Individual events in Africa, Japan and Europe influenced the rest of the world in 2011 via global trade flows, the global banking system, and the financial and capital markets and hence it is very important that individual countries cannot be considered and fully understood in isolation, but must be viewed in a global context. Sarasin’s current view of India is therefore quite rightly shaped by its assessment of the global economic trend and the performance of different asset classes.
India, like the other emerging market countries of Asia, is confronted by a global economic cooling at the start of 2012. But whereas countries like China can respond to weaker export demand with a sharp reduction in key interest rates, the Reserve Bank of India (RBI) will find macroeconomic management more difficult. Inflation in India proved extremely stubborn in 2011. As a consequence, the RBI can relax monetary policy only gradually, with the result that the downturn in India will be stronger than in the rest of Asia. However, the central bank’s difficulties in combating the downturn might also provide a catalyst for the country’s long-overdue structural reforms. India’s infrastructure, especially in the industry and the agricultural sector, lags the strong increase in aggregate economic demand and represents a serious bottleneck for the country’s growth.
India’s growth is less than 7% in 2012
India will have more problems in stabilising the economy and returning it to a growth path than, say, China. Sarasin expects the Indian economy to slow until mid-2012 and subsequently pick up in the second half of the year. The growth rate in 2012 is likely to be between 6% and 7%. This cautious outlook is supported by the timely indicators at the end of 2011: industrial production is decreasing sharply and purchasing indicators have dropped substantially in the last twelve months.
Yields should retreat in 2012
Whereas yields in the other Asian emerging market countries retreated in 2011, yields on 10-year Indian government bonds rose. Sticky inflation and the attendant powerful rise in key interest rates have weighed on bonds. But as the economy cools further, the first interest rate cuts during the year are likely to give Indian government bonds significant upside potential this year.
Philipp Baertschi, Chief Strategist, Bank Sarasin & Co. Ltd, Switzerland
“High interest rates and difficult conditions abroad mean that India probably faces a difficult first half in 2012, like other Asian emerging markets. If the RBI stabilises economic performance without losing sight of inflation, we predict a soft landing scenario from an economic and structural standpoint in twelve months’ time. Given the historically attractive valuation of the Indian equity market we are optimistic about its prospects in the 2012 investment year and expect it to produce a return of 20%-30%.”
Depreciation of the Indian rupee creates long-term opportunities
Following the unprecedented depreciation of the currency, the rupee is clearly undervalued and offers long-term investors attractive investment opportunities. Interventions by the RBI will slow the downward spiral but they cannot stop it. However in the short term, global risk appetite will remain the driving force behind the rupee’s performance. Whether the rupee rebounds in 2012 will depend on the global economy and the euro debt crisis. The rupee stands to profit disproportionately from any easing of the euro crisis. However, the future mix of Indian politics as well as high inflation represents a structural drawback for the rupee compared to other emerging market currencies.
Indian equity markets: Clear upside potential in 2012
2011 was a disappointing year for Indian equity markets. Whereas a year ago, the Indian stock market was considered expensive in absolute and in relative terms compared to the other emerging market countries, it decreased strongly in value as the year progressed as the earnings in 2011 continued to climb – albeit only slightly – to a record level and the market capitalisation decreased noticeably. The development of the two valuation components, equity prices and earnings, led to a sharp drop in the price/earnings (P/E) ratio of the Indian equity market. Although the valuation is not as cheap as it was at the end of 2008, it is well below the long-term average.
We are optimistic about the Indian equity markets’ prospects in the 2012 investment year and expect it to produce a return of 20%-30%. More than half of this expected return is likely to come from a decline in the risk premium. The Indian equity market at the outset of the year is likely to put in a below-average performance compared to other emerging markets. The stock market should advance strongly during the course of the year on the back of a decline in risk aversion, a stabilisation in growth and the projected recovery in the Indian rupee. Based on its medium-term growth prospects, we think the Indian market has above-average potential, which we do not think will be fully exhausted in 2012.