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Germany & France will not break up the EU: Benjamin Yeo

Interview with Head of Investment Strategy, Asia, Barclays

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A favourable might reduce, but not entirely remove, the risks of both Greece’s exit from the Euro area and the contagion spread to the other peripheral European countries, Asia, Barclays’ head of investment strategy for Asia, Benjamin Yeo, tells Puneet Wadhwa in an interview. Edited excerpts:

Have the recent global economic developments made you go back to the drawing board and recalibrate how the markets, including ours, may shape up over the next few quarters?
We have never thought that the Greek election was ever going to deliver a definite answer to the euro crisis. Thus, a favourable Greek election may reduce, but not entirely remove, the risks of both Greece’s exit from euro area and the contagion spread to the other peripheral European countries.

As far as the global economy is concerned, investors’ expectations for growth are already fairly muted, if not, somewhat on the low side. Our central scenario is that economic growth in the United States will hover around two per cent and the euro-zone may experience a mild recession. Countries in the emerging markets are likely to register a growth slowdown but nothing recessionary in nature.

What about India?
India continues to be locked in the grip of political instability and policy paralysis with deteriorating domestic economy and external sector. After years of woeful under-investment, supply-side issues together with its concomitant bottlenecks have emerged to raise the risks to growth.

In addition, this vicious cycle may continue as the country’s deteriorating twin deficits coupled with poor investors’ sentiment have negatively impacted both foreign direct investments and the currency. While India may not slip into a recession, it is being challenged to deliver a seven per cent economic growth rate, barring any resumption of strategic reforms or investments.

For the rest of the year, capital markets remain locked in a mode of volatility that will be in tandem with the ebb and flow of headlines arising from greater euro area integration and issues. Despite our short term caution, in the medium term, we maintain a constructive view of global equity markets as valuation, in general, is not excessive.

What next for the euro-zone / PIIGS countries and the world economy? Do you think that over the years, euro-zone would eventually break-up?
Our central scenario is that Germany and France have no intentions of bringing about the break-up of the (EU) although the exit risks of some peripheral countries have increased since two years ago.

Based on the observation of recent elections (France and Greece), the political rhetoric in euro-zone has broadened from the belief that austerity is required to reduce debt to one that also incorporate efforts to promote sustainable growth. Both Portugal and Ireland would be watching closely how and the Troika tight-roped through this austerity-growth balance.

Fundamentally, euro-zone’s current exposure to Greece is unlikely to directly impact the single currency and thus, any foreseeable and favourable outcomes by the Greeks may encourage these countries to renegotiate their bail-outs with the Troika.

The National Bank of Greece had predicted an economic contraction of up to 22 per cent, unemployment rate of 34 per cent, a drop of per capita income by 55 per cent and inflation of 30 per cent if the country exited the euro-zone. Is the reality much worse in your assessment?
As in any breakup analysis, there are also direct and indirect costs; realistically, it is always challenging enough to accurately estimate the direct costs.

Our central view remains that any austerity package that will be implemented in EU is likely to assume a longer execution time frame with measured doses – nothing akin to what the Asian countries did in the aftermath of the Asia financial crisis in the late 1990s.

Thus, the affected Euro-zone countries may experience throbbing pain over an extended period of slow grind – accordingly, one should, therefore, not expect a sharp economic recovery from current asset levels, though depressed they may be.

Do you think that India, despite all the current macro-economic headwinds and political logjam, may still be able to pull off a better growth rate and attract higher fund flows over the next few years, as compared to its emerging market / BRIC counterparts?
The Indian economy remains entangled in the eye of a perfect storm where structural and cyclical headwinds are blowing vehemently. For India to navigate out of the current storm, policy makers may need to exercise grit and gumption in terms of policy reforms and execution in order to attract foreign investments and achieve above-trend growth.

Small incremental but improving steps in the right direction to crank up the engines of policy reform, fiscal discipline and infrastructure projects would eventually bring India out of the deluge. Failing which, over time, India is likely to lag the likes of China and Indonesia in terms of economic development regardless of potential.

Do you see interest rates softening anytime soon given the recent statements by the Reserve Bank of India (RBI)?

The central bank may only loosen its stance when inflation is clearly under control or when the domestic economy is about to tail-spin into a deep recession. For now, the domestic economy is well supported by resilient consumption.

However, a potential risk that may threaten to derail India’s economy would come from worsening global/external conditions. Given this, the RBI may be forced to cut interest rates, in tandem with the other Asian central banks, in a coordinated manner to avert any systemic impact on the global economy.

How are you approaching India as an investment destination given all this?
Taking into consideration both the long term potential of India and the cyclical issues of high inflation and the lack of policy action, we maintain our neutral stance on the Indian equity market. We believe inflation in India is unlikely to recede rapidly in the near term despite lower commodity prices and the worsening external global sector. The saving grace is that current valuation, whether on an absolute basis or relative to its history, is supportive of Indian equities as they do not look stretched.

What is your outlook on corporate earnings?
We believe that corporate earnings may well have bottomed in the current quarter. In fact, consensus earnings have seen a minor upward revision post the recently concluded quarterly earnings season. Going forward, we expect earnings to grow modestly between the low double-digit and mid-teens supported by the favourable basis effect in the second half.

Depending on the timing and magnitude of any policy actions in the second half of the year on both monetary policy and/or reforms, we would gradually phase in some cyclicality into a fully diversified portfolio. Sectors include interest-rate sensitive, industrials and financials and longer duration stocks in infrastructure.

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