India is paying price for repeated failure to fix banking system: Jan Dehn

London-based Jan Dehn, head of research at Ashmore Investment Management,says he is not bearish on Indian equities and the current problems in India are cyclical, but the banking issue

As the September 2019 quarter results season gets underway and investors fine-tune their market exposure, London-based Jan Dehn, head of research at Ashmore Investment Management, tells Puneet Wadhwa that he is not bearish on Indian equities and the current problems in India are cyclical, but the banking issue. Edited excerpts:

• What’s your view on equities?

Emerging market (EM) equities are cheaper and supported by a better outlook than developed market equities. Investors in US stocks, in particular, are sitting on very big positions in very expensive stocks. They are holding out for the US Federal Reserve (US Fed) to cut rates as the economy slows, but rate cuts will not help many companies, earnings outlook of which is worsening. EM stocks are cheap and lightly owned. 

The big move back into EM equities will come when the US recession really sets in. At that point, the bullish money sitting in US stocks and the dollar will book profit and go elsewhere. The resulting dollar decline will make EM equities extremely attractive. 

• How are you viewing India as an investment destination?

Indian equities remain expensive to other markets and India is going through a painful downturn. India is paying the price for its repeated failure to fix the banking system. There are some policy moves afoot, which is good news, but now that trust in banks has been hurt, only a full-fledged recapitalisation and restructuring of the vulnerable banks will satisfy investors and reignite the business cycle.  

• Can the next leg of the correction in Indian equities be triggered by sub-par corporate earnings?

I am not structurally bearish on Indian equities. The current problems are cyclical, except for the banking issue. If this administration continues to take the long view, there will be a strong recovery over the course of the current business cycle. It is worrying that the government caved in on fiscal policy because a correction was required after the pre-election splurge. However, at least the government focused on corporation tax cuts, which should help employment. I do not expect any lift in the coming earnings season, but I see the economy bottoming out in 2020. So, towards the second half of next year, there should once again be good steam behind earnings. 

• Do you think markets are ignoring government’s policy response?

No, the market is not ignoring the fiscal stimulus, but frankly, fiscal stimulus is not what is required. There are headwinds coming from overseas. And the banking system needs to be fixed. The government then needs to get serious about opening the economy to foreign investors.

I am optimistic that the government has finally found a formula for opening the bond market without encouraging too much fast money, namely by requiring foreign investors to prove that they are benchmarked to an index.

• Your overweight and underweight sectors?

We like Indian bond duration and are underweight the currency and stocks. This is the right asset mix going into the current downturn. Trust in banks has been undermined by recent failures. The government and regulators need to get on top of the problem. We are not into the cyclical stocks right now. The best strategy is to stay defensive. There will be a better entry point for bull market stocks once the current cyclical downturn has matured.

• Will markets correct sharply if the fiscal position worsens? 

There is lack of clarity about the fiscal outlook. The government looks as if it capitulated as the economy weakened. It U-turned on what was the right policy, namely to correct the fiscal splurge during the election. The way forward is fiscal discipline with unrelenting reform. Modi can do this -- he is just re-elected and now needs to show the same boldness as in the first term. It is better to reform too much and get some reforms wrong than to reform too little. 

• Your  interest rate outlook for India and other central banks?

The Reserve Bank of India (RBI) will cut more as the economy softens. As the US economy slows, the US Fed will eventually cut the Fed funds rate to zero, i.e. 200 basis points lower than now. EM bonds will be the only bonds with a positive yield. There will be growing demand for EM bonds from institutional investors as yields in developed economies move inexorably lower. The prospects for global equities is far less appealing than for bonds, of course. Developed countries have been partying on easy money for a decade without reforming, without fixing their debt problems. There is pain ahead for developed markets and with this pain also downside risks for stocks, especially in the US.