The worst of India's economic slowdown and corporate earnings downgrades could be over, said Jan Dehn, co-head of research at UK-based Ashmore Investment Management, which manages assets worth $65 billion in emerging markets. In an interview with Nishanth Vasudevan, he said the Reserve Bank of India (RBI) had been right in resisting pressures to cut rates. Edited excerpts:
What is your outlook for India? Have the recent policy moves by the government altered your views?
The recent approval by the lower and upper houses of the Indian Parliament to open the country to multi-brand retail was important and positive for the outlook for three reasons. First, it showed the government has political room to pursue reforms. Second, it helps business confidence, which should stimulate capex and supply-side-led growth. Third, the government might now be encouraged to move on to further reforms, such as the introduction of foreign direct investment (FDI) in pension and insurance, setting up the National Investment Board, and even tackling the introduction of the goods and services tax (GST).
Many feel India's stock valuations are stretched after the recent rally, considering economic conditions have hardly improved from what they were earlier this year.
The government's renewed focus on reforms supports a broader view that emerging markets tend to get serious about reform once growth begins to wane. This has much to do with the importance of growth and stability to emerging market voters, in our view. We believe the worst of India's economic slowdown and corporate earnings downgrade cycle are now behind us. This makes India a very attractive market on a valuation basis, given that we are seeing positive momentum in earnings growth and very attractive price levels. Currently, we see opportunities in financials and industrials. We maintain overweight positions in consumer discretionary and information technology, as these areas should continue to expand on the domestic consumer growth story within India, as well as an increasing share of the supply side to the global growth story (technology).
Is the rally in emerging markets overdone?
Emerging market stocks remain some 15 per cent below their 2011 peaks, while US stocks, such as the S&P500, are more than four per cent higher than in 2011. The recent rally in emerging market stocks has therefore, been relatively modest so far and the outlook remains very strong. Emerging market stocks have lagged due to lingering uncertainty about growth because of the slowdown in Europe, tail risk fears also in Europe, and fiscal and election-related risks in the US. But the underlying business cycle in emerging markets shows signs of picking up and we expect further gains, once the uncertainty surrounding the fiscal cliff fades in early 2013.
Are concerns over the US fiscal cliff real or exaggerated?
A failure of the US Congress and the Obama administration to resolve the fiscal cliff issue would likely plunge the US into a sharp recession in 2013. So, the concerns are entirely justified and constitute a genuine risk to the US. The issue is also likely to impact global market sentiment, including markets well beyond the narrow confines of the US. However, any collateral damage imparted on emerging market asset prices should, however, prove a good buying opportunity. Previous panics emanating from the US and other HIDCs (heavily indebted developed countries) have similarly been excellent buying opportunities for emerging market assets. After all, this is a very US-specific problem.
RBI has resisted pressure from the government and industry bodies against cutting rates. Do you think the central bank has adopted the right step?
RBI has been pursuing the right strategy in resisting rate cuts. The combination of policy paralysis and heavy government spending had pushed inflation higher and eroded domestic business confidence. Rate cuts would only have contributed to further inflation without dealing with the fiscal or confidence issues. By resisting pressure to cut rates, RBI was sending a signal that the government, not the central bank, would have to act. This has now happened, vindicating RBI's position.
Turning to Europe, is the worst over? Is there scope for shocks?
Having neglected reforms for many years, Europe has now been forced to undertake tough austerity in the middle of a downturn. This will ensure growth remains very weak in 2013.
This means we are likely to continue to see frequent market panics arising from the resulting economic and political vulnerabilities, both in so-called core and periphery European economies. Having said that, Europe is a great deal more committed to defending the euro than what markets believe. A break-up of the Euro zone is not likely to happen, in our view. Austerity and reform will slowly achieve their objectives but the key reform in the Euro zone is going to be recapitalisation of banks.
What is your outlook for China? Some analysts forecast a hard landing for China. Is 7.4 per cent real GDP growth a hard landing?
The Chinese hard landing thesis is one of the poorest predictions on record. China's economy is now picking up, supported not only by a pick-up in global manufacturing, but also by a renewed sense of direction following the recent transition of power in China. Having said that, we do not expect a return to double digit growth in the near future albeit for very good reasons. China has embarked on a major structural transformation of its economy from export to consumption-led growth. This is visionary. China is adjusting in anticipation of the coming unwinding of global imbalances, which will almost certainly involve a major appreciation of emerging market currencies versus the US dollar.