Indian equities fell by some 15 per cent in the first two months of 2011, followed by a smart bounce back in March of about 10 per cent but valuations are still below the five-year average for the 12-month price/earnings multiple, a key measure of valuation. As such, we believe this recent correction means valuations are supportive for long-term investors.
The recently announced 2011/12 budget had many positive elements. In particular, the government laid out its plans to implement measures to boost manufacturing as a percentage of GDP and improve infrastructure, which we believe is critical in facilitating India’s growth. In general, the market had very low expectations regarding the budget. But its positive tone pleasantly surprised investors and the stock market reacted favourably to the announcement while bond yields fell and the rupee strengthened.
The finance minister had a surprisingly buoyant view on economic growth for the fiscal year 2012 as the economy continues to perform well, driven by the services and agriculture sectors. The government will implement measures to boost manufacturing as a percentage of GDP since this is an area that has been lacking.
In addition, the budget allocation to improve infrastructure, which is critical to facilitate India’s growth, rose sharply.
The government forecasts at least 9 per cent growth in real GDP and inflation of 6 per cent, leading to a 14 per cent nominal GDP growth.
We believe that this number is likely although we think the combination might be closer to 8 per cent real GDP growth and 7 per cent inflation.
The budget for the fiscal year 2012 also assumes an aggressive fiscal deficit target of 4.6 per cent of GDP, which is lower than the consensus of 4.8 per cent and the current fiscal year 2011 estimate of 5.1 per cent of GDP.
The budget also mentioned plans to continue with the privatisation of state assets to reduce the government deficit, and included plans to liberalise foreign direct investment to drive India’s growth were discussed.
But one of the main concerns is inflation, which is being driven by external factors such as high oil and global commodity prices and domestic factors such as changing food consump-tion patterns.
We continue to believe that the Reserve Bank of India will raise interest rates by 75-100bps in the fiscal year 2011-12. Further monetary action by the RBI will be driven by its inflation outlook. We do not see any material impact from additional policy rate hikes of 50-75bps since the market has already largely discounted it.
Although India will remain a volatile market, there are many factors supporting our long-term optimism – a young and educated population, with people under 25 years making up 50 per cent of the country, thriving consumer demand and strong economic growth.
India is likely to be one of the fastest-growing economies in the world in the decade to year 2020, expanding by three or four times in size in nominal terms. We believe this should present many ongoing investment opportunities in the India equity market.
Sanjiv Duggal is manager of the HSBC GIF Indian equity fund