No recession threat in India, but global downturn a worry: Bharat Iyer, JP Morgan

The Indian economy is unlikely to slip into a recession, but the probability of a global recession is about 40% over the next 24 months, said Bharat Iyer, head of India equity research at JP Morgan. In an interview ahead of JPMorgan’s India Investor Summit 2019, he told Rajesh Mascarenhas that large banks with a strong liability franchise, sectors that benefit from government spending and some state-owned companies with dominant franchises should deliver healthy returns in the current environment. Edited excerpts:

Many analysts believe a recession is coming globally and the fall could be bigger than what we have seen in 2008. How is India positioned to face such an event?
Our global macro team estimates the probability of a recession at about 40% over the next 24 months. Policymakers are easing monetary and fiscal policies in response to the slowdown and the impact of these measures remains to be seen. Developments on the USChina trade dispute will also have a meaningful bearing on the global economy and trade. India is a relatively small part of the global supply chain. Our economy is driven more by internal factors — consumption, supported by demographics and investments, supported by the need for infrastructure — rather than trade. So, we do not see the Indian economy slipping into a recession. But a global recession will have an adverse impact on growth due to slowing international demand and increased competition from imports. Also, our equity markets are relatively open and will be impacted by the volatility in global financial markets that a recession would suggest.

What do India’s macros suggest? Are we on the right track or heading towards a major slowdown?
India’s economic indicators are a mixed bag at this stage. On the positive side, there is macro stability. Inflation is well-behaved, giving policymakers substantial leeway in terms of easing monetary policy. The central government’s focus on fiscal discipline needs to be lauded. That said, growth has slowed down meaningfully over the last few quarters due to a bunching up of supply-side issues. We see a gradual revival as we go into the second half of the fiscal year, driven by increased government spending post the elections and improved transmission of easier monetary policy. A more robust revival should come through over the medium term, as capacity utilisation levels in the economy improve, triggering a meaningful pick up in the private sector investment cycle. Attracting FDI at a faster rate and aggressive divestments by the government to boost finances could fast-track the investment cycle. The surge in crude oil prices over the weekend needs to be watched. If sustained, it could be a source of pressure for the economy and markets.

What impression are you getting on foreign investors’ outlook for India?
Currently, foreign portfolio investors are on aggregate running a neutral position on Indian equities vis-à-vis the benchmark. Most of them appreciate the structural appeal that India has and its defensive nature in the context of emerging markets and that explains why they did not turn underweight even during the slowdown in the recent past. That said, the earnings trend has underwhelmed for a few years now. We believe signs of a meaningful pickup herein will be the catalyst for FPIs (foreign portfolio investors) to turn overweight on Indian equities.

How long do you see the dollar rally last and what is your outlook for the rupee?

As far as the US dollar-Indian rupee is concerned, it would be futile to look at absolute levels in such an environment. Policymakers would be well served to maintain a competitive currency. We are not an export-led economy and do not need an undervalued currency to boost exports. But an overvalued currency will expose our economy, particularly the manufacturing sector to dumping from trade partners looking to diversify their exports and boost growth, even as their traditional markets are slowing down or turning more protectionist.

Don’t you think midcaps have been oversold? What is your outlook for the mid- and small-cap stocks?
The midcap space in India is very vast in terms of numbers and varied in terms of composition. So, there will always be unique bottom-up opportunities. That said, for the entire complex to perform, we need a booming economy which is still some time away. Not to mention that valuations for well-managed midcap companies are still not cheap.

How do you see earnings going ahead and what is your view on India equities from here on?
Given the growth slowdown and gradual recovery expected, we estimate earnings growth in low double digits for the current fiscal year, driven mainly by lower credit costs for the large financials. Earnings growth should recover to the mid-teens by next year if our thesis on the economy plays out. Valuations for the broad market at about 20 times FY20 estimated earnings are at the higher end of the trading range. On balance, we believe we are in a modest return, high-volatility environment for equities over the next 9-12 months and target returns of about 8-10%.

Where are the opportunities right now?
Large banks with a strong liability franchise should do well in the current environment as monetary policy is supportive, credit costs are peaking and loan growth for the banking system is picking up. Insurance remains a structural theme given low penetration levels. Sectors that benefit from government spending like roads, affordable housing and water should do well. Some state-owned companies with dominant franchises are trading at very attractive valuations and should deliver healthy returns if there is a well-articulated divestment plan.

What is your advice for retail investors in the current situation?
For a 12-month time horizon, we would recommend a portfolio balanced across equity and debt with some exposure to gold as well.