Currently, the real economy (i.e. overall output, industrial production and trade) is weak. Headline gross domestic product (GDP) could weaken further in the December quarter (estimated growth of 5.2 per cent) on the impact of delayed monsoons. We expect 5.5 per cent real GDP growth in FY13 and 6.5 per cent in FY14. Inflation is nudging up as it starts to reflect the recent power and fuel rate rises hikes, and overall food inflation remains high. Higher inflation is the main impediment to policy rate cuts. But the ongoing drop in loan/deposit ratios and a narrower trade deficit should allow money market rates to drop more, creating room for rate cuts – of up to 100 basis points in January-March 2013. Meantime, we expect Reserve Bank of India to support credit growth, either through cash reserve ratio (CRR) cuts, or open market operations.
While we believe a mild cyclical economic recovery is possible in the next few quarters, even a sub-six per cent GDP growth (nominal GDP growth in double-digits) should be supportive of double-digit earnings growth. Recent government announcements have somewhat revived corporate and investor sentiment. Although it might take a while for companies to start seriously investing, at least they are rethinking dropped investment plans. Inflows from investors could also support capex recovery in the form of equity capital raising. A cyclical recovery, albeit mild, in corporate capex could be ahead.
We believe there are three ways to look at “reforms” in India: One, Policy stability/clarity in place of mis-steps - we are seeing some of that now but need to see more. Two, real reforms including GST and land acquisition - although this would be a more structurally positive scenario, it is not in our base case or in terms of market expectations. Foreign direct investment in retail could help but the impact is at least three to five years out. Three, administration - approvals/expediting projects. Infrastructure revival still awaits strong administrative measures – the major one being coal. These would be key for us to turn bullish in the long term. The Cabinet reshuffle reinforces the government’s effort to portray a reform-oriented image and may push forward the reform agenda, improving the administration of sectors such as power, petroleum and infra – and a positive for sentiment.
An improvement in investor sentiment could drive short-term improvement in India’s twin deficits. The Parliament arithmetic still supports government stability, but the dynamics could change as we approach the 2014 elections. Our view has been that arithmetically, the government has enough support and will not fall. However, this picture changes as elections approach. We will worry about this around Budget 2013.
We expect a Nifty trading range of 5,400-6,400 in the next three to six months, based on price-earnings range of 12.5-15 times. We believe any move beyond this range would be driven by perception of a different economic trajectory—either a boom or a bust — neither of which is our base case now. We would recommend investors remain tactically bullish. We recommend adding quality beta. We are overweight banks, infra, real estate, telecom and select mid-caps, and underweight autos, cement, consumer staples, IT services, metals & mining, pharma and power. We are neutral oil & gas and petrochemicals.
The author is managing director and head of equities, UBS Securities (India)
