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Risks recede, but macro factors point to modest equity returns: Krishna Memani

Krishna Memani-1200
Political risks have receded in India with the re-election of the Narendra Modi government and likelihood of substantive economic reforms has gone up, said Krishna Memani, chief investment officer, OppenheimerFunds Investments at Invesco. However, for the flows and sentiment in the Indian market to sustain, the government needs to deliver on the economic reform agenda, said New York-based Memani in an interview with Sanam Mirchandani.

Edited excerpts:


The Narendra Modi-led BJP has won the national polls with a decisive majority. Does it call for a re-rating of India?
Risks have clearly receded in India and therefore the likelihood of substantive economic reforms has gone up. Despite India being an expensive emerging market, I can see why flows are going to pick up meaningfully and sentiment is going to improve. For that flow and sentiment to sustain itself, Modi actually has to deliver on the economic reform agenda, at least take some concrete policy action, with very good articulation of how he is going to get economic growth out of its 7% kind of trend rate that has been there for a reasonably long period of time and slowing on top of it. Sentiment is good but unless those policies are forthcoming by the middle of the year, that sentiment can go away pretty quickly.

What's your returns expectation from the Indian equity market?
Because of the global slowdown and continued slowdown in India, the returns are not going to come from higher economic activity in the nearto- medium term. The best we can hope for is stabilisation rather than a turbo-charged recovery in growth. Therefore, earnings are not going to grow. The returns are going to be proportional to how much rates can come down and how much the economy can stabilise. At best, we ought to expect modest returns rather than turbo-charged returns.

What would be the top expectations from the government?
From a long-term perspective, it is about labour reform, land reform and improving the governance of the country in a meaningful way. In the short term what he needs to do is address issues with respect to the banking sector, use his political muscle to get the RBI to cut rates because RBI on a global basis, as inflation goes down, actually is getting the headroom it needs to cut rates. The government should deal with the NBFC issue, making sure that it does not end up being a drag on consumption and investments, and come up with some turbo charged ideas to restart the investment boom. Consumption has slowed down but investment has slowed down even more so. From a long-term perspective, that is a far bigger challenge. In India, incomes are growing reasonably ok and as a result, consumption will eventually pick up on its own if they see stability, for investments you need good policy.

Do you think it will be a good idea for a country like India to stimulate the economy fiscally?
The challenge with the Modi government on that front is they don't really have the fiscal room to stimulate the economy using fiscal tools. Fiscal deficit is too high to begin with. The stimulus if anything is going to be coming from good policy and maybe rates going down somewhat because the rates now have the room to go down because of what's happening on a global basis.

What is your view on the consumption space as an investment bet?
The large cap consumption stocks are not cheap by any measure. They are probably the most expensive part of the Indian stock market. Large-cap consumption stocks are an oversold story. I would rather focus on mid and small cap companies that can benefit from that or other corollary sectors like bank and finance to take advantage of the consumption revolution. For consumption to come back up the NBFC issue has to be dealt with and if that is dealt with, there are lots of really cheap assets, not in the large cap sector but in the other sectors like the bank and finance market.

What is your reading of the US-China trade tension situation?
This wasn't what anyone of us had expected and this outcome wasn't what Trump himself had expected. The trade issue is probably going to be with us for a lot longer than what we had imagined. As long as the trade issue, the conflict manifests itself only in tariffs as opposed to import ban or things like that, then it is a quantifiable downside, and in that regard, for the US economy it is 100 billion dollars in new taxes effectively. The impact of that is maybe three-tenths to five-tenths of a percent in GDP terms. If you look at the same thing for China, it is probably anywhere from 50 to 80 basis points in GDP terms. It is a significant number but it is not the end of the world.

The markets are already starting to discount the likelihood of a Fed cut to support the economy. The likelihood of a fiscal stimulus package in China has gone up as well. All of those numbers are going to be probably on the higher side of what the downside is. From a sentiment standpoint this is far more negative than the actual impact on the real economy. The sentiment as a result is probably going to be down for quite some time. The markets are de-rating prices. Our outlook is after that de-rating is done, then from thereon we still expect growth to improve in the second half and markets to go higher as a result.

How do you see emerging market equities performing going forward?
If there has been a meaningful impact on anything from trade, it really has been taking the wind out of the sails of the emerging market equity environment and that is to some extent expected. When US policy easing and Chinese stimulus manifests itself, those concerns will actually fade if yuan remains relatively stable and the Chinese pump in a lot of fiscal stimulus. Actually, emerging market growth may pick up and the equalisation of growth on both sides with the US slowing down and emerging markets kind of stabilising, the dollar will probably remain in a stable to a downtrend. That will bring back emerging markets but for that to happen we have to see the revival in growth and actual stimulus being pumped into China. That's probably more now a second half story rather than a second quarter story.

On the manufacturing front, lot of countries have seen slowdown in activity. What is this data suggesting? Is this a blip or a start of global economic slowdown?
Our expectation all along has been that the first half of 2019 is going to be meaningfully weaker than 2018. The back end of 2019 will improve from that base because policy overall would be far more supportive. Fed wouldn't be tightening. ECB would be not contemplating tightening, looking for easing measures and things like that. The trade issue certainly increases the likelihood of a global slowdown or recession but that likelihood in our judgment is still very small. We think 2019 probably ends up being slightly less than 2% for the US and around 6% for China and probably less than 1% for the eurozone. Trade issues have shaved a couple of percentage points off of that but trade issue in itself is not large enough to slow the global economy down to recessionary levels.
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