Growth on track

With global economy still firmly on the growth path, equity markets do not seem to be in any serious danger.

The stock market fall of 541 points last Friday has once again bewildered investors. And the predominant question on investors' minds is how deep can this correction get?

Although this fall was touted to be in line with the global meltdown triggered by the US markets decline on fears of the potential impact of rising borrowing costs and credit risk on US corporates and stock market, the real reason perhaps lies within.

Considering that the Indian economy is not highly correlated with the US economy given the limited trade relationship, the behaviour of the US consumer should not affect India as much as other economies such as China.

Thus, it is rather inconceivable that the problem in the US credit market could lead to investors pulling out funds from India due to risk aversion.

However, there are implications for overall money flows into global markets, but there is reason to believe that inflows into India would be better on a relative scale.

Just to recall, global interest rates and tightening liquidity have been inflicting pain on the market in some form or the other for a large part of this rally. But then, the global flows have only increased all through.

The first respite for global markets came from the fact that fundamentals are still strong for most of the world, US being an exception. Last week, the International Monetary Fund raised its global growth estimates to 5.2 per cent this year and the next, up 0.3 per cent from its last estimate.

More significantly, market experts believe that that the US economic growth would moderate and that the Federal Reserve could possibly look at a rate reduction, come September.

Besides, money flows from Japan should continue to be strong as those investors can still make a better return for their buck in market such as India even after the recent rate hike there.

Since the beginning of this year, India has seen the maximum fund flows ($9.6 billion) among key Asian markets this year. Despite this it has been among the worst performers in the emerging markets pack. 
 

FUND FLOWS YTD net purchases  in $bn
India	9.60
Indonesia	1.74
Philippines	1.91
S. Korea	-4.00
Taiwan	9.31
Thailand	4.11
Vietnam	0.69

Measured in the local currency, the MSCI India index gave a return of 10 per cent compared to 29 per cent by MSCI China, year-to-date. But thanks to the steep appreciation in the rupee, the dollar returns delivered by MSCI India stood at 20 per cent.

One key reason why money flows into emerging markets would continue is the dollar itself. The experience this year has demonstrated the extent to which currency movements can change total investor returns. 
 

RETURNS Absolute YTD returns
China	29.1
India	10.2
Indonesia	21.2
Korea	28.1
Malaysia	24.5
Pakistan	33.8
Philippines	18.4
Sri Lanka	-14.5
Taiwan	10.6
Thailand	28.7

If we go by the premise that the dollar would indeed continue to weaken, investors would continue to favour destinations other than the US. Higher allocations to emerging markets would be positive for India as well.

FIIs have been underweight on India this year and that itself increases the chances of a favourable rebalancing.

Concerns regarding domestic interest and inflation have already eased, which again means that growth should remain unaffected back home. As we are already close to the second half of this year, it is only a matter of months that analysts would be factoring in next year's growth estimates.

Corporate earnings are intact. This quarter, too, earnings have been pretty much in line with market expectations with positive surprises from automobiles and banks.

Analysts are expecting this year to end with earnings growth of around 18-20 per cent. Though earnings growth is coming off from the highs of the past four years, they are expected to grow at a reasonable pace of around 15 per cent. India looks reasonably priced compared to other markets too going by estimates of global analysts. 
 

VALUATIONS
Indices	PE (x)	CY07E	CY08E
Sensex	21.08	19.33	16.82
Shanghai Composite	45.34	36.92	29.77
Taiwan Taiex	21.30	19.73	17.03
Straits Times	14.12	17.47	15.17
Kospi	17.44	16.96	14.15
Jakarta Composite	22.99	17.38	14.80
Hang Seng	17.25	16.56	15.66

The real reason for the fall on Friday is that the market had run up too much too soon and the bears were just waiting for an excuse to pull the plug. The US subprime woes came as a timely excuse.

The correction seems to have served a good cause -- to cut the excesses from the system. Though a further downside cannot be ruled out, it is reasonable to expect that the market would not correct beyond 10 per cent at the worst.

The current valuation of around 18 times earnings current earnings looks somewhat stretched but not terribly expensive looking at the long term potential.

One way or the other, be it the domestic growth story or the outsourcing theme, the market will have opportunities to make money, may be alternatively.