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Morgan Stanley’s Jonathan Garner Expects Indian Economy To Revive Next Year

India could benefit from the supply chain diversification out of China by multinational companies, says Garner.

Pedestrians walk past jewelry stores during the festival of Dhanteras in the Zaveri Bazaar in Mumbai, India (Photographer: Dhiraj Singh/Bloomberg)
Pedestrians walk past jewelry stores during the festival of Dhanteras in the Zaveri Bazaar in Mumbai, India (Photographer: Dhiraj Singh/Bloomberg)

Global economic growth will determine whether investors would want to remain invested in stocks, according to Jonathan Garner, chief Asia and emerging market strategist at Morgan Stanley. And that has implications for India.

“It’s been a very tough two years for Asia and emerging markets, including India, in terms of underlying economic growth and earnings growth,” he told BloombergQuint in an interaction. “Now the question is, will the resolution of trade tensions, policy stimulus in the system including in India on the fiscal and monetary side lead to an economic turnout next year,” he said. “We’re kind of a little bit more optimistic that, that can happen.”

India, along with countries like Indonesia and Vietnam, could benefit from the supply chain diversification out of China by multinational companies, Garner said, apart from incentives like low tax rates for new companies.

The Indian economy grew at the slowest pace in six years in the April-June quarter amid waning consumption, increased stressed assets among banks and non-bank lenders and slowing global economic growth. The government responded by cutting corporate tax rates on local businesses and merging state-run banks, among other measures.

Foreign investor optimism in India, according to Garner, has been on the wane. “If you look at about six-12 odd months after Modi was first elected, that was when foreign investor positioning in India peaked out versus the EM (emerging market) index,” he said. “So, that’s not just the highest that has been seen in terms of exposure to India but also the highest we’ve ever recorded for any major emerging market—in terms of optimism.” So, yes, it’s dialed back on those levels to a moderate overweight, he said.

He, however, expected the rupee to remain less volatile. “With India’s inflation well under control, its current account deficit well below 3 percent of GDP with oil (prices) range-bound if not down, that probably means the Indian rupee would be reasonably stable”

Watch | BQ Conversation with Morgan Stanley’s Jonathan Garner

It’s a very interesting time to be in because we have already started to see a lot of improvement in sentiment across various equity markets (S&P 500, NASDAQ trading at record highs in the past year, India is trading at record highs, while the MSCI emerging market is up 7 percent), not just emerging markets. Do you feel that this is just a passing phase and that the excitement may not continue for a longer period of time?  

So, I think whether it continues for a long period of time will depend on what happens to the global economy next year and to earnings. It’s been a very tough two years for Asia and emerging markets, including India, in terms of the underlying economic growth and earnings growth. Now the question is, will the resolution of trade tensions and the policy stimulus (that’s now) in the system (including in India on both the fiscal monetary and monetary side) lead to an economic turn up next year? We are getting a little  bit more optimistic that, that can happen. 

From an emerging markets standpoint, there are various other moving parts and high frequency data have been coming in from China. There is still a little bit of a growth issue out there, and the full impact of the tariffs has not yet been seen. In fact, some say that if no deal is secured in the first phase, the first quarter of 2020 could actually see a 20 percent impact of the tariffs coming in. In light of that, how can investments be looked into within China, India, and the emerging markets? 

As I’ve mentioned, we’ve had two years of essentially zero earnings growth. We have had very meaningful downgrades to GDP-forecasts over the last couple of years, including India. I think the Indian economy peaked at over an 8 percent growth rate; it’s now tracking around a 5-and-half-percent rate (official figure) with double digit declines in auto sales.

So, I think, though there are definitely these trade issues, it is interesting that India is not participating in RCEP. That is something new. We do ultimately think that there is enough stimulus in the system. In India’s case, the corporate tax cut, the interest rates reductions, and the state bank recapitalisation will (help us) see credit supply improve in India next year and so my colleague Ridham Desai is expecting a bounce back in earnings from very depressed levels. So, on that basis, he has his 40,000 Sensex target. 

Since you mentioned RCEP, what is the repercussion of that? India is trying to protect the “Made in India” tag. It’s trying to protect the domestic industries and the farmers’ interest. But, from a medium to a long-term perspective, how do you view this?

We need to do more analysis on exactly the reasons why India’s chosen not to participate. When we saw President Xi visit Mr. Modi, we were interested (to know) if that was an attempt to put RCEP on track as well as talk about other issues. But it is interesting that the rest of the participants have chosen to go ahead. So, we need to understand better how that fits in the overall diagnostic.

What I would say is that India has improved its openness to foreign direct investment under Mr Modi’s term and we have seen a pickup in that segment of the economy. In capital goods, orders related to FDI. So, RCEP is just a part of the overall situation but it is certainly interesting to see this development.

We’ve already started to see the impact of the corporate tax cut on the bottom line of companies that have started to report their earnings for quarter two. This is obviously a big positive. But in terms of making sure that this translates into something more meaningful, where they can use the additional money to deploy into manufacturing and boost capital expenditure. Do you see that happening?

What’s particularly interesting about the corporate tax cuts is that if the rate goes all the way down to 17 percent, which is on par with Hong Kong or Singapore, (and) you set up a new manufacturing plant in India, (… then that could be beneficial). It is specifically designed not just to benefit existing incumbents but actually to help with capacity expansion and encourage the corporate sector to take more risks.

Even though we were just touching on RCEP, we should always remember that we are seeing a trend to supply chain diversification out of China by global multinationals. That includes Indonesia, Vietnam, and India, who are benefitting from that. So that element of the corporate tax cut is specifically designed to accelerate inward manufacturing in India.

Do you think India is capable enough to make its place in the global manufacturing supply chain?

Well, historically, we’ve had significant weaknesses, particularly around ports, roads, and railways. Telephony, has been a strong point, historically. But, when we actually look at (particularly) some of the attempts that have been made to improve the road network, we are getting more optimistic. You can kick start a ‘manufacturing-FDI’ story, which has always been a part of the Asian Development Model. That needs to happen to raise incomes per head in India.

Do you feel that this could also attract Foreign Institutional Investors who have shied away from India for some time now? We’ve just about started seeing their interest come back in the last two months.

If you look at about 6-12 odd months after Mr. Modi was first elected, that was when foreign investor positioning in India peaked out and people were around double (the) bench-marked weight for India versus the EM index. So, that’s not just the highest data that had ever been in terms of exposure to India but also the highest we’ve ever recorded for any major emerging markets- in terms of optimism. So, yes, it’s dialled back from those levels to a slight overweight versus benchmark now, where it has actually stabilised in the recent weeks. Going back to my colleague, Ridham’s earnings forecast 20 percent CAGR two years running off a very depressed base. This is why he and I have been recommending even at this depressed growth and earnings environment, we have been recommending a modest overweight on India this year and as you covered it, has outperformed with some volatility, but it has outperformed year-to-date.

Even during these times of volatility, where Brexit and Trade talks have been an issue, India has still managed to outdo itself. We would have expected a bit more, we’ve made record highs in the Sensex, we are now rescaling a record high on the Nifty.

Obviously, all of these measures that the government has taken is towards building a stronger foundation even though it creates short-term disruptions. In light of that, do you feel this is an opportune time to take it a step further (than just ‘overweight’) to gauge a little bit more in terms of the long-term viability.

Well, we have to look at the totality of our coverage universe to figure out our relative position. At the moment, we are happy with our modest overweight on India. What I would say is the key to some extent to why the market is being resilient is the domestic bit for equities.

That’s been consequent upon quite a stable government bond yields and a reasonably stable currency this year, very different, for example, from 2013. So, one thing that I think investors domestic and foreign would acknowledge is that the inflation performance of the Indian economy and the management of the external position has improved significantly in recent years. Now, that’s a good plank for being constructive activities and it’s a contrast for some of the countries we cover in our emerging markets universe.

So, in the emerging markets Universe you just mentioned, which is the more preferred market currently?

We are overweight (on) Australia, Brazil, India, and Indonesia. We are neutral on the large markets of North Asia like China, Korea, Taiwan and underweight on MSCI Hong Kong, Malaysia and also Mexico.

We have seen the past five weeks been positive for the emerging markets currency basket. Do you feel that’s likely to continue and what can you attribute that gain to? 

Well, that’s related to this whole debate about where the global economy goes next year and also the tendency of the U.S. dollar to be somewhat weak; now that we’ve had three Federal rate cuts and we are clearly in an environment where the Fed has changed its overall policy stance.

I think last week’s comments particularly at the press conference by Fed chair Powell really did suggest that we are unlikely to see the Fed going back to anything like a rate hike cycle for the foreseeable future. That will tend to support traditional carry-trade activity and emerging currencies. As I said, with India’s inflation well under control, its current account deficit well below 3 percent of GDP, with oil very range-bound if not down, that probably means that the Indian rupee can be reasonably stable. 

Any near-term risks that you would like to highlight for us, Jonathan?

Well we do think the markets now move to fully discount phase 1 trade deal. Obviously if that doesn’t get signed, that would be a disappointment. We just need to keep tracking this pace of economic stabilisation/stroke recovery, which is very nascent.

Whether we really do see the kind of turn in PMIs that we saw in early-mid 2016 or not. That is still highly debateable. The market pricing has moved ahead of the turn, that may occur in manufacturing PMIs. But we need to keep aware of that.

India is a peculiar case (in terms of earnings), where some companies even with high multiples and P/E ratios are considered the safer-haven stocks and people start to invest in them despite a higher-premium.

In light of that, do you still believe that it’s going to be the earnings growth momentum that’ll drive your interest, or a tactical play on valuation mismatches that could be something to look at.

So, we are getting more interested in value cyclicals, including in financials, consumer discretionary, and industrials. That applies across our coverage universe. We’ve been very much across our coverage universe, holding up in sustainable yields plays based of the reduction that has actually taken place in long-dated government bond yields in the U.S.

We are starting to show an interest and we are starting to see an improvement in earnings in cyclical cycles. That’s been more in the IT hardware sector so far, which is not that represented in the Indian market, but we are interested in whether that can actually spread.