Higher international oil price is making market participants increasingly suspicious of the next leg of growth.
After demonetisation and implementation of the Goods and Services Tax last year, the oil rally could be the reason why the next leg of growth in India gets delayed yet again, said Morgan Stanley’s Managing Director and India Equity Strategist Ridham Desai. “When you get a shift in terms of trade, which is what oil price represents, there will be some problem,” he told BloombergQuint in an interview.
The government is pretty bound on their fiscal [deficit] target. They are not going to let that slip a whole lot. And therefore, they have to cut expenditure elsewhere and that will bring an impact on growth.Ridham Desai, MD, Morgan Stanley
Brent crude has rallied 10.77 percent to $74 per barrel in the year so far. That’s made the market “suspicious of growth”, and as a result, growth stocks have struggled since the end of April, Desai said. The risk is that if the growth cycle falters, it could lead to a bounce-back from quality and value stocks, a Morgan Stanley report authored by Desai had said.
The shift in terms of trade for India is also causing nervousness among foreign portfolio investors who have consistently been selling over the past few months. FPI positions in India are now down to 6-7 year lows, Desai added.
Morgan Stanley expects Indian equities to grow at 7-8 percent over the next 12 months.
It is not an attractive return for somebody who is looking at equities from a 12-month perspective on the large cap index. That challenge arises because the market is fighting the likely political situation and the deteriorating terms of trade.Ridham Desai, MD, Morgan Stanley
The political uncertainty stems from the fact for the first time in three decades, the market faces the prospect that the government at the Centre gets weaker from its previous mandate.
“Since 1985, after the Rajiv Gandhi government, all successive governments have been coalition governments. Every time the market has traded into elections, it had the hope that the next government will have the stronger mandate than the previous government,” Desai explained. Now, with a majority government at the Centre, there is a chance that the next general elections in 2019 may not give any party an absolute majority, he said.
The market will start pricing in that situation or maybe it is already thinking about it and therefore could trade weak into elections, unless it gets some signals that these assumptions are wrong and absolute majority is possible.Ridham Desai, MD, Morgan Stanley
That doesn’t signal the end of India’s bull run, though, Desai said, even as he did not rule out a correction. Small- and mid-cap stocks, which saw a considerable selloff in the last few months are “unlikely to see a V-shape recovery and could definitely see further correction, but the large-cap stocks will continue to do better”, he added.
Rate Hikes Coming?
With the economy still in a “nascent” stage of growth, a hike in key interest rates would be appropriate later in the year, said Desai. Since the Reserve Bank of India's tolerance for inflation will be low, a pre-emptive rate hike will happen, but only later, according to him
Morgan Stanley's base case is a rate hike in the last quarter of 2018.
Watch the interview here: