity amongst several sectors of the economy, then quite frankly, China needs the U.S. more than the U.S. needs China, in our opinion. So therefore, there is some justification for Trump to change that relationship going forward. India is very well placed with a strong dollar so far, but clearly from a trading perspective it’s a very different proposition if you look at India versus China because it’s a very services-type story as opposed to export of goods.

Is it going to be 1-3 quarter hit to earnings? We haven’t yet fully modelled through the impact. I think it was interesting to look at the Reserve Bank of India’s comments earlier this week. I think they are being too bullish on the impact of demonetisation on Indian growth. For us it’s too early to whip up expectations of where earnings are going for the rest of this year and the next year as well because there is a lot of uncertainty still out there. What we do know is that it has been a fairly significant hit in the very short term. We are hearing some parts of the economy are getting back on the recovery track, certainly not back to normal, but some recovery. So we have not arrived at our numbers just yet. But we tend to try and look at a three-year view in the least. And from that perspective the story hasn’t changed a great deal. Obviously, the hit is in the short term.

I don’t think so. We read a lot of reports suggesting that demonetisation is a great policy implemented badly. But I think it’s somewhat unfair. Clearly what has changed is valuation. While the market certainly hasn’t gone back down to cheap levels, there’s certainly some individual counters, particularly in the midcap and smallcap space, where we have seen quite profound deratings in a very short period of time. But main line indices have come off a fair bit particularly if you’re looking at it in dollar terms. The rupee has depreciated quite significantly. Indices have come off. So if you look at India in dollar terms, it was looking like reasonable valuations again. If you look at the emerging market space...which is the economy that has genuinely fantastic growth opportunities going forward with a reform-minded government? Certainly India tends to stack up on those fronts. The reason money has selectively begun to come back in, is because we are finding certain pockets of value again.

Most foreign investors that we speak to, and I was in India a couple of weeks back with some major investors, most of them have come away with positive impressions about what India is trying to achieve with demonetisation. If you step back and move away from the short-term noise, which of course can be very painful. But if this move does encourage the growth of the formal economy versus the informal economy, then that’s great news for an equity investor, because you are ultimately investing into the formal side of the economy. So therefore, companies within that have greater opportunity to grow on a medium to longer term view. So it is positive on that front. Secondly if it does help the financial system to grow, and more people start getting involved with that formal financial system, then ultimately you will have a government tax benefit. So I think overall, while there have been questions on the implementation, certainly most people I speak to, and I would agree, say this is a positive move from a governance perspective.

So the biggest driver in Tata Motors is Jaguar Land Rover which obviously has very little to do with the India growth story. That stock has other issues from a governance perspective with the spat going on between Ratan Tata and Cyrus Mistry. Demonetisation does not have much impact on Tata Motors. Yes, it can hurt their commercial vehicles business and domestic car business but the story with that stock is external. So we move that to one side.

So we have been adding IT stocks over the last couple of days. Yes, I think these companies have shown in the past that they can adapt to change. So I would not be too worried about that. But if you look at the valuations and the prices of the large Indian IT players, there has been quite a profound derating over the last few months. We have begun to see real value emerging once again in these counters. We’re not saying that these things will scream up anytime tomorrow but a lot of them are very cash rich companies, many benefitting from the falling rupee. Ultimately, bigger and better companies can cope with a changing business model. We are not sure if America is going to launch a major trade war with India on IT outsourcing just yet. There has been a lot of negativity priced into share prices and we see value. We also think it is interesting to note that Cognizant, which is one of the large competitors in Indian IT space, has just had an active shareholder appear on their register to encourage the company to be more operationally efficient and use its cash pile for the benefit of shareholders. So we think that is also going to be a trend in the Indian IT sector. Some of the other IT majors are sitting on substantial cash piles and we think that they will start managing their cash piles better going forward.

It is inevitable with his statement. In the U.K. there has been a legal case against large American pharmaceutical companies whereby they have been accused of over-charging. I think there is a trend amongst developed markets to look at drug pricing and I think that trend will carry on. Ultimately that should benefit the generic manufacturers where India is obviously very strong from a demand perspective. But from a pricing perspective, that is the world we live in now and there will be a lot of noise, if you like, from governments all across the developed markets to try and deal with their massive budgets and the costs they face with ageing population. This is an area where we expect continued noise for a long time to come. So those companies which ultimately benefit, to my mind, are from the generics space. But it means some of the drug pricing and profits we have seen in single drug lines in the past, we will not expect to see that in the future. We did increase our weightage just prior to the U.S. elections into that space as we felt again that the concerns of a possible Clinton victory were more than priced into the share prices. We are still very underweight the sector, however. But we have an exposure by the two names. We think the valuations will come back into the pocket there as well.

India has underperformed other emerging markets this year. It has had its moments but I think a lot of developed market investors have not been in emerging markets at all over the last 4-5 years. Some developed market investors bought this India growth story under Modi. When you compare India to the developed markets from a three-year view, it has been outperforming. What you have seen is that a rise in energy prices has encouraged people to go to the really beaten-down emerging markets like Brazil and Russia and some money has naturally drifted out of India. I think next year will be a slightly different story. The commodity price increases that we have seen due to Chinese stimulus policy, hopes about Trump initiating new infrastructure spend, to our mind, a lot of that good news is in the commodity prices as they stand today. We’re not expecting an imminent collapse in commodity prices but a lot of good news is in the price. So I think next year, it will not be easy for investors to go into the slightly cheaper commodity-driven emerging markets. Clearly for India, the outlook will depend on the state elections in the first quarter, it will depend on GST and its implementation. India could actually surprise next year. We are not expecting Indian to race away any time soon because there is still the uncertainty about the effects of demonetisation. But I think at current valuations and a slightly longer term view, with what is going on on the ground and if those election results come through positively then India could do well next year.