Cautious optimism in markets

Last Updated: Fri, Dec 28, 2012 04:30 hrs

After unexpectedly gaining a little over 22 per cent from stock indices since last January, investors are painting a more sanguine outlook for Indian equities in 2013 than the current year.

Hopes of policy rate cuts, possible bottoming out of the decline in economic growth and uninterrupted foreign portfolio inflow expectations are making investors more bullish on India. However, they need to watch some factors which might scuttle these expectations, such as the US fiscal cliff, inflation, political uncertainties and a populist Union Budget.

Foreign institutional inflows
In 2013, analysts are betting on robust portfolio inflows, though not as huge as the previous year, as the decline in India's economic growth and companies' earnings growth show signs of abating. A loose monetary policy followed by leading central banks worldwide could also drive inflows. Foreign institutional investors (FIIs) pumped close to $23 billion into Indian equities after the government shrugged off a perception of policy inaction in the second half of the year. This helped Indian stocks emerge as among the best performing markets in 2012.

Indices 30-Dec-11 24-Dec-12 % Chg (year-to-date)
Bangkok SET 1,025.32 1,375.82 34.18
Dax 5,898.35 7,636.23 29.46
Nse S&P CNX Nifty 4,624.30 5,855.75 26.63
BSE Sensex 30 15,454.92 19,255.09 24.59
Hang Seng 18,434.39 22,541.18 22.28
Straits Times STI 2,646.35 3,168.57 19.73
Nikkei 225 8,455.35 9,940.06 17.56
NASDAQ Composite 2,605.15 30,21.006 15.96
Cac 40 3,159.81 3,652.61 15.60
Jakarta Composite 3,821.99 4,250.21 11.20
Kospi 1,825.74 1,981.82 8.55
Dow Jones Indus. Avg 12,217.56 13,190.84 7.97
Ftse 100 5,572.28 5,954.18 6.85
Taiwan Taiex 7,072.08 7,535.52 6.55
Shanghai Se Comp 2,199.42 2,159.05 -1.84
Source: Bloomberg Compiled by BS Research Bureau

Interest rates and inflation
Investors believe the extent of rate cuts by the Reserve Bank of India (RBI) during the year will be crucial to reviving sentiment. RBI has refrained till date from doing so, as inflation is yet to mellow the way it wants. It is likely to start cutting rates by January but the rate at which does so will depend on the extent of decline in inflation. "Interest rate cuts will be one of the biggest triggers for the economy and the market in 2013," said Navneet Munot, chief investment officer, SBI Mutual Fund.

Economic and corporate earnings growth
Fund managers are hoping India's gross domestic product (GDP) growth expectations would be upgraded revised to 6.5 per cent by the end of 2013, after falling to 5.3 per cent in July-September from the same period a year before. The GDP growth was almost eight per cent just a couple of years earlier. Expectations have heightened that lower interest rates and the recent pro-business measures by the government would instill confidence in companies, which are shying away from fresh investments.

"Bottoming out of a fall in economic and earnings growth will bode well for the markets in 2013," said A Balasubramanian, chief executive officer of Birla SunLife Asset Management. "A fall in interest rates will only help a bounce-back in earnings growth."

Union Budget
The government's fiscal measures in the Budget for 2013-14 will play a key role in determining the market sentiment. Investors are concerned that if the government announces populist moves in the run up to the general elections in 2014, there could be a sell-off. A section of the market believes the rate at which RBI eases monetary policy would partly depend on the government's announcements in the Union budget. RBI has been nudging the government to improve its finances - mainly, cut its subsidies - to curb inflation before embarking on rate cuts.

US fiscal cliff
The first hurdle investors might need to negotiate in 2013 is the US fiscal cliff, involving hundreds of billions of dollars in spending cuts by the American government, starting January 1. The lack of agreement among US lawmakers to tone down the fiscal tightening is making global markets nervous. The triggering of the fiscal cliff in its current form could push the US economy back into recession, squeeze global liquidity and spark an exit of foreign institutional money from riskier emerging market equities to safer havens such as gold.

Reforms and political uncertainty
Though the government pushed through a diesel price increase and some important pro-business measures such as opening the nation's multi-brand retailing sector to foreign supermarket giants and banking law amendments, the consensus on Dalal Street is that more is needed. Especially on the fiscal deficit, threatening to balloon out of control.

"Most of the recent reforms have been fairly modest and we rule out meaningful reforms that can address India's twin deficits (fiscal and current account) and job-creation challenges over the next 12-15 months," said Kotak Securities' analysts led by Sanjeev Prasad, in a client note.

Investors will also watch the ever-changing political developments, which are perceived to play a key role on whether the government wants to push through the bolder but politically-sensitive economic measures, such as cuts in fuel subsidies, and improve the country's investment climate.

"Short cuts and easy solutions may look appetising in the short term and perhaps even provide a temporary fix' but are unlikely to deliver sustainable growth," said Kotak's Prasad.

"Investors may want to ponder about this, as India finds the right' development model and grapples with fiscal (one-off revenues versus reducing entitlements) and balance of payments challenges (increasing overseas debt limits versus creating the right climate for exports)."

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