Outlook 2011 for India economy and markets

January 5, 2011

File photo of people walking past the Bombay Stock Exchange (BSE) building in Mumbai January 9, 2009. REUTERS/Punit Paranjpe/Files

(The views expressed in this column are the author’s own and do not represent those of Reuters)

2010 was the year of the “E”s. Equity markets across the world delivered positive returns in 2010, even though sovereign issues in Europe caused periods of market volatility.

Quantitative easing brought a flood of liquidity to Indian equity markets. Domestic factors also influenced Indian market performance, from the RBI’s Exit to questions on government’s Execution on reforms and the debates on corporate and political Ethics. Despite the uncertainty, backed by strong Earnings, India posted outperformance vs. the global indices for the second consecutive year.


1) Optimisation of risk – return through proper asset class/manager/market allocation
2) Disciplined investing – predetermined stop loss and book profits
3) Regular portfolio monitoring
4) Consider factors such as liquidity, capital preservation and absolute return while making investment decisions
5) Seek professional advice on investments


Indian policy makers have been boosting growth at the cost of macro stability risks, reflected in high inflation, a widening current account deficit and tight inter-bank liquidity due to low deposit growth.

WPI headline inflation and non-food inflation have moderated to 7.5 percent YoY and 7.9 percent YoY in November 2010 from the peaks of 11 percent YoY and 8.9 percent YoY (in April 2010) respectively. Monthly trade deficit narrowed to 7.1 percent of GDP, annualised in November, from the peak of 10.8 percent of GDP, annualised in August 2010.

Inter-bank liquidity should also improve over the next three months as recent aggressive deposit rate hikes will help improve deposit growth. Private sector capex has been accelerating over the last 10 months and it will soon begin to reflect in the form of commissioned capacity. At the same time, monetary tightening — as reflected in the 300 bps rise in short-term rates (91-day T-bill yields) over the last eight months — is beginning to help reduce the above macro stability risks.

Overall macro conditions will remain vulnerable over the next 4-5 months. Inflation, while moderating, will remain above the RBI’s comfort zone; while we believe the current account deficit will also stay relatively high.

Recent optimism in the developed world growth outlook has increased the risk of a potential rise in crude oil prices to $110-120/bbl. Similarly, there is additional risk of pass through of agricultural and commodity prices.


Relative valuations are on the richer side and hence we expect moderation in index returns for 2011 (in the 10- 15 percent zone from current levels). That said, we remain in a structural bull market so any dip will enhance returns and provide an opportunity to buy equities. The market is likely to consolidate in its current range in the near term and then a steady but not spectacular rise for the rest of 2011. We expect style rotation in 2011. Watch out for the beaten-down low ROE, high beta plays and stocks of less dividend-focused companies.

India’s policy favours a change in mix of growth from consumption to capital spending. An improving global growth environment could be the trigger for higher-than anticipated capex. We favour capex proxies such as industrials, materials and property over consumption sectors.


1. Buy disinflation trades – India’s inflation is likely to decline. Inflation has been sticky over the past 12 months, driven by a slow supply-side response to a significant recovery in demand helped by strong stimulus and a negative food supply shock. We expect both these factors to recede in 2011. If inflation declines, it could be positive for equity returns. Key sectors that do well during disinflationary cycles are industrials and financials. Technology tends to underperform. A corollary of declining inflation is that real rates are rising – this may not augur well for consumer stocks.

2. Surprise from the government? There are three areas where the government could spring a surprise: a) Accelerate infrastructure spending further; b) FDI liberalisation in retail; and c) Rein in the fiscal deficit more aggressively – long bond yields decline.

3. Protect the portfolio from tail risks. India’s key risk is that it is pursuing growth assertively. Consequently, public spending is still at elevated levels and the current account deficit is at record levels. The economy and the market may not tolerate extreme outcomes. A deep risk aversion event could cause India’s growth to stumble and markets to react adversely. The flip side is that the world recovers and commodities do well – India could still falter.

4. Macro in Vogue – Focus on sector trades. Through 2010, stock-picking has been in fashion. It is unlikely that the macro effect falls further, and, to that extent, stock pickers may have to take a back seat in the coming months. The message is to focus on sector trades.

5. Buy long bond proxies. Equities look more attractive than long bonds but not by a big margin. Equities may continue to beat long bonds in 2011, although the gap may narrow compared to 2010.

6. Buy Capex proxies. We expect a disciplined capex cycle in 2011 and capex-related sectors, such as industrials, property and materials (most of these have underperformed in 2010), to do better. Consequently, the consumer sector, could underperform.

7. “Growth” is policy. The significance of the Bihar election outcome reaffirms the evolving dynamics of “development” politics in India. The government is taking risks with the external deficit to fulfil its target of 9-10 percent GDP growth.

8. From cash flow generators to asset gatherers. 2010 was all about cash flow generators. Stocks of companies with long duration cash flows distinctly underperformed. We are now in a hesitant bull market. As the bull market matures, it may shift its attention to longer duration cash flow companies.

9. Market is at fair value – Buy Undervalued, Under-owned and Unloved stocks (3Us). Our residual income for the Sensex implies long-term valuations are at a fair level. At the sector and stock level, we are focused on the 3Us. Key sectors to own are materials and utilities. The consumer and financial sectors fail the test.

(The above article is not intended to be a financial advisory. Readers must seek specific advice from experts before making investment decisions.)

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