DESPITE a bullish view on global emerging market equities in 2006, Merrill Lynch is underweight on India.

The Chief Equity Strategist-Asia Pacific at Merrill Lynch, Mr Spencer White, feels that the retail Japanese fund flows to India may not remain strong in 2006 and dollar weakness in 2006 could see Japanese retail investors book profits.

Excerpts from CNBC-TV18's exclusive interview with Mr Spencer White:

Merrill Lynch thinks that Indian markets are overvalued. Is this going to affect flows into the country this year? We had $10 billion last year, including primary issues. What kind of money are you looking at in 2006?

This year has been very interesting. You really need to look at where the flows come from, a lot of global funds buying the Indian growth story as well as fund flows from Japan, from Japanese retail side, which has been particularly strong in the second half of this year.

Going into 2006, I have a concern, that these retail funds from Japan will remain strong because the Japanese economy is actually picking up strength. You had a decade where Japanese retail investors were net selling in their own market and that will actually reverse, that is buying in 2006, which may make less capital available for markets such as India.

On the plus side, one of the most positive trends, which has been emerging and will continue into 2006, will be the recycling of Gulf capital because, obviously, the Gulf markets have seen an enormous rise in the past three years. They have increased appetite now to actually diversify. The other thing you need to look at is the amount of new equity issuance, which India will be attempting to raise. I think the pipeline, probably for the next 3-4 months; is somewhere between $3-4 billion, which is still pretty sizeable.

Japanese investors committed about a billion dollars at least in the last 2-3 weeks, after Nikkei went up almost 50 per cent from the lows it touched in April. So they did send some money into countries like India even after this huge rally there. So why should that change in 2006?

Nikkei has actually been rallying for two years and still there has been this process of net selling of their domestic market and there has been appetite obviously for external equities at the time when the yen was weakening.

Now in the last two weeks, that has obviously began to reverse. If the process of dollar weakness extends, which I think it will into 2006, the yen, which is one of the weakest currency in Asia, fell by 15 per cent over course of 2005.

If we break the fund inflow into two - the old money and the new money - the new money constituting the point you made about Japanese inflows, petro dollars, would you be able to weigh both that money for the Indian story and tell us which one comes out stronger because the risk reward outlook for both those sets are quite different?

I wish I could. It is difficult because going forward the anecdotal evidence that I see and hear as I travel around the world and speak to various global investors is that there is sharp increase in appetite for diversification of the Gulf investors and so, Asia is undoubtedly going to be the beneficiary.

What we have seen is predominantly appetite for corporate assets like buying stakes in companies, like places in Pakistan. Over the course of last 12-18 months, now what I see is an appetite to simply get involved in the secondary equity markets, which I think is recycling the bubbles you have had in many of the equity markets in West Asia since last 2001.

What is the biggest concern about India - is it that valuations are stretched, forex fluctuations or the fact that corporate earnings may not deliver what they have in the past?

I think all these three are concerns, which many investors have, but ultimately it comes down to the fact that India is now much more expensive than it has been relative to its history but also relative to the region.

But it is not in itself enough to undermine the performance. Just to clarify - it is my emerging markets team who are underweight on India; the reason being looking at 2006, it is going to be an environment of slowing global growth.

The US is very much in focus with the movements in the bond-yield as there are global growth concerns, there will be a natural tendency for investors to go where they see more stable growth, both at the economical and GDP level.

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