India Equity Strategy The INR-Equities Divergence : JPMorgan

 Indian equities outperformed the peer group significantly over the last
month. This followed a sharp correction in global crude oil and gold prices.
Investors expect a substantial reduction in the Current Account Deficit
(CADs) providing the RBI with more leeway to cut benchmark interest
rates. Inflation and the fiscal account are also expected to benefit.
 But the INR has depreciated 5% from its April highs. The bulls will
point to US$ strength as the key reason. That, however, may not explain the
relative underperformance vs. peer group currencies. The currency market’s
caution could suggest that the moderation in CAD may not be as sharp as
expected. J. P. Morgan Economists estimate FY14E CAD at 4.6% (down
only 50 bps from 5.1% for FY13E) vs. consensus estimates of 3.5-4.0%.
 Recent datapoints are supportive of the currency markets. Lower gold
prices have led to a surge in volumes. Crude oil prices have recouped more
than half the losses sustained in early April. Our Global Commodities team
points out that the recent weakness could be more a function of seasonal
factors rather than cyclical or structural factors.
 The INR depreciation, if sustained, will put pressure on inflation and
also increase the cost of capital particularly for companies with
meaningful FX borrowings, in our view. Down the line, any tapering of
easy monetary policy in developed economies could accentuate the stress
for corporate earnings as leverage is high and growth is disappointing.
 We remain cautious on the equity market. Growth is below trend and
investor expectations. The policy environment remains challenging given a
substantial political calendar. Our portfolio stance is defensive and favors
high quality financials, IT services, Energy, State-owned utilities and ‘sin
stocks’ within the consumption basket.

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