Indian infra cos are ahead of China's in returns race: Nomura MD

Indian infra cos are ahead of China's in returns race: Nomura MD
The Economic Times, January 18, 2010, Page 14

Deeptha Rajkumar, ET Bureau

He feels bank and real estate stocks in India could suffer if inflation continues to rise at the current rate. Meet Paul Schulte, managing director & head of multi-strategy research, Asia (ex-Japan) at Nomura, who believes Indian shares have had a great run, but are expensive at these levels. In an e-mail interview with Deeptha Rajkumar, he talks of his outlook for Asian markets, and how there is a stronger case for emerging market equities than developed market equities.

Going forward, what is your outlook on Asian equities, emerging markets in particular?

The outlook remains very bright. Leverage levels in Asia are among the lowest in the world. Banks are flush with cash. Loan-to-deposit ratios are low. Government budgets are under control. Contrast with the West where we should see significant increases in tax rates over the coming years. The problem in Asia is inflation.

How do you view the liquidity scenario near term? Are people still chasing assets in emerging markets or are valuations likely to temper the mood?

Many western governments will be very busy trying to get out-of-control-budgets back in line. This will involve tax increases and budget cuts. They will do this to avoid being downgraded by ratings agencies, whose credibility is in tatters anyway. But markets must obey the ratings agencies, because the Basel II Accords unfortunately organise themselves around these organisations. So, central banks will be forced to leave ‘policy-loose’ to counter tightening fiscal policy. If central banks raise rates while governments are tightening at the same time, we will have a policy disaster on our hands. But I think, this has a small chance of happening.

Do you see a bubble formation in emerging markets due to access to cheap money and how is this likely to impact other markets?

The liquidity in bubbly markets like China has nothing to do with large increases in lending. It has everything to do with an undervalued currency. China may be doing itself a large disservice in the longer run by leaving the currency undervalued, because this forces central bank intervention and causes a surge in liquidity.

If you were to pick an asset class or market for this calendar?

We are looking at China and India and see a very important development. Indian infrastructure companies (hard infrastructure) are beating Chinese firms in terms of returns on equity. Companies like Reliance and GAIL are interesting. But financials and other services in China are beating Indian players in terms of RoE. This is the soft infrastructure. So, we would prefer stocks in China like CITIC Bank and CITIC Securities.

Will this be another weak year for the dollar? What does it mean in terms of fund flows or fund interest to a market like India?

Japan has done an about face in mid-December and has made a loud and unequivocal commitment to inflation targeting. A strong yen is a classic signal of deflation. The yen should continue on a weaker trajectory for 2010, offering a reprieve to the dollar. But the problems with Greece and Ireland remain an albatross for the euro in the long term.

Do you believe that there is still a leg of momentum left in global markets? And when that occurs, will it drive high beta sectors even higher?

The high beta rally may be waning. As inflation moves up, stocks like property counters and banks may suffer, especially in India. We would switch from Indian banks to Chinese banks now.

What is your outlook for the Indian market? The market had witnessed $17 billion of FII flows in 2009, do you foresee the same amount of appetite this year?

The Indian market is a bit expensive. It has had a great run. Indian banks have outperformed their Chinese counterparts over the past few months by a wide margin. It is the number one “inflation problem” country in the region in 2010. We believe the Reserve Bank of India (RBI) could tighten more aggressively than many think. It is already tightening by letting the currency strengthen.

What are the instruments drawing money this year? Last year, it was all about exchange-traded funds (ETFs).

Investors are focusing on Japanese financials and other Japanese equities, because no one owns them anymore. Investors threw in the towel on Japan. So, Japan is now draining money from Asia for the first time in years. Soft commodities like food are also getting the limelight. Look at India last week. It became the largest importer of palm oil.