Nilesh Shah and Sukumar Rajah.....

"MOST investors will sell emerging market assets in favour of developed markets. This is like jumping out of the frying pan into the fire" The stock market has turned highly volatile as global worries far outweigh the strong fundamentals of the domestic economy. Is it a good time to buy or just lie low? Bijoy Sankar Saikia posed the questions to Nilesh Shah, the man reputed for his razor-sharp analysis of the domestic market( He was a Topper and a Gold Medalist in CA), and Sukumar Rajah, the investment manager who knows global markets like the back of his hand. Both converged on one conclusion: There is a huge opportunity for smart investors in this crisis


The March quarter numbers, the GDP figures and the recent auto sales numbers all point to a strong undercurrent of consumption-driven growth in the domestic economy. But the stock market continues to remain jittery. Where do the downside risks lie? Do global prob lems such as the worries from the euro zone or China have the potential to derail our recovery?

While Indian stock market is linked to global flows, our econo linked to global flows, our econo my has less linkage with the global economy and continues to thrive on domestic consumption, demographic advantages and domestic growth opportunities. Notwithstan-ding the marginal adverse impact of global slowdown, Indian equity markets will get impacted adversely whenever FIIs sell to reduce the risk on account of global developments. However, it will be a short-term phenomena. On the contrary, these corrections will be beneficial for investors. Investors need to look at these corrections as opportunities to participate in the Indian equity market.

If one can take the short-term pain of volatility, every correction driven by global events will be a great entry point for investors. One needs to be patient and wait to tide over the volatility to gain in the long term.

One big worry is on the liquidity front. As overseas debt gets costlier and domestic liquidity gets tighter, will it delay the much-awaited domestic capex cycle?

The developed world has many issues to handle on growth and debt. They are likely to keep loose monetary policy for a long period. Overseas debt has become costlier for companies and countries that are likely to default. India has not defaulted to anyone since the Harrapa Mohejondaro days. Unfortunately, rating agencies did not read history and rated Greece, which did not have a strong credit history like us, at much higher level. Now their myth is out in open.

Hopefully, investors will realise that their perception of the developed world being safe and risk-free is no longer valid. Emerging markets being risky is also not true. The US has become the largest debtor to the world. By definition, it cannot be considered a safe haven any more.



The definition of risk is changing for global markets and this gives us the comfort that India will be able to raise the resources it needs to fund growth.

More importantly, we can pursue our growth targets with our own savings.

Our capex cycle is restricted by our inability to execute.



Do Europe and China top your list of worries or are there other factors that you feel could present challenges for the domestic economy and equities market?

Notwithstanding the fact that EU is India's largest trading partner, their crisis will have limited impact from an economy point of view. We expect China to soft-land its economy in FY11.

It should have a marginal impact on us.

For the Indian economy, the worry continues to be inflation, governance, reforms and speed of execution. Our economy is more likely to get impacted by what happens in India rather than outside. In the short term, equity markets and economies can be delinked. It is possible that Indian equity market moves in line with global mar kets, espe cially due to the fundflow linkage.

Other than that, our market will be impacted more by how the economy responds to factors like monsoon, inflation, soon, inflation, fiscal deficit, interest rates, etc.



Risk aversion seems to be the buzzword in equity markets worldwide. The volatility in equities and the sudden surge in gold prices point to a flight of investors to safe havens. The fear is strong across markets. Your comments?

Surely. When longstanding myths are shattered by harsh reality, it causes risk-aversion. A generation was told a myth that developed economies were safe havens. In global markets, investors are witnessing a six-sigma scenario. They did not build a model for such an event. Survival instincts are pushing them to be risk-averse. But many a time people jump out of frying pan into the fire. Maybe, most people will end up doing that as they sell emerging market assets in favour of developed market assets. Only a small minority of smart and intelligent investors will recognise the power shift from West to East.

The rupee has gone into a tailspin of late. Is there a risk of strong currency fluctuations hurting some key sectors?

The rupee is reflecting the movement of fund flows. It is not reflecting fundamentals. Our economy can easily withstand such short-term aberrations.

The RBI has enough reserves to manage any unwarranted move.



FIIs have been net sellers in May. The sentiments of foreign investors appear to be turning weak. What could be the trigger for this outflow? Is it their risk perception for the Indian market or their own domestic concerns?

FII outflows have been the result of the global financial turmoil rather than any concerns on India. On the contrary, the global crisis will put India in the spotlight again. For Asia and, specifically India, the global pain represents an opportunity to out shine the global economies.

India today is well poised with all the right constituents for success. The fundamentals of India are sound and opportunity is plentiful. Therefore, the crisis presents India with the opportunity to capture the attention of the global capital seeking better returns on investments. It will not be prudent to paint all FIIs in one colour. There will be many FIIs who will behave like a herd to get in and out of India. There are FIIs who are smart and will use the correction to enter India.



One view is that emerging markets are already past their worst and the move ahead from here is upwards? Another view is that emerging markets were actually the biggest beneficiaries of the easy liquidity and as purse strings get tightened, these markets are going to take a bit.

The Indian growth rate continues to be among the highest in the world, second only to China. The Indian growth rate even in a year like 2008 was higher than developed economies. The positives of the economy and its structural growth continue to make India an attractive investment destination. We will continue to draw inflows from overseas in search of high-yielding assets.



Also while the 2009 rally was liquidity-driven, the consumption story of the economy also supported the market well. First, while FII inflows have been key to the rally, the domestic consumption story has also been a significant contributing factor.

Given that our saving rate is around 35% of the GDP , we believe this consumption story will continue going forward. The test from here on will be on our ability to remove the bottlenecks in the growth path and demonstrate operational efficiency and real sector growth.



What are the five domestic factors you will be watching to remain confident on the economy and the stock market over the next two quarters?

Monsoons, oil prices, inflation and interest rates will provide guidance for the next two quarters. India needs to have a good monsoon to keep commodity prices low and moderate inflation. Oil price movement will be tracked closely as any significant upward price pressures on oil can increase inflation. Interest rate movements will be crucial to determine the direction of the market and the economy. The government has two options before it, one to raise interest rates and curb inflation and the other is to address supply side constraints of inflation by improving capacity and developing infrastructure. From a long-term stock market view point, there is only one factor to watch out for: India should not become complacent and take growth for granted.



How do you look at market valuations? What's your outlook on earnings upgrade for Indian companies over the next two quarters?

It is difficult to predict short-term market direction. At present level, the market is certainly not cheap like it was in March 2009. It is at the higher end of fair value. We do not expect the Indian market to get re-rated from present levels, which are in line with historical averages. From here on, the market growth will track earnings growth. What looks fairly priced at this point may look reasonable over the next six months and may look cheap on one-year basis

This is Sukumar's View

"FUNDAMENTALS prevail over the long term and India certainly has stronger fundamentals compared with most economies"




The March quarter numbers, the GDP figures and the recent auto sales numbers all point to a strong undercurrent of consumption-driven growth.

But the stock market continues to remain jittery. Where do the downside risks lie? Do global problems such as the worries from the euro zone or China have the potential to derail our recovery? Are there other factors, which you feel could present significant challenges for the domestic economy and equities market?

While India's growth prospects remain strong from a mediumto long-term perspective, stock markets have weakened largely due to weak global sentiment and FII outflows. The recent volatility in the global financial markets is an indication that the global economy has not fully healed from the crisis of 2008 and investors are wary of systemic risks.

We continue to believe that fundamentally sound economies like India (especially those dependent on domestic drivers) are unlikely to be impacted by the sovereign debt crisis in Europe. The impact is felt more so in the financial markets due to FII flows. In the case of China, we feel the recent tightening measures by the authorities should help address the concerns around the property market and overheating (of the economy).



The government has exhibited its ability to steer the economy well in the past and is likely to continue to do so in the future. There are some shortterm concerns, but domestic consumption has been increasing strongly helped by the rise in disposable incomes -as reflected in the fact that it has become the largest automotive market in the world. From a mediumto long-term perspective, we are positive on the China's growth prospects.



One key concern is on liquidity front. As overseas debt gets costlier and domestic liquidity comes under stress, will it delay the much-awaited domestic capex cycle?

From the international market's perspective, reduced global liquidity and risk appetite can have implications for corporate India's overseas borrowings plans. However, given that domestic credit has remained relatively muted in the ongoing recovery cycle, we don't expect any major systemic issues. Several large companies have managed to raise capital in the market over the past few quarters and credit offtake has begun to come off lows. While increased global uncertainty could have an impact on corporate India's plans, until and unless the global growth situation worsens dramatically, we don't see any major change of plans.



Risk aversion seems to be the new buzzword in equity markets worldwide. The volatility in equities and the surge in gold prices point to a flight of investors to safe havens. The fear factor is strong across markets. Your comments?

Market sentiment tends to move in extremes due to various factors, but over the medium to long term, equity markets reflect underlying fundamentals. Until a month back, global equity markets were ignoring rising fiscal deficits across the globe and the lacklustre uptick in employment growth.

Some of the markets even appeared to be in an overbought situation.



A series of headline news focusing on fiscal problems faced by few countries in Europe and the regulatory oversight of the financial sector has now brought the focus on the magnitude of the issues and hence, broad markets are now factoring in these issues.



As mentioned above, fundamentals prevail over the medium to long term and India certainly has relatively stronger fundamentals compared with most economies. In that sense, any sharp decline should be viewed as buying opportunities.



In spite of the strong volatility in markets, India has managed to put up a brave front in the face of the European crisis. Can India hold its fort if the crisis deepens and global economies go into another slowdown?

How real is the fear of a double-dip recession in the West?

The Indian economy is largely domestic driven and relatively lower credit growth and the large forex reserve should help India manage this phase comfortably and the drop in global commodity prices should provide some respite. However, export growth has been lagging behind import growth in recent times and could be impacted by a slowdown in Europe, resulting in a wider trade deficit.

Nonetheless, India's resilience through the global slowdown over the past two years clearly underlines the fact that the economy is one of best structural stories across the globe.



The rupee has gone into a tailspin. Is there a risk of strong currency fluctuations hurting some key sectors of the economy?

Currency fluctuations are largely dependent on global sentiments and foreign inflows ­ a strengthening rupee tends to impact export-oriented sectors while benefiting importers as well as reducing the impact of energy imports. However, most companies typically use various instru ments and contract negotiations to mitigate the impact of sharp fluctuations.



FIIs have been net sellers in May. The sentiment of foreign investors appears to be turning weak. What could be the trigger for this outflow? Is it their risk perception for the Indian market or their own domestic concerns?

The selling has been largely due to the change in risk appetite of global investors rather than any macro concerns about India.

Global investors with a longterm view are likely to view any sharp correction (in India) as a buying opportunity. Despite the outflows in May ($2 billion), year-to-date FII flows stand at a healthy $4.6 billion.



One view is that emerging markets are already past their worst and the move ahead from here is upwards? Another view is that emerging markets were actually the biggest beneficiaries of the easy liquidity and as purse strings get tightened, these markets are going to take a bit of a hit. Your views?

The rally seen in 2009 and the early part of this year has been driven by high global liquidity levels and investors being in search of higher yields given the sharp drop in global interest rates. As central banks normalise monetary policies, some of this liquidity will be drained out and it will impact markets. However, instead of lumping all emerging market economies together, one needs to focus on those countries with large populations and strong domestic consumption stories.

Such economies will be able to withstand any slowdown in the global recovery or liquidity. As per Institute of International Finance (IIF) estimates, emerging economies will receive inflows of over $700 billion in 2010, 33.5 per cent more than 2009 level.

What are the five domestic factors you will be watching to remain confident on the economy and the stock market over the next two quarters?

Among an array of domestic economic and corporate indicators, IIP, inflation, earnings, capex and consumption trends will be some of the factors to watch out for over the next two quarters.



For India, we believe at this point in time, key macro challenges are inflation and fiscal deficit. On the latter, the government has outlined a roadmap to consolidate imbalances and reduce government borrowing, which is a positive. However, the progress will need to be monitored, especially on marketdependent items such as disinvestment and subsidy outgo in FY11. Any substantial increase in international crude oil/commodity prices will be key to the inflation outlook for India as well as the monsoon season. The progress on some of the infrastructure programmes and tax reforms is critical for long-term growth.



What's your outlook on earnings upgrade for Indian companies over the next two quarters?

The recent earnings season has been a positive and earnings visibility for the coming quarters is on the brighter side, even as overall trends were divergent across sectors.



However, earnings revisions have slowed in the recent past, with changes being announced for select companies based on business developments. Most of the positive factors seem to be priced in and we will need to see progress in the first half of FY11.

The composition of the Sensex is commodity-heavy and, hence, sustained decline/low commodity prices can impact earnings growth