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The markets have seen a steady rise, fuelled by the liquidity injection drive of various central banks across the globe. Richard Gibbs, global head of economics, Macquarie Research, tells Puneet Wadhwa that foreign investors are firmly focused on the major economies where central banks are aggressively pursuing growth-orientated policies. The Indian economy is still struggling to overcome distribution system and supply-side constraints on growth, he adds. Excerpts:
Global equity markets have seen a steady run. Do the market fundamentals and the macro economic condition justify the rise?
On balance, the current fragile global macro economic conditions do not justify the steady run-up in equity markets we are experiencing. Rather, the recovery in investor risk appetite is a reflection of the determination of major central banks to focus policy on growth and not on restraining previous inflationary pressures.
How long do you expect the liquidity drive by various central banks to continue?
They can be expected to maintain the drive until cumulative signs of a narrowing in the output gaps and a reduction in the risk of deflation. Two key indicators are likely to govern the duration and extent of quantitative easing (QE) measures – the official unemployment rate and the annualised rate of growth of consumer/retail prices.
How are foreign institutional investors positioning themselves on the developed and the emerging markets? Where does India figure in their radar?
Foreign investors are firmly focused on the major economies where central banks are aggressively pursuing growth-orientated (reflation) policies. Most recently, this has seen Japan take a leading role in the portfolios of foreign investors. Overall, global investors are now seeking investments that will deliver enhanced yields and this is supporting a major migration of funds from sovereign government bonds into equities and lower-rated (higher yielding) corporate bonds.
Do you think the second half of calendar year (CY) 2013 could see risk-off sentiment returning as the country gears up for general elections?
In the near term, the markets will continue to be driven by developments in the major advanced economies and the QE activities of central banks. It is still too early for a reasoned focus on the 2014 Indian general elections, although moves by the government to embark on structural reforms are being viewed very positively by the markets. Probably the greatest risk to investor sentiment in India in the near term is the persistence of the twin deficits (fiscal and trade) and the risks these factors pose for stability in the country's capital account.
What is the nature of flows coming into India now? Is it more long-term in nature, given the outlook for the Indian economy over the next couple of years? Or, is it more short-duration?
Foreign capital inflows continue to be dominated by short-term portfolio investments into India and this situation is unlikely to rebalance in the immediate term. Foreign direct investment (FDI) and, therefore, long-term investment will only begin to recover when the economy's key macro economic parameters are stabilised. In particular, the government will need to show meaningful progress in addressing the twin deficits, so as to reduce the sovereign and long-term investment risk that is currently inherent in the Indian economy.
What is your interpretation of recent global economic data, especially from India? Do you think there is a recovery visible in the capex cycle?
Incoming economic data continues to reflect a gradual but uneven recovery in the global economy. For India, the data indicate the economy is struggling to overcome distribution system and supply-side constraints on growth.
As yet, there is little evidence of a durable pick up in capital expenditure (capex). The extent to which a recovery in this driver of growth occurs will depend on the stabilisation of key macro economic bearings.
In this light, how do you see corporate earnings panning out over the next few quarters?
It would depend on the sector. In particular, we anticipate ongoing growth in earnings in the health care and consumer staples sectors. In the energy, materials and technology sectors, we anticipate some decline in the rate of earnings growth. Not surprisingly, those sectors where earnings growth is expected to be challenged are those where capex has been particularly weak.
We anticipate 13-14% earnings per share (EPS) growth for the Sensex in FY14 and 11-12% EPS growth for FY15. The expected moderation for FY15 reflects the delayed impact on the current moderation in nominal GDP growth in the Indian economy.
Do you think there is a slowing in the consumer discretionary space? What about metals, banking and the infrastructure/capital goods sectors?
Cyclically, the consumer discretionary space is encountering headwinds. However, in a structural sense, the sector still appears well-placed to benefit from an ongoing rise in household income. There is no doubt that muted reforms to consumption tax and roll-out of the GST (goods and services tax) will be positive for growth, overall.
Metals will continue to be challenged by the realignment of the Chinese economy and changes in the intensity of use. In the banking and infrastructure sectors, we continue to carefully monitor the path of interest rates, as this is likely to be one of the key influences on the sectors. In the mid-cap sectors, pharmaceuticals, specialist health care and financial planning services continue to capture our attention.
Hindustan Unilever, Glenmark Pharma, Wockhardt, Coal India, Reliance Industries, Axis Bank, DLF, Cummins India, Sterlite Industries, Bharti Airtel, NTPC and JSW Energy are among our preferred picks.
Another concern for India has been coal and edible oil prices, given the high level of imports. Do you see some relief on the pricing front in 2013?
Coal and edible oil prices are expected to continue to consolidate over the remainder of CY2013, reflecting the expectation of the global economy recording sub-potential GDP growth. More, we continue to expect that China moves to a less inflationary and more sustainable growth trajectory, with real GDP growth of 7.5–7.8%.
How do you see the key currencies?
On the exchange rate front, the trading ranges of the major rates will remain captive to QE operations for the foreseeable future. In the event of a confirmed windback in QE by the US Federal Reserve, then we expect a sharp and sustained appreciation in the value of the dollar.
For the euro and the yen, it is unlikely that macro economic conditions will warrant any move to windback reflation policies in the near term, so we would expect these exchange rates to remain structurally weaker.
What about the rupee?
It is expected to continue to reflect the flows of global capital and any incremental change in global investor risk appetite. We do not anticipate any meaningful reduction in the sovereign risk premium in the near term, until evidence of a sustained reduction in the twin deficits is recorded.
