Morgan Stanley’s Garner Bats For Banking Reforms To Spur Earnings-Led Growth In India
Jonathan Garner thinks the financial sector clean-up could result in 15-20 percent earnings growth in FY20.
India’s finance ministry must infuse funds in non-bank lenders battling a credit crunch and ensure transmission of lower policy rates to drive growth led by corporate earnings, according to Jonathan Garner of Morgan Stanley.
The key issue to get the banking system fixed and fund growth hasn’t been pursued aggressively enough, which needs to be done at the start of the new Modi administration, said Garner, chief Asia and emerging markets strategist at Morgan Stanley, at the brokerage’s annual India summit in Mumbai. “Issues of transmission mechanism, bank recapitalisation reorientation and shadow banking need to be addressed to get a virtuous growth cycle going again.”
Since January, the monetary policy committee of the Reserve Bank of India has lowered the repo rate by 75 basis points. But interest rates have not changed much for the average borrower. That comes amid a liquidity crunch in the nation’s finance sector stemming from the surprise defaults by the Infrastructure Leasing & Financial Services in September last year.
Garner said around 15-20 percent earnings growth can be expected if the financial sector clean-up is undertaken.
The “quite obvious” macro solution for getting public sector banks in shape is to implement reforms such as mergers among the state-run lenders and bring changes in the top management, he said. “What is public-good aspect of lending (in PSU banks) and whether or not they are going to compete with private banks is to be made clear.”
Other Highlights
Trade War
- A significant benefit for India in terms of supply-chain relocation; already witnessing benefits in mobile handset assembling and textiles sector.
- India is one of the new bright spots where equities are performing well since May.
Positives For India
- Current account and fiscal deficits are under control; inflation is low.
- No threat of a spike in real interest rates.
- Rupee expected to appreciate to 65-levels against the greenback.
FY20 Outlook For India
- Around 15-20 percent earnings growth can be expected if the financial sector clean-up is undertaken.
- Should have operational gearing kicking in after a period of depressed earnings.
- Morgan Stanley is bullish on stocks of consumer discretionary, industrials and private sector financial institutions.
Watch the full interview here:
Here are the edited excerpts from the interview:
The buzz around the conference is pretty fantastic. Is the buzz around India fantastic, too? I remember our conversation after the exit polls but before the election verdict, you were sanguine about the prospects of India. How is it looking like as you are in India?
It is one of our key over-weights, along with Brazil, and I am pleased that it is performing well. It is a long way from the trade and tariff disputes that occupy China and the U.S. It is an economy that is relatively close to trade, particularly on the manufacturing side where we have got question marks over supply chains. We have had the election outcome and India is also able to benefit from the falling oil price, and that is in a bullish environment which has allowed the RBI to begin to cut rates. India is one of the very few markets in world that’s been rising in the course of May and so far in this month.
Were you surprised with the policy or did you quite expect the action as well as the commentary of the central bank?
We talked to two central banks in Asia—India and Indonesia. Both India and Indonesia will be able to begin their rate cut cycle and we think that there are two rate cuts to come here. Then there is the issue about the financial sector transmission mechanism, which the finance ministry needs to address because we have been going through issues in the shadow banking sector here. We still have this overarching issue about public sector bank recapitalisation and reorientation which need to be addressed. Then we can start to get a virtuous growth cycle growing again. The missing part of this story is the earnings growth for the broader market and the broader economic growth situation which is yet to improve.
What have you made of whatever little has come to the public eye thus far? What do you expect the next two months to throw up in terms of reforms and measures?
These problems are not unique to India. It is a challenge for many countries, including the advanced economies, to get their financial sector in the right shape to fund the growth that is needed in all countries, particularly it is challenging to engage with the private sector and smaller scale private sector projects. If we look at a sector in India that is ripe for further activity is the real estate, both in terms of funding construction and mortgage financing for creditworthy clients.
But we have noticed the weakness in economy, things like two-wheeler vehicle sales that have been impacted by problems in the shadow banking sector. And shadow banking sector got so big partly because the public sector banks were not in a position to lend. For public sector banks, there is a quite obvious macro solution, which is to use some of the reserves that India has built up to recapitalise, but also to merge and change management to make really clear what is and is not a ‘public good’ aspect of lending and where they are or are not going to compete with the private banks. In aggregate, there’s been a persistent problem of growth, which is a disappointment. Again, India is not unique in that and there are other countries in the emerging world like Brazil, which we also like for different reasons. Brazil is trying to address key issues which is an overly large public pension obligations and it needs to get private capex story going again. But we also need to see that happening in India. From the new finance ministry team, we want to see more action in this front.
Do you hope this action to be front-ended, immediately around or immediately after the budget? Or is it okay to happen three to six months down the line? There are a lot of people basing their targets or predictions on the market based on what happens in the budget, but not all of them will turn out to be true. In the last five years, this government has shown that it doesn’t necessarily ply to the demands and wishes of Dalal Street.
It was the case that the government set the overall environment, but it is the private sector (both consumers and corporates) that can really drive development in any country. Here, the oil prices are moving lower and the reduced fiscal subsidy regime should also pass through relatively quickly.
Also, the trade and tariff issues offer significant potential benefits to India in terms of supply chain relocation, which we are already seeing in sectors like mobile phone handset assembly and textiles. There’ll be others where you will get that relocation. So, the budget is not the only part of it. What we are interested in seeing in the budget is more infrastructure spending and hopefully more measures to attract FDI and FII. But this key issue about getting the banking system fixed to fund growth hasn’t been pursued aggressively enough and it needs to be at the start of this new administration.
So, you need this to be part of the budget in some form or the other?
Yes. We want to see more concrete initiatives and action on this.
So, is that the central premise? What are the two or three questions that the large investors have and what is your advice?
The topic you are just talking about is the one that comes up most frequently. Also, what is the attitude of the government to FDI in the first part of Mr Modi’s administration was quite welcome to FDI. Recently, there were more question marks over that, particularly in sectors like the internet space and internet retailing. We have to see how the divestment works. We understand the government’s not in a position to do widespread privatisation. But how does it partner the private sector, both domestically and overseas. I don’t want to dwell on the negative because there are more positives here.
The underlying valuations are relatively low. The fiscal and current account positions and inflation positions are much better than in the past. So, you don’t have to worry about spikes in real interest rates. India can well get quite lucky when the China-U.S. trade war tensions are putting question marks over capital flows between the U.S. and China. India can stand in the middle of these two competitors and use this situation to its own advantage.
Is that the reason why you are bullish on the currency where you believe that Indian rupee will appreciate over the years?
Yes, the local bond yield should go lower, and the rupee can get to 65 against the dollar. That is again part of the story of the last four to six weeks. We have been able to get a rate cut cycle going. We have had the equity market doing well and the currency has been very stable. In fact, currency has been appreciating against some of the North Asian units which are caught up in these trade tensions.
You briefly mentioned flows as well. They thought that India was maybe relatively under owned and will now start seeing favour. Do you expect that to continue as well because there’s been a fair degree of inflow that’s come in already?
If that narrative of the financial sector cleaning up and being in a position to support growth happens and if investors can see the earnings growth coming through, which is 15-20 percent in consensus, which is achievable, then you can get a virtuous circle going again here.
Recently what seems to be sanguine, dovish and more accommodative U.S. central bank, and if that stance remains, then will emerging markets be the net beneficiaries?
Yes. It is very different environment from last summer, when the oil prices were high, the Fed was aggressive and shrinking its balance sheet. The external environment is much better. Not all emerging countries can benefit from this change if you are running a very large current account deficit and if your fiscal position is not as strong. India’s underlying fiscal position is one of the better ones in the emerging markets these days. Certainly, the reserve coverage to external debt is very strong. This is why you can use reserves to fund public sector banks’ cleanup and reorientation. Then your currency wouldn’t be in as strong a position as the rupee. But at the moment, the rupee and the Brazilian real been strong in recent weeks.
Would you believe that FY20 will be that year where we will finally see some meaningful earnings growth?
It has been depressed in most sectors for quite some time but there are some exceptions to that. The underlying valuations are relatively low. The fiscal and current account positions and inflation positions are much better than in the past. So, you don’t have to worry about spikes in real interest rates. India can well get quite lucky when the China-U.S. trade war tensions are putting question marks over capital flows between the U.S. and China.There is hope from the start of the second term.