Valuations Attractive But Sentiment Broken, Says Morgan Stanley’s Ridham Desai
The economy has been bearing tighter-than-required rates for almost eight months now, says Morgan Stanley’s India strategist.
While valuations of Indian companies are looking attractive, investor sentiment is fairly broken, according to Morgan Stanley’s Ridham Desai.
“The equity markets are not just about what the data is but also about what’s priced in. A lot of the bad news is in the price and so stock market valuations are looking particularly attractive,” Desai, head of Equity Research and India Equity Strategist, told Bloomberg News in an interview, adding that investor sentiment is broken due to weak earnings.
So when the sentiment and the valuations both are as low as they are right now, usually if you look back in time, it has been a good time to buy equities.Ridham Desai, India Equity Strategist, Morgan Stanley
“Companies in India have just not been able to expand margins. This tax cut that the government has put through sets the stage for better margins as we go forward,” he said, adding that at least the Nifty companies could compound earnings at about 20 percent per year over the next two years. “That could be the best growth rates that you see for any large economy in the corporate sector.”
The economy has been bearing tighter-than-required interest rates for almost eight months, he said. “So the bulk of the slowdown that we’ve seen over the past several months is because of monetary tightness and the need of the hour is to loosen rates a lot more.”
The difference between the nominal GDP growth and the repo rate is at an all-time low, indicating there is enough room to cut interest rates further, Desai said. On Oct. 4, the Monetary Policy Committee cut rates for the fifth time in 2019, paring the benchmark repo rate by 25 basis points to 5.15 percent. Rates have now been cut by 135 basis points since the start of the year.
“The historical average gap between nominal GDP growth and the repo rate is about 600 basis points,” Desai added.
If we assume that the nominal growth is around 10 percent which is what the RBI is forecasting then repo rate can fall as low as 4 percent. It is not what we are forecasting. What we are suggesting here is that there is a lot of room for interest rates to fall in India given how weak nominal GDP growth is.Ridham Desai, India Equity Strategist, Morgan Stanley
Watch the interview here:
Edited excerpts of the conversation:
Do you this Monetary Policy Committee’s 25-basis point cut on Friday was a bit underwhelming?
Actually, this dates back to June 2018. Now we know in hindsight that the economy started slowing after that quarter. And, post that quarter the Reserve Bank of India raised rates a couple of times in June and again in August last year. It wasn’t until February this year, it started cutting rates. So the economy was bearing tighter than required interest rates for almost eight months.
I think the bulk of the slowdown seen in the last several months is largely due to monetary tightness and need of the hour is to loosen rates a lot more. And, the metric that I look at is nominal GDP growth minus the repo rate. That’s at all-time lows which means there is enough room to cut rates further.
I was hoping the RBI would go a little bit more on Friday. We were forecasting 25 basis points but what we forecast and hope for are two different things. But I hope the RBI takes this more aggressively in the next meeting and cuts rates even more aggressively.
So how much more cuts are you looking for considering that the repo rate is at 5.15 percent. Does the RBI just keep easing as long as necessary?
The historical average gap between nominal GDP growth and repo rate is 600 basis points.
If we assume that the nominal growth is around 10 percent which is what the RBI is forecasting then repo rate can fall as low as 4 percent. It is not what we are forecasting. What we are suggesting here is there is a lot of room for interest rates to fall in India given how weak nominal GDP growth is.
Nifty itself has already given up half of its gains since the Narendra Modi government announced the corporate tax cut and we were just talking about the concerns around the shadow banking sector at the moment. Do you think the negative news flow now is regarding that is overshadowing this fiscal windfall?
I think there are two headwinds. One is what is happening globally. So let us not forget that there is a global growth slowdown that we are dealing with. And, for everything said and done, 20 percent of India’s GDP is gross exports. Export growth has slowed down materially over the past few months.
I take gross exports and not net because a large part of India’s imports do not have flexibility. They do not have price elasticity, and therefore, gross exports to GDP is an important metric to look at.
And then the second thing is what you pointed out which is the confidence in the financial sector. It is visibly shaken. The slide happened after the Infrastructure Leasing & Financial Services Ltd. episode in September last year and I dare say not enough has been done to revive the confidence in the banking sector. We have had a lot of slowdown in lending growth from the non-banking finance companies which were accounting for the bulk of the incremental credit growth in the preceding three or four years. The large corporate banks in India are just coming out of a bad loan cycle and that leaves a very small number of banks that have both the capital and the profit and loss account to actually lend aggressively. So a lot of the lending burden is falling on a small number of banks. Clearly, there is stress in the financial sector which is the other overhang on the on the domestic economy.
What is your earnings growth estimate for the Sensex? And what sectors are you looking at in particular?
I think the equity markets are not just about what the data is but what is priced in and I reckon that a lot of the bad news is in the price. Stock market valuations are looking particularly attractive and as we can all see the sentiment looks fairly broken.
Somebody who is patient and has a time frame of 12-18 months, I think when you look back at this time frame— the last four or five months may turn out to be a good time to have bought equities. Notwithstanding the fact that there could be some more near-term pain before it all settles down.
So I’m not arguing for a V-shaped recovery in stocks from here but I think it is a good level to deal with stocks.
Now, as far as earnings are concerned, We have been repeatedly disappointed on earnings for various reasons and reasons keep emerging. The latest round of reasons came from the non-banking finance sector and overly tight monetary policy. So we have had a fair bit of disappointment on earnings growth. Companies in India have just not been able to expand margins. Our view is that this tax cut that the government has put through sets the stage for better margins as we go forward. We are getting a lot more optimistic on earnings growth and I reckon that over the next two years at least the Nifty companies could compound earnings at about 20 percent per year and that could be probably among the best growth rates that you see in a large economy for any corporate sector.
What about high oil prices? Is that one of the risks that you are looking at that could dent some of this momentum?
Absolutely. Oil prices are always a risk especially when oil rises due to supply-side concerns. See when oil rises because of demand, it is not so important because it is then offset by higher capital flows.
For India what matters is whether the oil is going up for supply reasons or demand reasons. And, to the extent that there is a potential supply-side problem in oil, that is a risk. You look at oil relative to copper, I reckon that both oil and copper respond to global demand impulses. So the demand factor gets neutralised in the oil relative to copper line. If the oil is rising relative to copper, that has usually not been good news for the Indian markets.
So obviously, we always keep an eye on oil. It is bad for India’s terms of trade and as I said is rather an inflexible portion of our imports. India really cannot offset that quickly.
What’s your outlook for the Indian rupee? And which are the sectors that will be linked to the rupee’s movements?
I’m not so concerned about the rupee, in fact, I think it’s largely a U.S. dollar call and our global team over a 12-month time frame is actually not so bullish on the dollar. So if you look at our 12-month view on the rupee, it suggests that the rupee could appreciate.
On its own, the rupee is going to be a function of how India’s balance of payment responds. BOP has remained quite good even through this troubled time that we have seen in India’s growth picture and the reason is that there are very strong bids for Indian assets from private-equity funds and foreign direct investors.
Both foreign portfolio investors as well as foreign direct investments into India are very strong and so far as oil remains benign in this $60-70 per barrel range, India’s BOP remains in surplus. Therefore, the pressure on the rupee may not be sustained. We are not too bearish on the rupee.
In terms of calls, I mean obviously, if the rupee depreciates then you go and buy export
sectors. Everybody's favourite is software services but keep in mind that if U.S. capex and GDP growth are slowing down then software companies in India will struggle to grow revenue. It has been a very strong-performing sector so we are actually recommending an 'underweight' position on software. If the rupee appreciates then you get a lot of domestic sectors doing well which includes autos, industrials and even the banks.