India does not now deserve a significant valuation premium: Jonathan Garner
India’s macro mix is not very favourable for corporate profitability and will erode valuations. The country’s relative valuation premium to other emerging markets will have to adjust lower, says Jonathan Garner, chief equity strategist (Asia and emerging market) at Morgan Stanley, in an interview with Samie Modak. Edited excerpts:
Which are the emerging markets you are favouring at this juncture?
We are overweight on five emerging markets (EMs) — China, Russia, Indonesia, Korea and Malaysia. Three of these have very strong balance of payments positions, combinations of strong external positions, reserves and therefore, less currency risks. The other element we look at heavily is valuation. China, Russia and Korea, in particularly, are unusually cheap in comparison to the rest of the EMs right now. Meanwhile, we are underweight on India. We have been underweight on India, compared to other EMs for about 18 months now.
What are the concerns about India?
The main concern about India is the twin deficits and the stickiness of inflation. Even though the growth environment has slowed, inflation is running at rates more than double that of the Chinese inflation. Twin deficits, high inflation and slowing growth tell us this is an economy characterised by a problem of excess demand. The supply side, which should feed this demand, is not strong enough to meet the economy's growth potential. That's a key issue and the government's involvement is needed to reduce the public deficit and improve infrastructure delivery.
How are India's valuations compared to the other EMs?
India is trading at a 30 per cent premium on price-to-earnings multiple basis, which is similar to the average of the past five years. But, if you go back to when India was last challenged in the economic sense in the mid to late-90s, India used to trade at a discount to other EMs. We don't think India deserves a significant valuation premium, such as it enjoyed during 2004-07 period. We are concerned about this relative valuation and it needs to adjust lower.
Do you believe India's valuations should be at a discount to other EMs?
We are probably not that bearish, as India’s return on equity is high compared to the EMs’ average. India’s return on equity is at a 15 per cent premium, while the price-to-book premium is about 50 per cent.
However, the macro mix is not very favourable for corporate profitability, on a relative basis. This has already started to deteriorate and may deteriorate further and erode the valuations.
Do you expect India's valuation premium to narrow?
We do. And, that's a key reason why we are underweight on India. It has already started to diminish but it still has a premium at the moment.
In the past few years, the Indian market has enjoyed more than its fair share of foreign flows. Do you think this is unlikely, going forward?
Yes, we think while most EMs will get positive flows, India’s relative share won’t be as large as it was in the 2009-10 period.
Are you recommending any Indian companies to your clients?
There are a number of Indian companies which have high-quality business models. HDFC Bank, Titan Industries, Sun Pharma and Infosys are the names we are happy to recommend to our clients. However, the overall macroeconomic environment is not very strong.
How has the General Anti-Avoidance Rule episode impacted sentiment of global investors towards India?
The tax issue is not unique in that regard. For example, there is a similar issue unfolding in Taiwan, right now. People understand any country has the legitimate right to impose taxes. But, the key issue is retrospective taxation, which seems to be in a state of flux.