2011 may be a choppy ride on Dalal Street

WARNING FOREIGN FUND FLOWS MAY SLOW

LAST Friday, most retired people had their best New Year eve in three years with banks promising them 9.25% for deposits. That should ring alarm bells for the young who plan an early retirement with bountiful returns from equity investments.
    Nine per cent growth hysteria notwithstanding, stock investors would do well to look at factors that lurk — rising borrowing costs, soaring commodity prices, poor infrastructure, pressure on profit margins, expensive share valuations, fiscal profligacy, early revival in the US and a likely slowdown in overseas fund flows because of all these.
    Indian equities have had a dream run over the past two years since the credit crisis when yield-chasing global investors poured in record funds. That made the benchmark Sensex one of the best performers in the past two years, and also the most expensive among peers.
    More than $45 billion in overseas equity investments in two years and cheap domestic funds helped many, including investors. Companies on the brink of collapse got their lives back, the government's tax revenues accelerated and incomes rose for most.
    All that had an unintended, but well-known fallout — soaring prices that now threaten the very growth that made investors fancy Indian equities.
    "It will be a challenging year," said Dharmesh Mehta, Head (equities) at Enam Securities. Challenging Year: Many adverse factors loom
IT WILL be a challenging year due to rising inflation, higher interest rates, record crude oil price, large money-raising target, political pressures and volatile global markets against India's strong domestic consumption and 8%-plus growth story," said Dharmesh Mehta, Head (equities) at Enam Securities.
    Reserve Bank of India Governor Duvvuri Subbarao, who signalled that he may be through with raising policy rates after doing it six times to 6.25%, may reverse his stance due to reemergence of inflation that was expected to cool after the monsoon.
    Inflation, as measured by the Wholesale Price Index in November was at 7.5% compared with 4.5% a year earlier. The RBI's estimates put it at 5.5% by March. Food price inflation averaged 16.9% in April-November, compared with 12.4% a year ago. The UBS Commodity index rose by a quarter in 2010. Even if domestic factors are tamed over the year, the loose monetary policies of the US Federal Reserve and the European Central Bank for a long time could cost emerging markets such as India dear.
    The easy availability of money has led to many commodities such as copper, rubber, coffee and gold trading at record highs. That could slow the profit growth of companies, leading to investors cutting equities. Crude is racing to $100 a barrel threatening India's current and fiscal deficits.
    That would be a bigger drag on Indian shares which are already trading at a valuation that is more than peers such as Brazil and China.
    "The Indian market appears to be fully valued on a number of metrics," Saurabh Mukherjea of Ambit Capital wrote in a report. "Even after the scam-induced correction, India is one of the most expensive."
    Indian shares returned 17.6% in 2010, more than the 81% a year earlier. That compares with 15% negative returns for Shanghai and 1% gain for Brazil. That performance pushed India's shares to a forward year price-toearnings multiple of 19.42 times, compared to Brazil's Bovespa at 12.94 times and China's at 15.95 times. Russia is at 8.69 times. Weak fundamentals could be worsened by fiscal issues too. The government, which got more than Rs 1 lakh crore as a one-time revenue from auctioning 3G telecom spectrum, seems to be headed towards spending more next fiscal, worsening its fiscal deficit forecast at 5.5% of gross domestic product.
    With assembly elections scheduled in major states such as West Bengal, the government may be generous with welfare spending.
    "With the rise in government revenues, we are raising this (for welfare schemes) allocation further," Finance Minister Pranab Mukherjee said last week. "The government income will increase once investment increases."
    Higher borrowings because of welfare programmes and fuel subsidies to oil marketing PSUs would put further pressure on interest rates which have firmed up in the last six months.
    With the Manmohan Singh government close to paralysis due to the telecom scandal, it may not move much on economic reforms such as higher foreign direct investment in insurance, that have been pending for years. The government has missed its target in many sectors, including power generation, road building and mining. "The complexity of doing business in India, high levels of bureaucracy and opaque processes contribute to high corruption," Sanjeev Prasad of Kotak Securities wrote in a report. "India may need to overhaul some of its current practices and strengthen its institutions to sustain a high level of GDP growth for an extended period of time." Overseas investors could take a dim view of investing in India after a spate of scandals such as the arrest of eight finance executives in the bribes-for-loans scandal.
    With the US recovery still fragile and European sovereign crisis in headlines, international investors may play safe with US treasuries, which yield 3.5% now. "This may impact the FII/FDI flows to India, which is critically dependent on them today as we run a high current account deficit of almost 3.5%," Edelweiss said in a recent report.