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Indian equity return correlations at multi-year lows: Ridham Desai, Morgan Stanley

While Indian markets have seen an unprecedented fall, market experts offer cogent reasons to stress on the relative soundness of India's fundamentals in the emerging markets' universe.
While Indian markets have seen an unprecedented fall, market experts offer cogent reasons to stress on the relative soundness of India's fundamentals in the emerging markets' universe.
While Indian markets have seen an unprecedented fall, market experts offer cogent reasons to stress on the relative soundness of India's fundamentals in the emerging markets' universe. On a relative basis, they point out that Indian equities are doing pretty well.

One is reminded of the fact that India has never achieved the present financial stability even when FIIs had an hawkish stance for EMs. In an extensive conversation with ET's Ashutosh R Shyam, Ridham Desai, head of India Equity Research & India Equity Strategist, Morgan Stanley, shares his optimistic view of Indian markets. Edited excerpts:

How is Yuan devaluation likely to change global investors’ perception towards EMs?

How does one interpret India’s recent outperformance over emerging markets? Keeping aside the long-term story, we think the recent outperformance has been a consequence of fundamental change in Indian equities For the first time in history, Indian equity return correlations are negative or at multi-year lows with falling commodity and bullion prices.

Hitherto, when commodity prices have fallen, correlations have risen, underpinning the historical importance of global risk appetite to India’s macro and stock markets. Even the correlation with global equities has fallen to decade lows. This decoupling or collapse in correlations is a manifestation of India’s improved macro stability, which in turn reflects a hawkish fiscal and monetary policy that is increasing domestic savings, and India’s growth optionality relative to a growthstarved world.

The fact that oil is also facing a supply shock helps India’s weak correlations. As a corollary, for India to retain these low correlations, it becomes imperative that its policy-makers smoothly transition from caring for macro stability to pursuing growth. If it does so, the equity market will likely retain this newly-acquired low beta characteristic but if it doesn’t, the correlations will mean revert.

FII flows have been listless over the last 3 months. Are FIIs relooking at allocation to the Indian equities?

When you see foreign flows into India you should always see in the relativeterm context. Never see it in the absolute context. So, the fact of India’s flat FII flows is that it saw a massive outperformance as compared with other emerging markets.

The fact that EMs have seen such big outflows but India has not. This itself is remarkable. It's not true that the FIIs have turned bearish on India, but instead they have turned bullish, which is why you can see them pulling money out from rest of the EMs, but not India. If we combine frontier as well as emerging markets, which is a total of 40, out of these 22 markets are in the bear markets phase. India is an exception, it is in a bull market phase.

Do you think outperformance of Indian equities will sustain as compared with other EMs?

India needs to come out of transition. It has focused on stability that was well-timed and it also happened when several economies were suffering from lack of stability. So, India has to benefit from that. Now the time has come for India to transition to the path of growth.

Street is expecting substantial earnings growth. What kind of margin improvement are you expecting in the long-term?

If you strike out global commodities and Tata Motors from the universe of company, overall earnings growth for the June quarter has been 17% YoY, which is one of the best quarters we have seen in five years. So the growth is back and it is coming largely from the margin improvement which is our thesis actually. We believe share of corporate profit in the GDP will rise, along with investment rate will rise. At the same time current account deficit is falling faster than the fiscal deficit, which are great tailwinds for the earnings. The margins are starting from near all-time low level. The corporate profit margins at the peak of 2012, were at 12%, currently we are at 7%, this offers enough room for improvement.

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