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Key challenges for India will be to tackle inflation and liquidity

Key challenges for India will be to tackle inflation and liquidity
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First Published: Wed, Mar 09 2011. 10 32 PM IST
Updated: Wed, Mar 09 2011. 10 32 PM IST
We are witnessing different economic battles being fought in different parts of the world. In the largely open economic environment, policies in one part of the world create unintended consequences for another. A large part of 2011 will continue to be a transition year for financial markets before definitive trends are borne out. Here’s the outlook for India.
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In India, we seem to be tackling issues across the board—gigantic political corruption, parliamentary standoffs, corporate governance, offshore black money and rise in food prices. But the key battle that is relevant for long-term economic growth and financial markets performance is inflation and inflationary expectations.
Fixed income
There is a universal consensus that interest rates in India can only rise and that inflation is a big issue. This is also the key variable for the equity market outlook. All this at a time when inflation has most likely peaked, bond yields are close to long-term highs (barring a few months in 2008) and liquidity crunch remains a concern.
In our view, India’s inflation is a supply-side issue. If it were demand-led and pricing power were back, manufacturing capital expenditure would have been roaring—it’s clearly not.
The Wholesale Price Index for manufactured products is still steady. In our view, the biggest risk to the world economy is the threat of deflation caused by over investment in various parts of the world.
As for liquidity, it should only be a while before the government starts spending all the money parked with the Reserve Bank of India which should address liquidity issues.
The government borrowing program for next year should also be reasonable and we actually expect a reduction in relative terms over the nominal gross domestic product base. While bond yields may remain volatile in the short-term, we expect yields to come significantly lower (7% and possibly lower) as the year progresses. Also, it remains a key asset allocation call and hedge in the event of a major correction in commodities and equities.
Equities
The late 2010 correction notwithstanding, we have a strong conviction that Indian equities are in the middle of a major structural bull market. Most of the current constraining factors such as inflation and politics should recede by the second half of 2011 allowing markets to scale back previous highs.
The story in Indian equities though is not in 2011, but actually in 2012 and 2013. We expect a major investment cycle to hit the ground beginning with infrastructure investments and followed by manufacturing.
An investment cycle always leads to explosive earnings growth and catches analysts off-guard. So if the markets are assuming a 20% range of earnings growth for FY13, one should not be surprised if one witnesses earnings growth of 40-50% in FY13 and FY14.
This could translate into a Sensex earnings per share of about 1,700 for FY13 which combined with a bull market price-earnings multiple of 25 can bring us to 43,000-45,000 levels for Sensex by FY13-end.
It also follows that in this bull market, the investment theme should outperform the consumption theme after lagging for the last three-four years.
Edited excerpts from a report by Anand Rathi. Your comments are welcome at mintmoney@livemint.com
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First Published: Wed, Mar 09 2011. 10 32 PM IST