Not many on the Street are talking about an year-end target of 22,000 for the Sensex. But, Abhay Laijawala, who heads research at Deutsche Equities India, is bullish. In a chat with Ashish Rukhaiyar, he says the number is achievable as GDP growth has returned to the 8-9 per cent trajectory and global economic growth is seeing a paradigm shift. Edited excerpts:
Deutsche Equities has an year-end target of 22,000 for Sensex. What is the rationale for this, especially when most people on the Street are sounding quite bearish?
Our 2010 India outlook is premised around two broad themes — shifting paradigm in composition of global economic growth and, more important, restoration of Indian GDP growth to the 8-9 per cent trajectory. While consensus is still cautious on restoration of the growth trend, we remain confident that the economy is on course to do so. We believe earnings expectations are not factoring this is.
Hence, as confidence builds on the return of the above-trend growth, we expect upward momentum in Sensex earnings’ forecasts. The consensus earnings for FY11 are factoring in year-on-year (y-o-y) growth of 22-24 per cent. At Deutsche, we are looking at 24 per cent y-o-y growth in earnings for FY11.
Our confidence in anticipating the return to robust economic growth is based on domestic consumption, which is not only resilient but also far more inclusive than we have seen before in India. The enabling drivers of domestic consumption are gaining additional strength, leading us to believe a new structural consumption cycle has begun in India which could surprise all of us.
One part of your premise is based on global growth. Of late, there have not been much positive news globally. How will that impact India?
That is exactly our point. The fact that the western world is unlikely to move back to the ‘old normal’ in the interim term will only make countries like India attractive investment destinations. We are going to see a shift in paradigm in terms of the composition of global economic growth. I think 2010 is going to be the year which will amply underscore the belief that the developed world is not going to go back to growth rates of the past few years. Primarily, because developed economies are staring at very high debt to GDP ratios, in the range of 84-90 per cent, and periods of high unemployment.
In addition, the consumer there has also been impacted, which leads us to believe that trend GDP growth rates in developed markets will be lower than in the past. However, global GDP growth will be driven incrementally by emerging markets, which are more populous and material-intensive. The share of emerging markets in global GDP growth is set to rise meaningfully. India has a unique mercantile model and its economic growth is largely driven by domestic factors, unlike some of its other emerging market peers.
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However, India could be impacted by weakening capital inflows as the private sector is reliant on foreign inflows. During such periods, there could be a risk of large government borrowings crowding out private sector investment.
Your target is based entirely on fundamentals. What happens if there are negative surprises related to liquidity?
Liquidity will be determined by global macro factors and, hence, is a generic risk for all equity markets, including India. However, we strongly believe that we are going to see a shift in the pool of money from developed to developing markets. At this point in time, emerging markets account for barely 10-15 per cent of the portfolio of global investment funds. With the developed world staring at a multi-year period of slow growth and high fiscal deficits, and with a disproportionate share of money invested in its markets, we are going to see money shifting over time from developed to emerging markets.
Country fundamentals will, hence, become paramount in determining the relative attractiveness of emerging markets. Countries such as India, with a large insulated domestic market, its youthful demography and high savings rate will turn out to be among the most attractive investment destinations.
So, once the quantum of money directed towards emerging markets increases, do you think India will be able to attract a significant share of the incremental flows?
Emerging markets will have to compete for investor flows. And, this is where country fundamentals will come into play. So, India stands out at this point in time in terms of country fundamentals. Never before in India have we seen such resilient domestic consumption. And, this primarily stems from what the government has done over the last four to five years (rural job scheme, farm loan waivers, record procurement prices, fiscal stimulus, etc), which have enriched rural India. We are seeing inclusive growth for the first time in India. The Indian economic growth story is an inclusive growth story.
In addition, we are seeing an across-the-board rise in wages. We are convinced that strengthening domestic consumption and accelerating momentum in employment generation across swathes of rural and urban India is leading to steady return of business confidence. We expect that these factors will lead to an accelerated return of the investment cycle, which should drive the next round of GDP upgrades, earnings forecasts and rising conviction in restoration of the 8-9 per cent GDP growth trajectory.
How do you see the increase in the cash reserve ratio (CRR) impacting the market?
The CRR hike has primarily focused on taking liquidity out of the system without impacting policy rates. A very good move because it was the right medicine for the right illness. A rate hike at this point in time would not have been able to control inflation, because what we are witnessing currently is non-manufacturing inflation.
What are the negatives that could hamper reaching your target?
One would be the return of manufacturing inflation. We are worried about rising global oil prices, because that could lead to significant pressure on the deficit. And, of course, there are generic geo-political risks such as the India-Pakistan tension, worries over India and China on the eastern border and rising Naxalism in central and eastern India.
Divestment issuances might suck out a huge amount of liquidity from the secondary markets.
Why just divestment? We should be talking about total issuances, both government and private. So, to some extent, the deluge of paper supply is a risk. However, we have factored that in while arriving at our target.
What is your advice to investors at this point in time?
We like three key investment themes in India — domestic consumption and consumption beneficiaries (autos, metals, paints, private sector banks), infrastructure and software. In our model portfolio, we are overweight on metals, industrials, IT services and automotives. So, the bias is in favour of consumption. We are neutral on cement and utilities. We are massively overweight on private sector banks. We are underweight in pharmaceuticals and FMCG (fast moving consumer goods).
How do you see rising commodity prices impacting India?
Global commodity prices are important as they essentially feed into manufacturing inflation. Indian commodity prices are also benchmarked to global commodity prices and, hence, rising commodity prices globally put pressure on domestic prices. So, there is a concern, but what will probably help is the appreciation of the rupee. We are confident that 2010 could see record FII (foreign institutional investment) as well as FDI (foreign direct investment) inflows. It is very likely that the Reserve Bank of India will, in the interest of managing inflation, allow the rupee to appreciate. So, a part of the global commodity pricing strength could be offset by a sharper-than-anticipated appreciation of the rupee.
