India Down but Not Out

By Guneet Singh Sahni - India Analyst

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Sharp global recession and RBI's trimmed growth estimate renders market to three-year low

The bears have gone on a complete rampage sending the key Indian indices to their biggest one-day fall in percentage terms on Friday. There is a complete crisis of confidence and liquidity in Indian markets (NYSE: IFN, NYSE: IIF), triggered by massive selling of foreign institutional investors (FII). FII sales have been spurred by redemption pressure and the inaction of the Reserve Bank of India (RBI) in its monetary policy (announced on Friday). Adding to the downfall, the RBI has reduced its growth forecast to 7.5%-8% for FY09, from 8% previously.

The market breached its crucial technical support levels of 9000 on the BSE Sensex and 3000 for SNX Nifty, after respective declines of 11% and 12% on Friday. The Indian rupee touched an all-time low of 50 against the dollar on substantial FII outflow, making it the second worst performing Asian currency (PCX: INR, PCX: ICN). Stocks are trading at attractive valuation well below book value, and a few BSE stocks are even trading below their cash holdings per share.

FII turned net sellers to the tune of $12 billion tanking the markets by 57% YTD

Massive FII selling to the tune of $12 billion, triggered by global turmoil, has led hedge funds to cut exposure in emerging market assets, India being no exception. After the Indian market was opened in 1992, FIIs have invested more than $56 billion thereto, leading to an unprecedented bull run. With the BSE Sensex having fallen 57% YTD, does this indicate the secular Indian market rise which started in 2004 has come to an end?

Key Macro Risks for India – High current and fiscal deficit

• India runs one of the largest trade and current account deficits in the Asian region. Its current account deficit of 2% of GDP and fiscal deficit (including off- balance sheet items) of more than 8% of its GDP, make Indian weightage unfavorable among global fund managers.
• An increase in the wages of Government employees, and subsidies for fertilizers (a major portion of off-balance sheet fiscal deficit), are of permanent spending nature and are therefore unlikely to reverse when the cycle turns upward.
• The Government needs to borrow to fund its deficit, leading to squeezing of liquidity from the system; hence crowding off public sector credit. Additionally, the drying up of capital flows would put further strain on liquidity in the system, thereby hurting growth.
• The weakening Indian currency makes the real return less attractive for global funds, leading to more outflow.

Opportunity in Adversity

I believe that India's long-term fundamentals including pro-active monetary policy, high savings rate, domestic consumption oriented economy and valuations at historic lows make the country highly favorable to be the first to bounce back after the end of global turmoil.

• India has one of the highest foreign exchange reserves among major economies of $274 billion (as of 17th October) to tide over imbalances and to counter any liquidity crisis.
• India remains a strong domestic consumption oriented economy (exports being 15% of its GDP), with a high savings rate of 36% of GDP and low levels of corporate leverage.
• Inflation has started showing signs of peaking, falling from a peak of 12.91% to 11.07%, giving enough room to the RBI to lower interest rates.
• India remains a favorable destination for investments, with FDI (Foreign Direct Investments) increasing by 124% Y/Y, to $14.6 billion for Apr-Aug 2008.
• India's expected growth of 7.5%-8% for FY09 against 9% recorded in FY08 is still comfortably far above global growth.
• BSE Sensex trades at a historic low valuation with trailing EPS of 10.63 as of 24th October.

Outlook

The market could witness more pain on fresh redemption pressures from domestic mutual funds. Chances of a V-shaped recovery seem to be highly unlikely, owing to global bearishness. The slowdown in industrial production, and tight liquidity pressure leading to high interest rates and forex losses, have put a strain on domestic companies. Fresh rounds of selling on every relief rally cannot be ruled out. It's hard to say where the bottom might lie for the indices, but I strongly believe India will be the first among major economies to stage a comeback after the global meltdown has concluded.

(Article interests: Article interests NYSE: SAY, NYSE: WIT, AMEX: PUA, AMEX: NWD, AMEX: CZJ, Nasdaq: ASIA, Nasdaq: PRASX, Nasdaq: MEAFX, Nasdaq: EBASX, Nasdaq: EVASX, Nasdaq: MACSX, Nasdaq: MATFX, AMEX: DIA, AMEX: SPY, Nasdaq: QQQQ, NYSE: NYX, AMEX: DOG, AMEX: SDS, AMEX: QLD, AMEX: XLF, AMEX: IWM, AMEX: TWM, AMEX: IWD, AMEX: SDK.)


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