While the GDP growth of 4Q has been a pleasant relief for investors, the question still lurking in their mind would be, is it sustainable? The good news in the 4Q GDP report is the strength in private consumption at 14% growth in 4Q in nominal terms despite the drought and the revival in the investment cycle with 25% growth in nominal terms in 4Q. I think this momentum will continue into FY11, and barring unforeseen circumstances, one can expect FY11 GDP growth of 8.5%. Private consumption and the revival in the investment cycle will be bigger contributors to growth in FY11, more than offsetting the deceleration in government expenditure, monsoons being the big wild card. On the flip side, however, such strong growth numbers would imply continued policy tightening from the RBI, in response to the inflationary pressures. I expect another 100bps hike in policy rates through the rest of FY11.
The sudden spike in the price of risk in early May has resulted in huge swings in currencies, commodities, equities and bond prices, with some key commodities declining 10-25% MoM. Perversely however, the fall in commodity prices will have beneficial impact on inflation and the current account. At current oil prices, FY11 current account deficit will be under US$30bn (<2% of GDP) and will be lower than that in FY10. This is a fairly modest quantum of deficit for a country of India’s size and I think it will be easily funded by even modest capital flows.
The worries over fiscal deficit have also abated with the highly successful 3G and BWA auctions. The extra revenue from these auctions will lower government’s fiscal deficit (and borrowings) by ~1ppt easing the pressure on long bond yields. This, coupled with prospects for normal monsoon and consequent easing of inflation will ease the upward pressure on interest rates – RBI will tighten rates gradually (~25bps hikes) rather than have to raise interest rates sharply in my view.
While the European Union is an important market for India’s merchandise exports (with a share of 15-20%, though it is declining), the share of the severely affected PIIGS countries is just 4%. The share of India’s services exports to these countries is even lower, in my view. Thus, I do not see a negative impact of the current European crisis unless the crisis spreads to the bigger European countries like UK, Germany etc. However, with the euro weakening significantly (it’s down ~15% against the rupee since the start of FY10), imports from EU into India (primarily capital goods and transport equipment) will likely increase.
Market valuations are currently trading broadly in-line with or a shade lower than historic average, leaving room for appreciation for long term investors. With macro fundamentals improving significantly and prospects for over 20% earnings CAGR over next two years likely, equity markets look attractive for investors with patience to ride out the intermittent bouts of volatility.
The above is my article published in Business Standard Smart Investor on 8th June 2010