According to Merrill, there will be a strong capital inflow, which should facilitate higher rate of investment than permitted by domestic savings.
Inflation is expected to come down and remain in the 6-7 per cent range. Factors that are expected to dampen inflation include an expected tightening of the monetary policy by the Reserve Bank of India (RBI) by controlling money supply growth, thus facilitating fiscal consolidation.
It is expected that as structure reforms lead to more competition in electricity supply, telephone services and public transport, it could have a significant downward pressure on the prices of these non-tradable goods. Besides, international competition is expected to exert a downward pressure on prices.
Factors like strong growth leading to a demand-pull pressure, increase in wage and salaries in urban-areas could compound this demand-pull inflation by adding more cost-push pressures, and increase in various administered prices could add to an upward pressure on prices.
Merrill Lynch expects the rupee to be stable at around Rs 35-36 to a dollar. With a modest current account deficit fully financed by strong capital inflows, the rupee is not expected to be under the kind of pressure experience in late 1995 and early 1996. Given the inflation differential between India and its major trading partners, the rupee should depreciate around 4 per cent during the next year, itsaid.
The overall macro-economic fundamentals, the report says, are very positive in the equity market. The Merrill Lynch equity strategy groups view is that Indian equities appear to be undervalued on a trailing P/E basis. A trailing P/E shows that the domestic market is at the bottom of its historical valuation range relative to other emerging markets. Against a positive backdrop of liquidity, corporate earnings, and an exporter-friendly currency, the low valuation in part makes a compelling case for an aggressive market commitment.
On the infrastructure front, the report states that the cumulative investment requirement in infrastructure over the next five years is estimated to be at least $200 billion. Domestic private sector and foreign capital are expected to play a big role in moblising resources for infrastructure development.