Election result comes at a time when global money can reallocate towards India: Jonathan Garner, Morgan Stanley

In the last two weeks, we have been aggressively suggesting switching out of China into India and also Brazil, Australia and Japan, said Jonathan Garner, MD, Morgan Stanley, in an interview with ETNOW.

Edited excerpts: .

The exit polls are indicating that NDA-2 is coming back to power. From an investor stand point, is the NDA-2 victory already in the price because markets have already seen a run up of 5% plus in last one week?
We obviously wait for the result of votes to be counted but the exit polls certainly made the market move higher as you mentioned. I think, we step back a bit as we are overweight India. We were overweight before this week. In terms of our recommendations, we are recommending that clients rotate out of China where we have a negative catalyst in trade tensions between US and China and we think that the Indian economy is primed for a cyclical upturn in the post election environment.

We think that interest rates can remain on a downward trajectory, particularly as the US Federal Reserve has changed its view. We think that the valuations on a relative basis to other emerging markets are quite attractive. We are overweight India and we would continue overweight India here.

In terms of economic reforms, what would you expect from NDA if it were to come back to power? What more from the finance ministry and government in terms of reforms?
Re-energised emphasis on infrastructure investment, land acquisition reforms, more on the ease of doing business and speeding up the regulatory functions of the state. These four elements of the government’s agenda were very vigorously persued in the first phase of the government but perhaps demonetisation and the shadow banking issues that India has experienced have sort of taken away from the initial reform agenda. We would like to see the energisation of reforms.

One would argue that NDA-1 has enjoyed majority in both the houses of parliament. They had the political freedom and the number advantage. What do you think NDA-2 will be able to achieve in one or two years which NDA-1 was not able to achieve?
The achievements in relation to bringing fiscal deficit down and working with the RBI to bring inflation down were very important achievements and if you look at the inflows to domestic mutual funds, the financialisation of the economy is hopefully the beginning of an upward trend. That is another important development from stock market perspective for India to become less reliant on foreign investor flows than it was in the past.

One consequence is also that the current account deficit has come down with the fiscal deficit and so the overall macro balance is a very important part of the improvement that we have seen in India.

Which are the key reforms do you think NDA-1 has implemented that will be able to kickstart a new cycle per se?
We have already seen the insolvency reform. That is very important for recycling capital in the economy. A lot of the groundwork has been done. I do not think we need any dramatic measure, The environment now, particularly with this structural reduction in real interest rates, should allow private sector capex to come forward. That has been very weak up to now. Also, the consumer should come forward.

Again, the trade faceoff between US and China may be to India’s advantage. We can already see some large contract manufacturers in Taiwan and elsewhere are starting to relocate plants into India. India is geopolitically very well positioned to benefit at this particular juncture. It is not the only country which is benefitting. Brazil stands to benefit from increased agricultural trade with China.

US agriculture is really going to be compromised by what is going on, but India has quite an optionality in relation to the trade and tariff dispute between US and China.

Where do you find valuation comfort within the Indian markets because while we hit an all-time high on the indices yesterday, the whole move is very restricted, very isolated. Only 8-10 stocks are holding the indices up.
Yes. If you look at trailing PE basis, the market is not at quite a high valuation in the mid to high 20s. But that is because we are cyclically depressed. We would prefer to look at a price book relative to other emerging markets which is much more towards the low end of the range round, where we were in 2013. Remember, for someone like me always looking at the relative opportunity set, it is not just the absolute. That is quite an interesting feature for us.
Broadly, in terms of what my colleague Ridham Desai is overweight on, it is private sector financials, consumer discretionary and part of the industrials. We continue to be quite cautious on telecom and some of the exporting sectors.

Do remember that the outlook for the rupee is quite bullish on our side. We are already seeing the rupee strengthen somewhat this week but we think the rupee can strengthen down to the mid 60s to the US dollar going forward. That is obviously quite a bullish outlook for domestic stocks rather than export stocks.

Do you get a sense that there is a wall of money which was waiting for the election outcome and once clarity emerges tomorrow and if it is a clear mandate flows could automatically come back to India?
We certainly have been recommending very aggressively in the last two weeks to switch out of China into India but also into Brazil, Australia and Japan. We did see very large inflows going to the China market in the first part of this year but now with the trade tensions between the US and China, this election result has come at a very interesting time when global money can reallocate towards India.

There is a sudden slowdown which the Indian consumer space. It started with autos two quarters ago and now it is getting pronounced even in consumer staples and durables?
Yes, that is right. The economy has really been quite weak. I must do a diagnosis of that. I think it had sequential shocks from demonetisation to the teething issues around GST reform to shadow banking and obviously with the Fed hiking rates last year, the Indian economy on the consumer side has been quite weak for some time. Also on the private capex side, following that turnaround that we are hoping for after the election, we would expect foreign direct investment to start to move higher as well.

Do you buy this decline in consumers or not just yet?
Yes, we do. Yes. Yes.

If a client walks up to you and says look I want absolute return ideas, I can digest a 10% downside, maybe a 15% volatility but I am looking for compounders where my money can grow at 15-18% for the next three to five years. What I should be buying then?
Well, I am afraid, for this interview we do not have permission to talk single name stocks. So, I gave you the sector recommendations. I do think the financial sector broadly can do very well as we get lower real interest rates. Typically what you see is financialization of the economy, people taking on more mortgage credit and we start to get a more developed real estate sector which people collateral in terms of their personal borrowing. That also offers opportunities for financials. We are overweight financials and that is the key part of our thinking.