>INDIA STRATEGY (MORGAN STANLEY)

Bright Green Shoot

• Election results spring a big positive surprise: The Indian electorate delivered its most polarized verdict since 1991 and brought the Congress-led UPA back to power with close to majority seat count. The Congress party has won over 200 seats which was our bull case for the election result. This is the highest seat count for any party since the Congress won 244 seats in 1991.

• Change in market strategy from “sell the rallies” to “buy the dips”: We think investors can look forward to five-years of political stability. More importantly, the new government will have more latitude with policy reforms as it will not be as encumbered by coalition politics as it was in the preceding five-years.

• Raising earnings estimates and Sensex target: We think that these election results creates room for better earnings growth (through policy action). Thus, we are raising our earnings estimates. In our base case, we think earnings growth for the BSE Sensex constituents on an aggregate basis will likely be +2.5% and +12.5% for F2010 and F2011 respectively (up from our previous forecast of -10% and 11%). Consequently, the fair value estimate for the BSE Sensex rises to 13201. We, now believe, that there is greater probability of our bull case (40% versus 10% previously) rather than our bear case (10% versus 40% previously). Thus, our 2009 target for the BSE Sensex is now 15,300, a 26% upside from current levels. Our view before the elections was that a polarized mandate will likely to drive Indian equities to outperform emerging markets over the ensuing 12 months by a margin of 25%. We think we are now set up for such performance as the consensus revises growth forecasts higher.

• What are the risks/headwinds? This is the best possible mandate the electorate could have delivered. The onus is now on the government to deliver on policy reform. The market multiple will almost immediately rise to reflect more optimistic expectations. The biggest risk factor is therefore that the government does not deliver or that it prefers to exercise restraint on stimulus due to the
fiscal situation. Global factors remain outside India's control and will continue to influence the absolute returns in India. India’s return correlation with SPX returns remains high though it may decline in the coming months if India delivers on policy reforms. The third risk factor is the pace of extent of corporate sector operational deleveraging. This will still play a role in determining the
strength of earnings recovery in the second half of F2010. Recent quarterly earnings indicates margin pressures are intact. The fourth headwind to sustained market performance is that valuations on a relative basis are not exactly attractive.

• Model Portfolio changes: We are turning more aggressive with our model portfolio. We are reducing defensives in our portfolio and adding more cyclicals. We are going underweight healthcare and closing underweight positions in financials and industrials. We are going overweight consumer discretionary. Consequent to these changes, the cash balance in our model portfolio reduces to zero (we had halved the cash balance in October 2008 to 400 bps). We are adding Maruti Udyog (Rs848) and Larsen & Toubro (Rs988) to our focus list and removing Marico (Rs63) and Cipla (Rs231)

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