The upward movement in the market over the past few months has mainly been driven by re-rating, with the expectation that the reforms process will continue, believes Ramanathan K, CIO, ING Investment Management. Ramanathan says these reform measures could prompt the RBI to effect a token 25-bps rate cut at its policy meeting next week. In an interview with Ashley Coutinho, he says the pace of earnings downgrades may be bottoming out. Excerpts:

What is your outlook for the equity market in the year ahead, especially in the light of the reform measures initiated by the government of late?

The positive momentum in the equity market may continue if the government continues with its reform initiatives. The GDP growth for FY13 is expected to be in the range of 5-6%. This is much lower than the 7-9% that we used to clock earlier.

For us to go back to this level of growth, the government needs to create a conducive environment to help restore the confidence of entrepreneurs and consumers, and revive investment demand.

The government needs to control wasteful expenditure and take concrete steps to tackle the high fiscal deficit. Also, steps to reduce subsidies are essential. The upward movement in the market over the past few months has mainly been driven by re-rating, with the expectation that the reforms process will continue, implementation will be smooth and the same will get reflected in the earnings growth of companies over a period of time.

The key triggers for the market going forward are continuation of the reforms process initiated by the government, monetary actions by the RBI and developments in euro zone.

How do you view the interest rate trajectory for the year ahead?

We expect a cumulative 50 basis points (bps) cut in the repo rate by March 2013. We would assign a 50% probability of a 25-bps cut in the upcoming credit policy. High inflation and high fiscal deficit would dictate that the RBI would hold rates. However, one key reason to expect a 25-bps rate cut is action by the government on the reforms and fiscal fronts. The government has come out with several measures on this side and may possibly follow up with more fiscal reforms and measures to control expenditure. This could tilt the RBI in favour of a token 25 bps cut in repo rate.

Which debt products are likely to do well in case the RBI goes for a rate cut?

Being low on duration, the short-term income funds and the money market funds would do well in case the RBI maintains a status quo. These typically are accrual products.

The income and gilt funds would do well if the RBI goes for a rate cut. These funds typically have higher duration bonds which would benefit from a rate cut.

Will we see downgrades in the coming quarters? Do you see the fundamentals of the economy improving going forward?

We see the pace of downgrades bottoming out and expect the pace of reforms to continue. The country needs speedy decision-making in tackling issues pertaining to areas such as environmental clearances and infrastructure development. If the reforms announced over the past few months are implemented the way they should be, we can hope to to get back to the 7-9% GDP growth range. Interest rate cuts and maintaining adequate liquidity to spur growth will also be critical.

What are the global cues to watch out for?

Developments in the euro zone and growth recovery in the US and China need to be watched closely. The ECB and Fed have clearly shown their intention to sustain easy liquidity to foster growth.

Continuation of easy liquidity is positive for FII inflows. Global oil prices and related tensions in the West Asia would also be factors to keep an eye on.

Which sectors are you betting on?

We are positive on the financials, cement and pharma sectors. In the financial space, while we are still seeing asset quality issues (especially in PSU banks), valuations are attractive. Private sector banks that have managed their asset quality well are seeing good earnings growth.

The cement sector has seen a structural change in the level of profitability. Also, there are several mid-cap cement companies available at steep discount to large caps. We are underweight on metals and utilities. We do not see global commodity prices rising significantly as the recovery in the developed economies is expected to be prolonged.