India Q2 Review - Reason for Rise

Guneet Singh Sahni - India Analyst

It's no secret any longer... The Indian market has been outperforming its global peers. Our second quarter review shows you why.

(Article interests (AMEX: DIA, SPY, DOG, SDS, QLD, PUA, NWD, CZJ), (Nasdaq: QQQQ, ASIA, PRASX, MEAFX, EBASX, EVASX, MACSX, MATFX).)

India's BSE Sensex outperformed its major Asian and global peers by gaining more than 10% for the month of June, thereby closing out the second quarter strongly. Robust revenue growth in the April-June quarter earnings reports reduced the fear of a domestic slowdown. The Indian market ended the month of June with its fourth consecutive weekly gain on back of IAEA approval for the India-US nuclear deal, not to mention range bound oil prices and above expected domestic earnings. The markets even shrugged off greater than expected interest rate hikes and an inflation figure that is now within kissing distance of 12%.

India's Central Bank increased the repo rate (the rate at which RBI infuses liquidity) by 50 basis, points to 9%, and raised the CRR (funds which banks have to keep with the RBI) by 25 basis points, to 9%. As a result, foreign institutional investors were net sellers on the month.

The National Council of Applied Economic Research, India (NCAER), downgraded its GDP growth projection to 7.8% from its earlier estimate of 9% for FY 2008-09, and in the process, said the global slowdown and rise in inflation will have an adverse impact on the growth of the Indian economy. On the trade end, India's deficit expanded to an estimated $30.4 billion for the June quarter, against a deficit of $21.5 billion in the previous year.

Major Development

The Central Board of Employees Provident Fund has brought in 3 more private sector financial companies, including ICICI Prudential (unlisted subsidiary of ICICI Bank Limited NYSE: IBN), HSBC (subsidiary of HSBC Holdings NYSE: HBC) and Reliance Capital (BOM: 500111), in addition to public sector SBI (BOM: 500112), to manage the Provident Fund Corpus of around $60 billion.

The nuclear energy sector is going to be the next big thing in India, after getting the go ahead from the Indian Government and the IAEA. This month saw both domestic and international nuclear power companies trying to consolidate their presence in the sector, as market share slices are too attractive to pass up.

Top Gainers for July

The top 5 gainers in the Sensex for the month of July included DLF Ltd. (BOM: 532868) - up by 38.2%, State Bank of India (BOM: 500112) +38.1%, Reliance Infrastructure Ltd. (BOM: 500390) +37.5%, Reliance Communications Limited (BOM: 532712) +26.3% and ONGC (BOM: 500312) Ltd. +26.0%.

Third Rate Hike in 2 Months to Curb Inflation

The Reserve Bank of India (RBI) hiked the Repo rate by 50 bps to 9% and the CRR by 25 bps to 9%. The CRR hike will be effective from the fortnight beginning August 30, 2008, and will absorb about $2.1 billion from the system. Consequently, markets reacted to the move in negative fashion, but thereafter, took just one day to recover from the jolt. The RBI Governor has finally resorted to control inflation by tightening money supply. He hopes to bring down inflation to 7% by 2009 as lower inflation may prove key for next year's general elections. We believe that the RBI is worried about the risk of second round effects from relatively high global commodity prices, and thus inflation expectations leading to strict monetary tightening.

Inflation at Kissing Distance of 12%

The Wholesale Price Index (WPI) hit a new high of 11.98% for the week ended July 19, 2008, (against 11.89% the previous week and 4.65% a year ago) from a low of 3.1% during the week ended November 24, 2007. The prices of primary articles rose by 10.2% Y/Y; fuel items increased by 16.9%, and manufactured products grew by 10.8%.

Inflation has remained significantly higher than the RBI's comfort zone of 5% since mid-February 2008. We believe that inflation will continue to remain in double-digits till the end of 2008, as per RBI estimates.

Nuclear Deal to Spearhead Growth

The IAEA unanimously cleared the accord for the US-India nuclear deal, which helped Indian equities end higher. Mohamed ElBaradei, the UN nuclear watchdog chief, said that a basic inspection plan for India met safeguard standards and that talks had begun on a system of extended checks. Hence there was increasing share demand in capital goods and the power space.

We discussed which companies should benefit most from this deal on July 29th, in our article "India Equity Market Briefing." The agreement will allow India to have civilian nuclear energy as an option, plus pave the way for the transfer of a lot of hitherto denied technologies.

Flat Derivatives Expiry

The expiration date for derivatives in the Indian market falls on the last Thursday of every month. Expiry of the July contracts in the derivative segment passed without undue volatility. As per Economic Times data, Nifty rollover was at 65.05% in July, one of the lowest points in recent times and matched against the past six month average of 70.13%. Such low rollovers offer a positive sign for bulls. This is because, for a series that had begun at a discount of over 70 points, low rollovers simply mean that the short positions that existed in the system are now out of it. The markets witnessed low rollovers even for single stock futures at 79.19%, against a six-month average of 82.05%.

Burgeoning Trade Deficit on Account of Oil Prices

The trade deficit for the month of June increased 29.6% Y/Y, to $9.8 billion, primarily owing to month's surge in oil imports. Imports for the month of June increased from $19.4 billion last year, to $24.5 billion in June. The growth in oil imports was the main reason for a surge in overall imports, a key reason was the high international crude prices that pervaded through the period. Non-oil imports grew by a subdued 14%. At $15.4 billion, a key driver was the slowdown in domestic expansion plans amid rising interest rates and commodity prices. Exports for the month of June surged 24% Y/Y, to $14.6 billion, on the back of the depreciation of the rupee, which depreciated by 1.7% against the US dollar.

The trade deficit for the April-June period surged to $30.4 billion, against $21.5 billion previously. Exports for the April-June period increased 22% Y/Y, to $42.8 billion. Total imports grew 30% Y/Y, to $73.2 billion. India is targeting exports of $200 billion in 2008-09, up 29% from $155.5 billion last year.

Outlook

We believe that Indian markets will need a slew of positive news to sustain this bear market rally. The August reporting of Industrial Production Data and Q1 FY 09 GDP figures should drive the direction of Indian markets. India's June Industrial Production numbers compared against a disappointing performance in May. International monetary policy meetings, including the Bank of Japan's congregation that concluded today, should also prove important. Q1 FY09 GDP data is due on the 29th of August, and we'll be watching attentively.

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