India has been low on sentiment earlier but this time it’s a combination of inflation, interest rates, government policy and action inertia, a capex slump and downside risks to economic and earnings growth. It’s not hard to see why India is one of the worst performing markets globally (-14.4% year-to-date). However, a bottom-up analysis shows that the picture is rather different.
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Industry suggests a certain caution over the next one-two quarters, but it continues to plan, invest and position for a more robust,longer-term outlook. Also, consumer demand remains relatively positive. Adjusting for the increase in interest rates, we see earnings growth remaining decent at 18-19%. The macro problems—inflation, rates and government inertia—are elevated and could have structural implications. Nor are there enough signs to suggest a near-term reversal. However, a Citigroup Global Markets report says that falling growth and higher rates may not go together. With slower growth now baked in, it expects an easing in both demand-driven inflation and further rate pressures. While India is still not conspicuously cheap, it sees the potential for strong returns in the second half of 2011, given earnings multiples are at a 15% discount to long-term averages; interest rates are already high; commodity price/inflation pressures should ease; India’s growth differential against the developed world could rise; history suggests a strong second-half performance; and sentiment could be boosted by macro/government action. The report targets a Sensex level of 21,500 by December 2011.
Graphic by Ahmed Raza Khan/Mint