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India's Potential is Huge

Didier Borowski, Head of Strategy and Economic Research at Amundi Asset Management believes India's massive need for infrastructure will be a key engine of growth in the coming 20-30 years

In this interview with Ashutosh Gupta, Didier Borowski says that the next phase of growth will come from emerging markets and India will be an outlier among emerging-market economies.

India's Potential is Huge

What's your view on the state of the global economy?
The global GDP growth is trending lower for structural reasons, both aging population and lower productivity gains. The potential growth is slowing almost everywhere and it has nothing to do with the recent financial turmoil. In the US, we believe that the potential growth is below 2 per cent, and in China it is probably around 4 per cent, so we will never come back to 8 per cent or 9 per cent for sure. The slowdown in China is due to its structural transition towards becoming an economy driven by consumption and services, and it will take time to engineer. As a result of this rapidly slowing global potential growth, the rate of return on capital will also be lower than that in the past. Bond yields have declined substantially over the past 30 years both in nominal and real terms and we believe that the bulk of this decrease is structural. India, however, is very interesting because its potential GDP growth is still very strong. The massive need for infrastructure will be an engine of growth in the coming 20 to 30 years. We have kept our exposure to Indian equities unchanged despite the recent financial meltdown. At global level, the interest rates have diminished substantially. It's important to diversify your assets towards high-yielding currency and clearly the Indian rupee is a high-yielding currency. We do not believe it is overvalued. Investors from Europe and the US will continue to search for yield in the coming years and India will be a key place to invest your money.

For the last 20 years, India is said to have been emerging. But our scale of business, from a global perspective, is very small. Do you think Indian companies have the scale to absorb capital?
We need to be forward looking. People are sceptical mainly because they are backward looking. I think the trade-off is not linear. Sometimes it takes time to start the process but once it has started it gains momentum and can be exponential. It will take time. If you want to be forward looking, you can imagine where India wants to go in the coming two to three decades. But it's much more complicated for Europe, the US and Japan because for them we have to find a new growth engine.

Has the change in government brought about any change?
Clearly, the election of the Modi government was a game-changer for global equity markets, especially for equity fund managers in Europe. A government which is 'for business' is clearly positive. But I think it's important to understand that you cannot reform a country like India very rapidly. And problems such as corruption still concern investors. But we really believe that the direction is correct. There is an ongoing reform agenda that could be accelerated somewhat in the coming years. India's potential is huge on everything - the rising middle-class, more consumption, etc. The coming two to three decades are going to be very complicated at the global level because we have a lot of debt, very slow growth and almost no inflation, so it's going to be very painful to de-leverage the global economy, especially the major advanced economies, while some countries like India have huge potential.

What are the key threats you would watch out for in this India story?
Corporate governance. If you want investors to be increasingly in the market, you need transparency, efficiency, very clear governance and that's the key. I would say one hundred percent of investors are convinced about the potential of India, but some investors are very reluctant because they believe that governance is not that clear. It's not an economic problem; it's an organisational problem I would say. It's a political and social problem. But it's important to understand that things have evolved in the right direction over the past few years. We believe that in the coming five years, things are going to improve much more rapidly than the past five years.

The Indian equity markets are tanking right now. The near term outlook for them seems to be at its most pessimistic point today...
Almost everywhere! It's a global phenomenon. And we believe there is something wrong in the markets. They are behaving as if there were a big macro financial shock like that in 2008. But we see the current situation to be more like the financial crisis of 1998. You will, for sure, see some credit events at the global level because you have too much leverage and many countries and corporates are highly dependent on oil prices. But we do not see these risks as global risks. But the fear has become excessive. I'm not that optimistic about the global growth, but it's not a global recession that we are going to face. When you look at global markets, there is a level of fear which is not consistent with economic fundamentals. If you look at the valuation of the bond market versus that of the equity market, a global recession is already priced in. A recession is priced in the United States. Otherwise, you would not understand the recent bond rally and the equity fall. Simply from an economic standpoint, it does not make sense. Maybe we are wrong, but we simply don't see any extreme event occurring. We don't know exactly when we will see the bottom of this financial meltdown but we believe it will occur in the coming months and at some point it will be highly rational to increase the risks in portfolios very rapidly. You'll have big stock-picking opportunities.

What did you think about India from an economic standpoint ten-15 years ago?
We were much more sceptical ten years ago. But PM Modi was clearly a U-turn for investors worldwide. To give you an example, when an equity fund manager in Europe explains why to buy Indian equities, the first slide is on the new government, the new governance, the fact that things have improved over the past few years. So that is the first game-changer. The second one is the relative attractiveness of India vis-a-vis other economies that I've talked about. We are globally trapped in an environment of slow growth and high debt. In relative terms, India has become much more attractive.

How is the whole European crisis shaping up? Will the Euro zone remain intact?
I think the worst of the financial crisis is behind us. We do believe that the Euro zone will remain intact. The decoupling that you saw in the Euro zone has started to vanish. A cyclical recovery, which started two years ago, is under way. And we should not underestimate what the ECB is doing. We believe it is doing a great job in maintaining very low bond yields and accommodative monetary and financial conditions. We think that the ECB will intervene very rapidly in order to insulate the Euro zone from the global financial meltdown. And it has ample room to manoeuvre. We expect even fiscal policies to turn a bit more expansionist in the coming two years, starting with Germany. I'm not saying we are out of the woods, but we are going in the right direction. Having said that, we have to bear in mind that the potential GDP growth in the Euro zone is around 1 per cent. It's too low. Besides, the government debt has continued to rise over the past few years. So the problem in Europe is that of government debt and low-growth environment. We need to find ways to boost business investment, but we are convinced that the worst of the crisis is over.

What key global factors could impact the Indian economy?
We've seen a decoupling between services and the manufacturing sectors in 2015. The growth in China has fallen while the Indian economy has been resilient because of this decoupling. The continued strength in services can be explained by the strength in consumption, which, in turn, has been benefited from the fall in commodity prices. The fall in commodity prices is not a by-product of the manufacturing recession in China; it is a by-product of excess supply. It's a positive supply shock and a positive supply shock is always positive for consumption. But we will have to closely monitor any signs of re-coupling between the services and the manufacturing sectors. We are close to a global recession in the manufacturing sector and should we see a weakening in services in the major advanced economies, it could impact India to some extent.

India has a very small proportion of the emerging-market allocation of foreign funds. Given its relative attractiveness, will India be looked upon differently with regard to the current allocation?
The problem with these indices is that they are based on the past. We believe that we have entered into a new world and the indices do not represent this new world. We believe that investors will have to change their asset allocation and increase exposure to emerging markets. We will have no choice because looking ahead the rate of return on capital will decline in the major advanced economies and bond yields will stay low for a long period of time. In this environment, the search for yield will be so intense that investors will have to reconsider their asset allocation towards economies that are growing very fast and that are reforming.

Have you seen any other economy which was at a similar point ten-15 years ago as India is currently?
I would say that to some extent India has still to do what China has done. Infrastructure spending was the key engine of growth for China in the past 15 years. It's the best example you could have on how it has worked. On the road to development, you see lower real GDP but higher real GDP per capita. You saw that line of evolution in Korea as well as in Japan. In the case of India, consumption should remain a key engine of growth and the real GDP per capita should continue to increase. If you have that and massive infrastructure spending, I think you would be on the same curve.

This interview appeared in the April 2016 Issue of Mutual Fund Insight.