After US Federal Reserve Chair Janet Yellen turned more dovish in mid-February and held rates steady, foreign capital inflows into emerging markets have revived significantly. Some market experts see no Fed rate hike in all of 2016, which means that the US dollar may not appreciate much and the sharp depreciation in the emerging market currencies will be arrested. Bloomberg TV India caught up with BNP Paribas Securities’ Head of Equity Strategy for Asia (ex-Japan), Manishi Raychaudhuri.
Can you take us through the details of your portfolio earnings?
It’s quite apparent from the way the market is behaving — you would have seen the equity market appreciating very sharply over the past six-seven weeks. I think that is a clear indication of two variables. Both the external global variables turning in favour of emerging markets and within India, the mood turning is a little more positive because the expectation that this earning season may turn out to be slightly better than the previous four or five months is possibly getting a bit of little more trenched. Indeed, the numbers that we have seen from the IT service companies and some of the non-banking finance companies do ignite such hopes, though it is still very early days for the earnings season.
Emerging market flows revived significantly from mid-February when the Fed turned decidedly more dovish. It started with Janet Yellen’s Congressional statement, which was reinforced in March and April when the Fed did not hike rates. Our global economic group’s point of view is that there will be no hike in rates at all in the year 2016, which obviously means that the US dollar that has been stabilising and consolidating, would remain in that path. And, therefore, the emerging market currency depreciation that we have seen right from early 2014 will not continue in the same range. These are all very good news for the flows into the emerging markets. That is why we saw some of the record inflows in March and that is almost $12 billion in Asia ex-Japan. India normally gets about 25-30 per cent of the inflows into Asia ex-Japan but it actually under-performed slightly in March. But we think over the medium term, there is no reason why the flows into India should not catch up to the longer term averages, which obviously means that this is likely to continue over the medium term. It is difficult to say exactly how it will pan out in the very short term, may be in the next few weeks or so. But over the medium term we obviously remain positive about the flows.
How do you compare valuations in India with the rest of the emerging markets?
If you look at the price earnings or the price to book valuations in India in relation to the Asia ex-Japan average, they are about one standard deviation higher than the long term average. For example, India is traditionally traded at about 30 per cent premium to Asia ex-Japan. Today that valuation premium is about 42-43 per cent. That said, we think that both Asia ex-Japan and global emerging market (GEM) investors have actually reduced their over-weight stance on India slightly over the past six months. Therefore, that over-weight position is not that egregious as it used to be. So in net analysis, I would think that India may continue to move sideways for a while before that valuation premium sort of gets corrected. But over the longer term we are not really turning negative on India as a consequence of this valuation premium given on it.
What is your outlook on India and what will change it?
We remain over-weight on India. We have had an over-weight stance on India for almost one-and-a-half years and we are not changing it. So our current stance is India is almost about 40 per cent higher than the benchmark rate. The benchmark rate in India and Asia ex-Japan is about 9.5 per cent. And we have close to 13 per cent for the Asia ex-Japan model portfolio dedicated to India. The only thing that can force us to change the over-weight stance in India is possibly another chance of a global shock in the form of a change in the Fed stance from dovish to significantly hawkish. We do not see that happening. But if that happens one would have to kind of recalibrate expectations about the emerging markets as a whole. And in the Indian context, if the forecast of a good monsoon turns wrong and by that time we will be close to the end of the season, we would possibly get a sense of that. I am again not really expecting that will happen. But those are the possible external and internal variables that could force us to make a change.
Within India where is your portfolio allocated?
It’s mainly three or four different buckets. First are the private sector banks, particularly those which are geared to retail lending. Second, the IT services companies —we think the top-ranking IT services are significantly successful in getting their incremental orders from the developed market companies. Third, we have some of the high-quality cyclical firms, particularly the building materials sector. And finally a few odd companies in utilities, industrial and consumer staples, which may not have a sector-specific story attached to them but conform to the criteria of cash generation and low leverage on their balance sheets.
What are your thoughts on IPOs starting with Indigo?
In a sense, it has been a region-wise phenomenon not exactly in emerging markets but we have seen a similar rush of fund raising from other parts of Asia as well, particularly North Asia. It would be difficult to paint all these IPOs with the same broad brush. There are some sectors and some companies within them which are seeing growth opportunities. And the kind of examples that you gave, they pertain to the discretionary spending environment — travel and tourism and so on. So we would think that those sectors, which should be benefiting from householders’ increasing affluence, would continue to expand. And, therefore, to make possible those expansions you would have to raise equity.
There has been a lot of debate on public sector banks. Some say valuations are attractive while others say their non-performing assets (NPAs) are a bigger problem. What are your thoughts on that?
We think that the clean-up attempt by the central bank (RBI) is possibly the best thing that could have happened to the Indian banking universe. The asset quality review (AQR) that the central bank has done, that has led to a short-term increase in NPA recognition and also restructured loans. But essentially it means that a large part of the potential non-performing loans are already being recognised by the Indian banking universe, which is actually a departure from the trend in much of emerging markets of Asia. So in that respect India stands out. And we actually treat that as a very positive development that has taken place.
Now, having said that, we would still hold our horses as far as the public sector banks are concerned before turning more constructive on them because accretion of NPAs may continue for one or two quarters. And, therefore, we would like to watch the outcome in one or two quarters. But over a longer term, we take this as a very positive outcome.
What about metals? Are you interest in them or not?
The over-capacity in metals still continues, obviously led by China. So even though the metals stocks have rallied significantly, we think that investors would have to be very nimble-footed in these deep cyclicals. \
The cyclicals that we like are the ones that have better balance sheets, which have traditionally outperformed the cost of equity or in other words the return on equity has been higher than the cost of equity over cycle averages for the last two or three cycles.