Markus Mueller, managing director, global head of chief investment office at Deutsche Bank Wealth Management, says he is concerned the recent pro-growth reform measures announced by the government could raise India’s fiscal deficit by 0.7% of GDP over the next year. Mueller, however, expects interest rate cuts by the Reserve Bank of India to support economic recovery in the coming quarters.
“We have a tactical overweight on India within emerging market equities and could see further gains,” Mueller said in an interview with Fortune India, adding the valuation of Indian equities are not cheap, but they offer interesting opportunities. Edited excerpts:
Moody’s recently cut India’s credit rating outlook to negative from stable due to weak economic growth and fiscal risks. Do you concur with the concerns raised, and will it affect foreign investments?
The change of India’s sovereign rating outlook from stable to negative by Moody’s can be seen as a warning flag for the Indian government, now they are starting with pro-growth stimulus measures. We share this concern as the latest tax reductions and reforms could raise India’s fiscal deficit by nearly 0.7% of GDP over the next year. But we are expecting a recovery in India’s economic growth in coming quarters, which should soften revenue pressures on the government. The Moody’s rerating will have repercussions as many institutional investors can only invest in certain rating categories.
Investment and consumption engines are on low gear, and the NBFC, auto, and real estate sectors remain vulnerable due to credit crunch challenges. Do you expect the situation to improve soon?
The government has shown a strong willingness to tackle these problems and support growth using a range of instruments like tax cuts and depreciation allowances. It will take some time to implement these measures and for their full impact to feed through, but their effects should become noticeable in the coming quarters.
The Reserve Bank of India has cut interest rates five times this year, but banks are yet to pass on the benefits to customers. So, to what extent can the rate cuts help to revive the economy, could it instead potentially heighten the risk of financial instability?
We think these interest rate cuts will have a meaningful impact in supporting both corporate and household sectors. The rate cuts will lower the financing cost for corporates. Together with the recent tax cuts, these measures should support corporates’ willingness to invest. The rate cuts should also benefit household consumption, in our view. Our forecast of an economic recovery in India’s growth is based on these supportive economic policies.
Above normal rainfall and floods in some major agrarian states could adversely affect crops and put pressure on farm income. Could this further hurt and delay consumption recovery?
Extreme weather effects are negative for crops, farm income, and food supply. Usually, such effects are short term and the government helps in the affected regions via measures like subsidies and/or credits to overcome such emergencies and reduce possible dampening effects for the economic recovery. So we think that the consumption recovery will still continue.
The government has rolled out a slew of policies to boost growth, but there will be a lag effect. Do you think the fiscal stimulus addresses the core issues to accelerate growth?
Yes, we think so. India needs more fixed investment. The recent tax changes to support corporate investment are in the right direction and risks around them may be reduced by lower inflationary pressures in the economy. However, the government needs to carefully monitor the fiscal deficit situation as a result of the stimulus.
Many economists have cut India's growth forecast to 5% from 6.1% for FY20. Why do you stick to the 6% forecast given the prevailing growth and fiscal risks?
Given our expectations of a bottoming-out in global growth and given increasing support from recent and planned fiscal and monetary policy measures, economic growth in India should be able to improve in the course of next year.
Oil prices are showing signs of decline, does this mitigate one of the key growth and fiscal challenges for the domestic economy?
India was globally the third largest oil importer in 2018. Oil price changes therefore can have a substantial impact on the Indian economy. However, we do not expect a sustained fall in oil prices over the next 12 months; our end-2020 oil forecasts are only slightly down on current levels, so they are unlikely to play much of a role in mitigating growth and fiscal risks.
How do you expect the rupee to play out over the next six to eight months in the current macroeconomic environment?
Our 12-month target for USD/INR is 75, implying a slight depreciation. EM Asia currencies in general may continue to be weakened by trade war fears and India-specific factors (e.g. RBI rate cuts) will also have an impact on the rupee.
While the economy is grappling with slowdown challenges, India’s stock market has scaled new highs. What’s feeding the bull run and where do you see the S&P BSE Sensex in the next few months?
We are constructive on Indian equities for the following reasons: 1) the positive impact of the corporate tax cuts; 2) the RBI rate cuts; 3) government privatisation plans; and 4) the likely improvement in economic growth in coming quarters as fiscal and monetary policy easing measures provide support. We have a tactical overweight on India within emerging market equities and could see further gains.
Do you think Indian equities are cheap at current valuations? Which sectors look attractive in terms of growth potential and what's the ideal asset allocation mix for investors looking to invest in India?
Indian equities, as usual, don’t look cheap on standard international valuation comparisons, but they do offer interesting opportunities. Sector-wise, we are most constructive on the domestic-driven sectors, as they could be the main beneficiaries of the large-scale tax cuts and the monetary easing. We like industrials as their profitability could be supported by the tax cuts and they are likely to expand their capacity. We also like consumer sectors as consumption recovery is possible given the rate cuts. On the other hand, in the near term, Indian financials could be affected by the slower macro environment and weak credit flows. With the funding challenges for many wholesale banks, credit flows could slow further as they tighten their lending criteria.
On the global stage, how do investors see India as a business and investment destination in the medium to long term?
India is likely to become an ever-more important business and investment destination for global investors in the medium to long term. In particular, the recent U.S.-China trade tensions and higher tariffs could make many manufacturing companies rethink their global supply chains. India has the important advantage of being a large consumer market with a large, young and educated population. India’s industrialisation is still at a relatively early stage, but it could pick up pace with the government’s support measures for this sector.
Have you changed your views on cryptocurrency investments?
We haven’t changed our views. We think that governments will go down the route of trying to regulate the on and off-ramp of so-called cryptocurrencies rather than banning them entirely—first steps have been done, e.g. incorporation of “virtual currencies” into the AML5 regulation in Europe (5th Anti-Money Laundering Directive, effective Jan 2020). In fact, what we are seeing is the emergence of even more digital currencies—or at least ideas for them—with China recently introducing laws to (in theory) support this development rather than hinder it. From our point of view, this is a strategic move from some countries to get a handle on this particular development. This isn’t going to go away. This development in general is an important part of the digital world and technology is very much the zeitgeist. Obviously, we are still in the early days of this process which needs further time before taking off completely.
There is still the need of a further maturing of the market plus providing and showcasing its trustworthiness and efficiency. We should also remember what the catalyst was for the original boost of development of bitcoin and blockchain. The underlying narrative was a criticism of the traditional monetary system, which evolved hand in hand with the technological developments.