Morgan Stanley has downgraded India to equal weight in its Asia Pacific ex-Japan/EM market allocation framework due to worsening scores on earnings revisions, net margins and asset turnover.

“…with current earnings revisions trends looking worse than peers’, while weak net margins and asset turnover trends are partly compensated for by cheap relative valuations,” said Morgan Stanley analysts in a report led by the Chief Asia and Emerging Market Strategist Jonathan Garner in a note dated July 12.

This downgrade comes even as Indian equities have rallied more than 40% from their March lows.

“…it currently stands as more of a stock-picking opportunity rather than providing material upside beta versus the overall Asia/EM universe,” said Morgan Stanley.

The brokerage has also increased its overweight on China as a number of factors suggest the potential for China to enter a meaningful bull market phase led by A-shares on market reforms and rising investor inflows. Morgan Stanley has upgraded South Korea to overweight.

Morgan Stanley also believes that MSCI Emerging Markets in aggregate will lag behind developed market equities due to weak return on equities trajectory which it says is not compensated for on a relative price-to-book valuation basis, greater policy stimulus in developed markets and relatively adverse COVID dynamics in emerging markets excluding North Asia.

As per Morgan Stanley’s list of market recommendations of Asia Pacific ex-Japan/EM allocation framework, it is overweight on Singapore, Greece, China, Russia, Brazil, South Korea, and Indonesia. Morgan Stanley has an underweight stance on Argentina, Saudi Arabia, Thailand, UAE, and Mexico.

On Indian market, Morgan Stanley has a neutral view.

In a note dated July 9, Morgan Stanley noted that Indian equities are struggling to beat emerging market equities. They have seen a significant de-rating and are trading close to all-time low relative valuations, said Morgan Stanley.

“India has suffered a 27% fall in relative P/B (price-to-book) to EM over five years and 14% underperformance…We believe this fall in growth has been caused policy choices – both good and bad – and poor private sector investment decisions at the turn of the last decade,” the brokerage said.

Structural reform would be the antidote to this de-rating, it said.

Morgan Stanley said growth prints before COVID-19 were looking promising but the pandemic is presenting a new set of risks to growth and the financial sector.

The government’s response to COVID-19 has been to conserve macro stability, which the market may not appreciate in the near term,as India’s tepid relative performance would seem to signal, said Morgan Stanley.