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Interview

"Indian yields unattractive in the short term"
Richard Iley, chief economist, emerging markets, BNP Paribas, talks about the prospects for the Indian market  

Jitendra Kumar Gupta

Of late, India has become the most attractive destination or rather the most-preferred destination for global investors because of higher yields, a stable rupee, better economic growth and a stable political environment. In an interaction with Outlook Business, Richard Iley, chief economist, emerging markets, BNP Paribas, dwells on what lies in store for the Indian market.

Is the Fed rate hike becoming a non-event with the markets perceiving it as a very remote possibility?

As far as data points suggest, we are reaching a point where a hike is quite likely in December 2016. But that would be more of a tactical move and it will not have an impact on global markets because our view is that the US Fed will not be able to move rates decisively up anytime soon. I think Yellen has articulated the same at the recent Fed meet. And this is why our conviction is that emerging markets (EMs), particularly India, will continue to benefit.

What is prompting the Fed to go slow on a rate hike and does it mean that the Fed portends a bigger problem?

There is still some spare capacity in the US labour market, which means long-term unemployment is still quite high. Second, inflation in US is still very low and well below the Fed’s target of 2%. I think they are hoping that the economic momentum improves even further so that it can revive the labour market. The Fed used this phrase that there is scope for the economy to run further without tightening the policy. That will give more time and opportunity to bring workers back into the labour market. In a nutshell, there is no inflationary pressure in US. And if you do not have to act, why act now? Besides, you do not want to make the dangerous mistake of tightening too soon.

Isn’t low-to-negative interest rate a bigger risk to global markets, particularly EMs, than a higher interest rate?

It is a double-edged sword. On one hand, low rates bring in more funds into EMs in search of higher yields. But on the other side, Europe and Japan are locked in at a zero rate and have been resorting to quantitative easing for the short term. As a result, the world remains in this trajectory of low growth and super easy monetary policy, which is fundamentally not healthy. It is a sign of underlying sickness. There is a lack of confidence and optimism among corporates that are still not investing and putting more money into their businesses. For now, the super easy monetary policy that central banks in the West have been pursuing, has reached the point of diminishing returns. These policy measures are not stimulating growth anymore, but fuelling a grab for higher yield and returns.

In other words, EMs such as India will continue to see more flows?

Yield trade is going to remain in trend as developed economies will find it increasingly difficult to accelerate growth. India is going to stand out because it is one of the faster growing economies in the world, where the yields are relatively high. I am not sure if inflows could increase further but they should be pretty consistent over the next 9-12 months. But, from a short-term perspective, a fair bit of juice has already been squeezed out of this trade. Nine months ago the 10-year G-sec yield was close to 8%, today it's down to near 7%. Yields are not as attractive as they were. Only if India’s inflation continues to fall further and the RBI cuts rates, will inflows continue to remain high.

Why do you think India is attracting liquidity despite not-so-attractive valuations?

There are three reasons for liquidity flowing into India. First, if oil prices remain at current levels or in the range of $40-50 a barrel, India will remain in a sweet spot. Second, a better than expected monsoon will result in improved earnings. Third, low global interest rates are and will remain supportive for India in terms of providing liquidity. The Indian market is expensive but valuations are not out of wack. We see improvement in earnings led by the basic sectors such as commodities and a recovery in the rural economy, spurred by a strong monsoon. So, in this world of rock-bottom interest rates, Indian equities will continue to do well.

So, is India better off than China?

Investor concerns around China have increased significantly and they see India as a good alternative. China’s growth was largely investment led, which was not sustainable and now needs to be more balanced. This is going to be one of the most difficult transitions for China. The country’s growth could be more volatile and investors might have concerns about the stability of its currency. For China, this is going to be the new normal as slow growth will trigger policy challenges and induce financial market volatility. There are some structural issues in China that will take years to resolve.  Against this backdrop, the IMF feels that the sustainable long-run potential economic growth for India is 7.5% against 6% for China.  

But isn’t India actually exposed to higher risk and more vulnerable to a reversal of flows?

India is still not at that point where it needs to worry about flows. India is a real winner in an environment of weak global growth, lower interest rates and benign commodity prices. Oil at $40-50 a barrel as against $100-110, makes a humongous difference for India. The current account balance is much more balanced and foreign exchange reserves are stacking up. Even if the Fed were to hike rates at a faster pace next year, India would still be in a better position than what it was three years ago. Even at 5-6% GDP growth, India will still appear strong. Hence, any positive development will be an icing on the cake for India. GST, for example, has the potential to be a real game changer. It will bring huge efficiencies in the system, improve corporate margins, lower prices and result in better operating costs.

What could upset the applecart?

A poor monsoon could spell bad news for India. Second, if something happens to global oil supply and takes prices back to say $70-80 or above, it will make India more vulnerable in terms of Balance of Payment, current account, exchange rate, ability to provide for subsidy and curb its spending on infrastructure. Third, a persistent up-move, particularly in the US Fed rate, or a significant change in lower interest rate environment globally, will be a big risk. But for that to happen we need to see inflation accelerating in the US. If the US' 10-year-yield moves up to 3% or above that, it would be a key risk to countries such as India.

But India’s capex cycle and corporate earnings are telling a different story?

At this point in time, India is facing two key headwinds, which are not going to abate anytime soon. Private side capex is still sluggish and on the exports side, there is no growth. Nothing is going to change quickly. Only after the NPA issue is resolved, will we see a gradual revival in credit offtake. Another aspect is with regards to FDI, which so far has been very supportive. India has seen one of the highest annual FDI inflows in its history. It is better but it still needs to double from the current levels. India is still getting FDI inflows of 1.5-2% of GDP against 4-5% in the case of China.  

Rural consumption growth is going to be another critical factor. After two droughts, this year the monsoon is certainly looking good enough, which will help revive rural income, which is crucial for an earnings recovery.

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