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Keep An Eye On India
Malaysia Perspective | 22 February 2012

By Yeoh Mei Kei

In 2011, India’s equity market was characterized by volatility as investors’ sentiment was negatively impacted. The poor investors’ sentiment was a result of various factors such as an unfavorable economy, rising inflation, monetary tightening by the Reserve Bank of India (RBI), depreciation of the Rupee, prolonged government divestment programme, a lack of policy reforms, and the unresolved European debt crisis among others. Declining by 24.6 percent in local currency terms and by 34.4 percent in RM terms, the Indian equity market was the worst performing market in 2011.

Looking ahead into 2012, investors are likely to remain concerned over India’s economic outlook. We explored some of the key issues that the Indian economy are currently facing as well as which of these should garner investors’ concern going forward.

Inflation: WPI To Trend Down

India’s annual inflation based on Wholesale Prices Index (WPI) has been sticky and has remained elevated for more than two years. WPI continued to remain at elevated levels, though moderating to 7.47 percent in December 2011, the first time after 12 straight months, in which annual inflation has been over 9 percent. The drop in the WPI to 7.47 percent in December 2011 is the first sign that slowing growth and a good monsoon are finally reducing inflation in 2011. However, it doesn’t mean that inflation will start sliding downwards. A closer look at December 2011 figures narrates the actual picture.

One of the reasons why the WPI in December 2011 moderated to 7.47 percent was because food prices have fallen after a good harvest. Traditionally, food prices tend to fall in winter due to higher near-term supply after summer’s harvest, a seasonality effect. Hence, this seasonality effect on inflation is not likely to be sustainable as is not a result of anti-inflationary policy or monetary action. Meanwhile, inflation on both food and primary articles, which account for a weight of around 20percent in the WPI, have significantly fallen from 8.53 percent in November 2011, to 0.74 percent in December 2011, attributing to almost all the moderation on the WPI. In addition, manufacturing, and fuel and light, which constitute 65 percent and 15 percent of the WPI respectively, or nearly 80 percent collectively, are also easing. Inflation on manufacturing eased from 7.70 percent in November 2011 to 7.41 percent in December 2011, while inflation on fuel and light reduced from 15.48 percent to 14.91 percent over the same period.

While inflation has started to show signs of easing, it is mainly due to the base effect and the good kharif harvest. The vegetable prices have started declining subsequent to the good harvest, which has resulted in a substantial easing of the food price index recently. In the coming months, if the inflation on food, manufacturing, and fuel and light keep on reducing, then we may see lower inflation numbers in the near future. We think there is a scope for further moderation in inflation due to softening impact of primary articles and also due to the base effect. Therefore, we expect WPI to trend down, leading near to 7percent by financial year FY11 (ended March 2012).

Interest Rate: Rate Hike To Pause

After increasing key policy rates 13 times since March 2010, the RBI has paused hiking interest rates in its recent mid-quarterly review of monetary policy, held on December 16, 2011.

The Central Bank has maintained the Repo Rate (rate at which banks borrow from RBI) at 8.50 percent, and Reverse Repo Rate (rate at which the RBI borrows from banks) at 7.50 percent. The Central Bank also maintained the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) at 6 percent and 24 percent respectively.

The RBI policy in the last two years has been focusing on inflation in the economy in varying degrees. Now, the focus has started to shift to growth, since, as explained by the RBI:

“Downside risks to growth have clearly increased.”

With the Repo Rate and CRR unchanged, the cost of doing business in India continues to remain high. Going forward, we expect RBI to pause the interest rates hikes for some time and then start cutting rates in 1Q13. As the interest rates were raised to tame inflation, RBI may cut the rates only after seeing the definite signs of inflation coming down.

Gross Domestic Product: Slow To 7.25percent-7.75percent In FY2012

India’s Gross Domestic Product for July-September 2011 (2Q11) grew at a pace of 6.9 percent year-on-year, down from the prior quarter’s 7.7 percent expansion. This was the slowest growth in nine quarters. High inflation combined with global uncertainties was the probable cause for the slowdown. The government has cut its growth forecast for the year to around 7.5 percent, down from a previous forecast of 9 percent. However, a fall in industrial output has raised doubts about the economy’s ability to even meet this new target.

During the first half of the current financial year, the economy grew at 7.3 percent, which suggests that it would be rather difficult for the government to meet its deficit target for 4.6 percent for 2011. Economists expect the deficit to cross 5.5 percent owing to higher borrowing, lower revenue accrual and the increasing burden of subsidies. The government has also admitted that it wouldn’t be able to meet the current financial year’s targets for growth, fiscal deficit and disinvestment, and pinned its hopes on the economy bouncing back in FY12.

However, as the RBI started moving from inflation management to growth management, we expect it to start easing monetary policy somewhere in the 1Q13. In the mid-year analysis of the economy for FY12, we expect growth may possibly slow to 7.25 percent-7.75 percent from its budget estimate of 9 percent.

Rupee: Remains Weak In The Near Future

T rupee fell to a record low of 54.17 per USD breaking the 54 level for the first time in history. It has fallen by nearly 18 percent since the start of 2011, depreciating sharply since July 2011 even though it stayed range-bound (between 44 to 45 Rupee per USD) in the 1H11. Among the Asian currencies, it has performed the worst.

The RBI and the government have taken certain measures to support the Rupee recently. For example,

  • The RBI sold USD and bought Rupees in the last couple of months.
  • The RBI has reduced the net overnight open position, or trading limits, for banks in the foreign exchange market.
  • The RBI allowed microfinance institutions to raise up to USD10 million during a financial year through external commercial borrowings for permitted end-uses.
  • The RBI raised the ceiling on interest rates that companies can pay on foreign loans, subject to the funds being brought into the country immediately. By this step, the overseas borrowing by Indian firms has become easy and foreign money may flow in.
  • The government increased the ceiling on Foreign Institutional Investment in Government and Corporate Debt by USD5 billion each.
  • The Government is launching some reforms in various sectors to boost the economy. For example, the 100percent Foreign Direct Investment in Single-Brand Retail Stores. The government hopes the provision of full ownership in single-brand retail will bring in much-needed foreign investment.

These steps taken by the RBI and Government have seen the rupee appreciated slightly against the USD. At the end of the day, sentiment on the Rupee is still subjected to various external factors and the RBI has very limited control on it. The major domestic issues, slowdown in growth, and widening fiscal deficit may as well cause the rupee to remain weak in the near future.


We discussed some of the big issues faced by the Indian economy in 2011. As per our in-house estimate, the Indian equity market is currently valued at a PE of 13.1X and 11.5X for FY12 and FY13 (as of 3 February 2012), with potential upside of 41.7 percent by end of FY13. Hence, we maintain a “Very Attractive” rating of 4.0 stars for the Indian equity market. With the prospect of inflation further softening following significant easing in the last 2 months, room for the central bank to stimulate growth by easing monetary policy is now available. Investors can consider entering into the Indian equity market with a long term perspective.

Yeoh Mei Kei is a Research Analyst at

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