Monday, January 4, 2010

>The India story: Opportune times (EDELWEISS)

Interest rates to stay “lower for longer” in advanced economies
The global economy is up from the trough. However, we believe growth is still nascent and stimulus-dependent, especially in the developed world. Globally, particularly in developed nations, stimulus unwinding is likely to be slow as policymakers would rather prefer to err on the side of caution than putting growth recovery at risk. While most of the extraordinary stimulus measures are to be gradually rolled back during the first half of CY10, we believe, the Fed will keep interest rates at current levels for most of the year. Appreciation in the EUR is anyway acting as a “pseudo tightening” for the Euro zone and will delay rate hike by the European Central Bank (ECB). On the other hand, Japan is still in the process of injecting fresh stimulus, acknowledging likelihood of poor economic performance for a prolonged period.

USD to remain weak; flows to remain strong into emerging markets
We expect the USD to remain weak during CY10, primarily driven by: (1) surging federal deficit and large treasury issuances; (2) sharp expansion of the Fed balance sheet; (3) improved risk appetite globally, reducing significance of the USD as ‘safe haven’; and (4) several emerging markets (EMs) shifting their reserves from USD to gold. Low interest rates in the US, without the fear of any quick appreciation of the domestic currency, will lead to continued flow of USD to EMs. Even in case of a slowdown in USD flows, EMs will still enjoy inflows of other low yielding developed country currencies. JPY remains a prime candidate for being used in such “carry trade” as a result of the near-certainty of its continued weakness and extremely low interest rates in Japan.

India stands to benefit more than peers
India has been relatively less battered in the global crisis and most indicators suggest a strong growth recovery ahead. The country remains largely immune to the risk of any rollback in stimulus as the same was miniscule at less than 1% of GDP (against ~15% of China), targeted at the lower strata of the economy—in line with GoI’s long-term strategy of “inclusive growth”. In our view, the current phase of high inflation will be a concern for just around six months and, thus, will not put undue pressure on the interest rate scenario. With the economy poised to re-enter a healthy growth zone, the pro-cyclicality of India’s fiscal dynamics will reduce deficits considerably over FY11-12. With stability and strength in income generation, efficient use of capital, favourable demographics, India is in the early phase of a virtuous cycle of high savings, capital formation, and high growth.

Focus on consumption and infrastructure creation in India
India’s current valuation premium over EMs has been in line with the recent past. Given the strong visibility of growth and political stability, there should not be any de-rating in the premium over the near term. We expect earnings estimates for FY11 to grow further. Even if there is no further uptick in valuation multiples, Indian markets will keep moving up along with earnings upgrade. While we are bullish on Indian equities in general, we believe key to outperformance will be with bottom-up sector and stock selection. We prefer to play the India growth story via infrastructure creation and end-consumption. We are overweight on BFSI, industrials, real estate, and consumer discretionary.

To read the full report: INDIA STRATEGY