Markets could Decline by Another 10-12%

And that will be the perfect entry time for investors, says Morgan Stanley MD Ridham Desai

The ongoing Eurozone crisis is a bigger threat for Indian equities than its own economic woes, said Ridham Desai, managing 

director, Morgan Stanley India. In an interview with Nishanth Vasudevan, Desai said there is a possibility of a 10-12% fall in the market which will be a good time to buy stocks. Excerpts: 

What is the worst that can happen to markets and the economy? 

In the case of markets, our models show that there is a possibility of a 10-12% downside in the event of a tailrisk which, I suspect, will be very swift. This will be a perfect entry point for investors. I am already bullish on stocks because the market is already pricing in a lot of bad news. In the case of the economy, it's a far more complex situation. By running a higher fiscal deficit and the consequent widening of the current account deficit, there is a bit of a macro stability issue. In itself, the situation is not disastrous. But the world is not inclined to provide funding to India because of its own problems, which is resulting in our growth getting depressed. So, the tail-risk is that there is a funding crisis in Europe and that leads to a withdrawal of risk capital. And, as we saw in 2008, India's current account deficit will have to shrink, which will come with its concurrent reduction in growth and a fall in the inflation rate. Growth could end up averaging 5%. We are already there, but we could face a slightly prolonged growth slowdown because the difference between now and 2008 is that we do not have the fiscal tool to respond. All the response will be from the monetary side which may not be as potent as in 2008-09. 

What is a bigger risk for India now — eurozone or the domestic economic slowdown? 

Europe is a greater threat than domestic matters because a further crisis in the eurozone can create a tight BoP situation, which can impact sentiment like we saw during the Lehman crisis. So, Europe is more crucial than the domestic problems. We can moderate the impact of Europe by taking domestic actions. If things worsen in Europe, we will feel the pain, but the extent of this will depend on how we react domestically. 

At this juncture, will an increase in diesel and LPG prices do more good or bad for the economy? 

From a macro stability perspective, it will do more good. It will reduce the fiscal deficit and also the current account deficit. The government's fuel subsidies have allowed households to keep consumption high which, in a way, is the current account deficit. If the government increases the prices of fuel, then households will either reduce their savings to accommodate that or will shift consumption to other things. The latter is more likely because household savings tend to be relatively stable. But, it will have a concurrent damaging impact on growth because consumption will be down. So, there is a balance that needs to be maintained while running the economy. But, given where the twin deficit is now, the balance is tilted towards macro stability over growth because if that does not happen, it will start reflecting on things like a weaker rupee and stock markets. 

Despite all the gloom surrounding India, why is that foreign portfolio investment data is not showing any major outflow? 

Global institutional investors can be broken into two buckets. The first are those who invest in India as part of their mandate such as global emerging market investors and India-dedicated funds. It's safe to say these investors have been taking money off the table. But they have been matched by long-term pension fund money, primarily from North America, that is taking this opportunity to build a long-term portfolio. 

There is a worry that the RBI is left with very little ammunition to arrest the rupee's fall. 

The rupee is reflecting what the US dollar is doing. The dollar is rising against every currency in the world. So if you place the rupee across a bunch of 25-30 currencies, it's actually in the middle of the pack. It's not the worst-performing currency. The Latin American and eastern European currencies have fallen a lot more than the rupee. I am not denying that we do not have our own fundamental problems, but the rupee's absolute fall has to do with the way the dollar has appreciated against most of the currencies. What is happening in the currency market is that investors are expressing their opinion about a country's funding requirement. The good news for India is that we don't have a large global balance sheet requirement, which means our government does not fund its deficit with dollar money. The bad news is we have a lot of current account requirements. So, we are somewhere in the middle of the pack. I don't think the current situation requires any panic reaction from the RBI. 

So, what would be a good time to buy stocks? 

It feels like 2002 right now. If you bought stocks in 2002, you did not make money for a whole year. But, it was difficult to pick the bottom of April 2003. And, it was difficult to buy stocks from 2004 because most stocks had doubled. So, 2002 was the right time to buy stocks though macro and earnings situation just did not feel right. Like in 2002, India may see a few more months of sluggish returns, but that is the time to build a portfolio and wait for things to happen. We may be dealing with one big downside relating to a global event, but from these levels equities will make upward progress marked by volatility.