Eye GST rollout, reduction in subsidies in the budget: Mark McFarland

Q&A with the Chief Economist of RBS Wealth Division

Mark McFarland, chief economist, RBS Wealth Division, believes the government should communicate its plan on GST (goods and services tax) in the budget apart from expediting approvals. In conversation with Sheetal Agarwal, he talks about Indian markets versus global markets and earnings outlook. Edited Excerpts:

What are the key measures or low-hanging fruits that government could announce in this budget?

GST is an important signal. Though it does not necessarily make much difference to efficiency levels or transparency, it is an important signal that India is able to roll out a nationwide policy that will improve collection growth in the tax base and actually provide long term fiscal benefits. Rolling out of private-public-partnerships infrastructure programs and its proper implementation is a low hanging fruit. (Narendra) Modi has the opportunity to speed up the approval process, which is already happening. The third thing is to reduce subsidies, which is not so easy politically, particularly, agricultural subsidies.

Do you expect Indian GDP (gross domestic product) growth to pick up? What will be the drivers for the same?

We expect GDP growth of five per cent in 2014 and six per cent in 2015. On the expenditure side, the drivers of that would be improved investments, improved exports and bit more consumption. On the output front, improved outlook for industry, particularly services and manufacturing will be key drivers. Agriculture, though, is a mixed bag.

What is your earnings outlook for India Inc?

The earnings outlook depends to some extent on the budget measures on reducing bureaucracy and also on growth. The economic cycle seems to have turned. The PMI (purchasing managers' index) data, for example, is very strong on the services sector side in particular. And that's likely to improve further leading to higher earnings per share. So I would be fairly optimistic from here. One cannot overestimate the impact of a structural change in a country and the effect it has on companies' willingness to invest. And I think we have just had one of those in India.

How do India's equity markets stack up versus other emerging markets?

On price/earnings (PE) basis, India is expensive. But, with supply side reforms and all other measures that we have been hoping to see, there is no reason why earnings per share growth cannot pick up. Thus, you could see price to earnings ratios falling because the earnings goes up faster than the price. Russian markets trade at 4.5 times earnings but I would not buy it because of growth concerns. Brazil, though cheap, has a messed up economic policy.

I would buy China even though it is cheap. The economic reforms are also a positive. However, one needs to stay invested for two or three years. India I could buy now even though its expensive and probably make good money and also earnings per share estimates are beginning to pick up.

I would look at parts of economy that benefit from structural supply side reforms, rolling back of government subsidies and red-tape. Cyclical industries are the primary beneficiaries of an improving outlook.

Indian yields are expected to come down even as that in US and other developed economies are likely to go up. So do you see a flight of money from bond markets here to the ones in developed countries?

I think yields have to move up significantly in America for that to happen. In May 2013, there was a big move out of emerging markets, partly due to fear more than anything else. But that is unlikely to happen again. However, there is no manual for exiting QE (quantitative easing). A lot of the next twelve months is about how the Fed communicates what it wants to do.

So we have a preference for equities over fixed income as far as global markets are concerned. Fixed income investors should have a very short tenure of investment because they are the ones that are most insensitive to US interest rates.

What is your outlook on developed markets of US and Europe?

We like the European equity markets and the peripheral bond markets in Europe because of European Central Bank's loosening policy. But that is in response to a very uncertain outlook for Europe.

On the other side of the Atlantic, the US had two great quarters of growth in the end of 2013 and then the first quarter was far below expectation. But the S&P continued to rise. Investment is very weak suggesting that the companies are very uncertain about long term profit growth. Exports are very weak too. Thus, it is the US consumer who is driving the US economy. We do not want to see too many raises in interest rates. We prefer European equities to American equities because we believe that policy loosening by ECB is good for markets.