Even super bull Rakesh Jhunjhunwala says he believes that the next few months will be tough for Indian markets.

In a recent presentation to the students of IIT Mumbai, he approvingly quotes former US Federal Reserve chairman Alan Greenspan saying that “history has not dealt kindly with the aftermath of protracted periods of low-risk premiums." He says the impact of the current credit crisis in the US will lead to a slowdown in the US economy, and that is bound to affect world equity markets. But the pain in India is likely to last for only a short time. “India may benefit," argues Jhunjhunwala, “but only after an intermittent transition period."

What’s the basis for this upbeat view?

The presentation lists all the usual reasons: a large pool of skilled people, favourable demographics, domestic consumption-led growth, increased productivity, and so on. But it does give a couple of other reasons that aren’t often cited, such as the fact that the corporate sector will grow faster than the unorganized sector. That implies there is plenty of space for companies to grow, as they muscle into space vacated by the unorganized sector. The withdrawal of reservations for small scale industry is a case in point—it may result in the closing down of small firms, but it will also benefit the larger companies.

But the crux of Jhunjhunwala’s argument lies in the “significant potential" of “rising savings, yet low equity ownership" of the typical Indian household. The percentage of savings to GDP is forecast to rise from 30% in 2007 to 33% by 2011. The proportion of financial savings within overall savings will also rise—from 17.3% of GDP in 2007 to 20% by 2011. Moreover, investment in equities, debentures and mutual funds will rise from 3.8% of financial savings to 15% by 2011. This trend, coupled with increased FII inflows, will lead to a quantum jump in the amount of funds entering the market, from $13.9 billion (Rs56,573 crore) in 2007 to $64.9 billion by 2011.

Is all this the stuff of which bulls’ dreams are made?

Well, the Central Statistical Organization data show that the percentage of gross savings to GDP is already well above the estimates given in the presentation and it is expected to rise to 35% in fiscal year 2008. But forget the detailed numbers—the point that savings are rising, and that the proportion of savings invested in equities is also likely to rise is well taken. In 1994, the proportion of household savings flowing into equities/debentures/mutual funds amounted to a high 13.5% of total financial savings. The question is, what will it take for those glory days to return?

The most critical factor is the continuation of the bull run. The surge in equities in the last four years has led to some investors returning to the market and the proportion of household money invested in equities is probably understated, given the popularity of the ULIP (unit linked insurance plans) schemes of the insurance companies, which are not included in the official figures of household savings flowing to equities.

In the long run, a rising allocation of household savings to equities does hold the potential to expand price-earnings multiples in the Indian markets, just as it has done in the Chinese.

Mutual fund inflows

After two lacklustre months, inflows into growth funds picked up in the months of June and July. The last two months have seen net inflows of over Rs3,200 crore, on the back of new fund offerings worth Rs7,600 crore. In these months, net inflows into growth funds are almost back at the level they were during February and March. That’s a contrast to the situation in April and May, when equity funds had net outflows of Rs145 crore, thanks to the correction in the markets in February-March. Mutual fund investors now appear to have laid those fears aside. But fund managers still seem to be exercising caution with the deployment of the newly acquired funds. According to data released by the Securities and Exchange Board of India (Sebi), mutual funds have been net buyers worth only Rs200 crore since June. They made net sales worth Rs900 crore in July, when the markets reached new peaks. This month has been much better, with net purchases of Rs400 crore in the first two weeks.

What’s important to note is that new fund offerings continue to spur net inflows into equity funds. The irony is that much of the flows into new schemes have been because of sales of existing schemes. Existing schemes saw net outflows of Rs7,300 crore since April. While much has been written about this practice by mutual fund agents to earn higher fees, it’s high time Sebi did something to put an end to it.

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