Global investors may prefer developed markets to emerging economies in 2011

While fundamentals haven’t deteriorated, the next couple of quarters could see margin pressures on rising interest rates and higher commodity prices says Sashi Krishnan, CIO of Bajaj Allianz Life Insurance. He tells FE?s Ashley Coutinho that he expects modest return of 15% in 2011 for Indian equities with return of growth in US and inflation being major headwinds.

How do you see the market performing during the rest of the year (FY11)?

Indian equities should give modest returns in 2011?returns very similar to 2010 which are in the region of 15%.

What are the headwinds that you foresee for the market?

Large inflows from the FIIs into Indian equity characterised 2010. We may not see this kind of inflow in 2011. However, growth is returning to the US and, therefore, global investors may prefer to invest in the developed markets instead of emerging markets. Secondly, if US growth revives, export-led economies like China, Taiwan and Korea will benefit. Emerging market allocations will, therefore, find their way into these markets.

Growth in 2010 has been largely driven by demand-side factors and private consumption. This could have peaked and if we expect the growth cycle to continue, the investment cycle has to return. This, however, looks unlikely as liquidity is extremely tight.

Inflation is another big worry. Because of mismanagement of the food economy, food inflation remains elevated and this will ensure that RBI will continue to tighten through 2011. Further, there is little hope on the fiscal deficit side as expenditure is relatively inelastic and will only rise next year with the continuing under recoveries on the oil subsidy front and the introduction of the food security legislation.

Being one of the most expensive emerging markets, do you think India?s premium over other markets is justified?

The premium that India had to other emerging markets has reduced quite significantly in the recent few weeks though they still remain high. The one year forward P/E for the Indian market is around 17 times against the one year forward P/E for emerging markets is 12 times. This premium can be justified because India is one of the few countries with a nominal growth of 16%. There is also good growth visibility and ROEs have been consistently high. Investors also were willing to give an additional premium as they though that corporate governance standards had improved and market regulations were robust. I think that some of this premium will have to be given up as perceptions on some of these fronts have changed.

Which sectors are you betting on and which ones are you bearish on?

While fundamentals have not deteriorated, the next couple of quarters could see margin pressures on account of rising interest rates and higher commodity prices.

We remain bullish on domestic consumption driven sectors and remain wary of sectors that depend on the revival of the investment cycle.

What impact will rising commodity prices, especially crude oil prices, have on the earnings of Indian companies?

India imports 75% of its oil requirements and any increase in oil prices leads to a substantial increase in our trade deficit and an equal increase in under recoveries for the oil companies. Rising oil prices thus leads to a higher current account deficit and rising inflation. Thus the macro impact is substantial. While oil marketing companies will be directly impacted, other manufacturing companies will see a squeeze in margins because of rising input costs.