India is expensive, but attractive

MUMBAI: Despite expensive valuations, India appears more attractive compared with other emerging markets. This is because India is seen as a defensive market amid global growth downturn, says Brad Durham, managing director, Emerging Portfolio Fund Research. In an interview with The Economic Times, Durham said there are potential new sources of flows to India from non-dedicated funds, which had reduced their exposure to the market in recent years. Excerpts from the interview.


Do you expect emerging markets to feel the heat of downturn in the commodities at some stage, especially with many hedge funds having exposure to both commodities and equities?


I think some markets will feel the heat of declining commodity prices, such as those that are major commodity exporters (Russia and Brazil being the most prominent ones). Other markets , like many Asian markets that are net importers of commodities, are helped by lower commodity prices. The oil price drop is good for India since the country imports about 70% of its oil needs and fiscal deficit has forced the central bank to raise rates to stifle inflation. Lower oil prices may take some pressure off inflation.


How do you rate India’s prospects vis-àvis other emerging markets?


I think India rates better now against other emerging markets. That’s because India is seen as a defensive market amid a global growth downturn. Because so much of its growth is internally driven and due to domestic sources of demand, India is less vulnerable to downturn in global growth than other more export-intensive markets like Korea and Taiwan. India has a low correlation with US growth.

On the downside, I am troubled that economic restructuring appears to have lost momentum , unlike in some other emerging markets . Sell off of state-owned companies could bring much-needed revenue into the government , which could step up infrastructure spending and ensure sustained growth and corporate profits over the longer term. These special economic zones seem as they give incentives to investment that may just shift activity into a taxfree environment and may be hurtful to public finances. Investors would prefer to see broadbased restructuring and incentives to invest throughout the economy rather than in small pockets. And labour reform, allowing for more hiring and firing to meet changing market needs will be needed for sustainable corporate earnings over the longer term.

India appears to be expensive compared with other emerging markets, but still foreign investors are ploughing money into Indian equities. How come?

It still is among the most expensive, but is more attractive after the May-June sell off, which has pushed it back in the vicinity of 16.5x forward P/E. And expectations of earnings growth of 20% going forward should provide some scope for further market gains. While India is among the most expensive emerging markets , along with Chile and Czech Republic, but unlike these two markets, India’s EPS in ’06 is among the highest (30%) after Turkey and Taiwan . And the earnings are driven by strong domestic factors — consumption, demographics, infrastructure spending, etc. Hence, the higher valuation is pricing in a secular growth story, with the latest quarterly GDP growth figures confirming the strength.

I also think that there are potential new sources of flows to India from non-dedicated funds. Global Emerging Market funds, for example , have a 4.9% weighting to India, which is well underweight the MSCI EM index weighting of 6.5%. It is the lowest weighting since May ’02. On cap weighted basis, though, lowest weight since 1998. Some fund firms with low India weighting include Templeton, with 1.9%, Schroders 0.8%, and so if these funds start to view India as more attractive then there could be plenty of new flows find their way into the market.

A lot of money has been flowing into the Chinese stock market of late, though most fund managers say that corporate governance has always been a problem area in that market. Your comments.

Investors like China because of the current growth and future growth potential. They have to hold their noses at the poor corporate governance and a potential harder than expected landing after so much poor quality growth and over investment. But like in many EMs, such as Russia, as the capital markets developed and when company management discovered that their interests were aligned with those of shareholders , the quality of corporate governance improved dramatically. I suspect the same will happen with China, but it will take time.

Which are the emerging markets, other than India, you are bullish on?

I like China because of its defensive nature, Thailand because of the new-found political certainty and low valuations, Indonesia because of declining inflationary concerns and monetary easing (rate cuts)and Turkey because of year to date underperformance and strong corporate earnings and growth rates.