India: High beta on Bernanke’s benevolence:: IIFL

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India: High beta on Bernanke’s benevolence


• The US-dollar carry trade is back with a bang. Since the last week of August, when the Fed indicated its
intent of another round of quantitative easing, all non-dollar assets—commodities, currencies, emergingmarket
equities, junk bonds—just melted up. Precious metals are up 10%, base metals have risen 15%
and emerging markets by 15% in US-dollar terms. India is no exception—since 1 September, FII flows
have surged, and net buying in 2010 YTD has hit a new record of US$23bn. In contrast, DIIs have been
big net sellers since 1 September (US$5bn), mainly owing to continuing redemptions in mutual funds.
• The INR is up 5% since 1 September, as capital flows have overwhelmed the increase in the current
account deficit, and RBI has maintained a hands-off policy. In all likelihood, FY11 current account deficit will
cross US$50 billion, ~3% of GDP. FDI inflows remain sluggish and are down 30% YoY in FY11 YTD. India is
thus critically dependent on FII flows to fund its savings-investment gap and sustain growth at current levels.
In effect, India is a high-beta proxy on global liquidity. On the fiscal side, the 30% YoY jump in tax collections
over April–August is a positive surprise.
• Despite a good monsoon, sequential food price inflation has remained stubbornly high. However, we
expect overall inflation to subside in the next few months on a YoY basis, thanks partly to the rupee’s
recent appreciation, and the higher base. We believe RBI’s calibrated monetary policy-tightening is
headed for a pause after another 25bps hike in November. Monetary transmission, post the effective
275bps increase in policy rates in the past six months, is gathering pace.
• With the 15% jump in market capitalisation in the past six weeks, India’s market-cap-to-GDP has risen to
104% (vs. last six years’ average of 81% and 2008 high of 151%). Trailing P/B is almost in line with
medium-term averages, while forward PE multiples continue to discount strong earnings growth. The
recent recovery in metals prices will help, given the sector’s 15% earnings weight in Nifty. Sustenance of
current valuations hinges on consensus estimates for Nifty FY10-12 EPS CAGR of 22% being met.