The kind of liquidity flows that the Indian markets have seen and as a result of which the rally that we have had, how long do you think both of these phenomenon could continue?
There were two factors here. First factor is obviously the flow of domestic Indian savings into the Indian equity markets and clearly when you have negative real interest rates in India that encourages domestic savers into the equity market because money markets and bond investments in real terms are unattractive.
The second way of looking at it is to look at foreign investors who are first of all looking at the outlook for emerging markets. Generally the consensus is increasingly positive on emerging equity markets. They are looking at India versus other markets, most notably comparing India with China and Brazil as the two other major emerging markets. Obviously this year we have seen a significant out-performance by India and if we look at for example India versus China, India is up 33% versus China. The big difference is partly due to the headwinds that the Chinese market has faced. Possibly in the last three months, investors have been focussing on the slowdown in the Chinese economy. Earlier the investors were concerned about tightening of monetary policy in China. More recently in the last couple of days, investors are concerned about statements coming out from China about capital raising and risks in the banking system. Hence, you have had a lot of negative news flow, which has directed foreign investors into the Indian market and out of the Chinese market.
What about the foreign money flowing into emerging markets and particularly India because over the last fortnight, there has been some amount of flows coming into our markets in particular in excess of $1.5 billion? Do you think this trend is likely to continue or do you think now foreign investors can get a little bit cautious if we run too ahead?
My view is that foreign investors actually will remain positive on India given the strong macroeconomic environment and also given an expectation that come January-February, the monetary tightening cycle could be over by then. Obviously in the next two or three months, interest rates would go up further. Subsequently we will see some easing of monetary policy in the first quarter of next year. Having said that, there is some increasing concern amongst foreign investors, if you look at India on a forward price earnings multiple relative to China and Brazil and particularly compared with Russia, obviously India is now looking as one of the more expensive emerging markets. Hence, on that basis, purely on a valuation basis not on the basis of the very strong macroeconomic fundamentals, we could see some slowdown in the foreign flow. I do not see any major reversal though and a lot of that foreign capital flow is what I called sustainable and durable capital investment as opposed to hot money, which is in one week and then out the next.
What could actually wrinkle the growth in equity markets from here onwards? What could hamper growth from here onwards?
Clearly the risk is that the RBI tightens monetary policy too aggressively. We would all agree that the RBI has been moving very cautiously on tightening monetary policy so far and that's clearly demonstrated by the fact that real interest rates remain negative. Another risk factor, which again is minor, is what would happen if we had a spike in commodity prices. This would be very good for markets like Brazil and Russia as commodity producers and obviously negative for India and China. If I am right and for example oil prices gently move up to $80 a barrel, copper prices by the first quarter of next year move up to between 8000-8500 per tonne, that gentle rise in commodity prices is not going to derail very good numbers that we are seeing out of the Indian economy. Another risk factor obviously, which the RBI is watching carefully is what happens if there is a strengthening of Asian currency and particularly strengthening of Indian rupee. Currency strength has been a factor in the past, which has been negative for the Indian equity market but with negative real interest rates, the RBI will be successful in arresting any upward pressure on the currency. Therefore, there are risk factors out there but I would say at the moment they are all minor risk factors.
What would be an immediate red light for global equities in general and, therefore, Indian equities as well?
I see there are two global risk factors to watch. First is in America where obviously the Democrats are under severe pressure ahead of the midterm elections and clearly we will see some Republican gains. At this stage it is actually unclear as to the extent of those potential gains but if we have political gridlock between the Democrats and the Republicans in the States, then it is potentially a problem because the Bush income tax cuts roll off in November. Now it is very important for the American economy that those tax cuts be extended or rolled over because if they are not, then there is potentially a negative effect on the American economy of between 1.5 and 2% of real GDP. Hence, although I do not think there is going to be a double-dip recession in the US, clearly the risk of economic recession increases if those income tax cuts are not extended, so that's risk factor no. 1 we have to watch.
Risk factor no. 2 is here in Europe and the pressure on the weaker banks in the weaker European economies and in addition potential restructuring of Greek debt remains a major issue.
Let's focus mainly on metals and particularly gold, which is seeing new highs almost on a daily basis and also in terms of the industrial metals, what's the outlook there?
On industrial metals, we will see a modest upside on the basis that there is weakness in the Chinese economy. Chinese demand will be the key driver in industrial metals and most notably in the copper market.
On gold, clearly we have seen a recent upside, that upside has not been driven by a fear of renewed inflation but it has been driven by weakness in the US dollar against really all currencies and I would argue most notably against the Euro and the Swiss Franc. In recent weeks, we have seen quite significant renewed US dollar weakness against the Euro, with Euro now trading close to 130-150. If the dollar weakens it will be reflected in higher gold prices. My forecast for gold at the end of this year was always 1300, frankly I am going to be wrong because this is going to happen over the next few days.
In India, is it still the domestic consumption plays and financials that would look attractive at this point in time?
The answer to that is very much is 'yes' and I would just reemphasize the solid nature of the balance sheets of the Indian banks. It is interesting today when we have official Chinese statements focussing on risks in their financial system, which has worried some investors. In contrast I do not think there are any concerns about the quality of bank assets in India.
Source: Economic Times