‘India needs $40 bn inflows in 2011 to just have a flat market’

Credit Suisse expects the Asia region to do well even in 2011 and sees a 20% upside to the MSCI Asia ex-Japan index. But feels India will lose its attractiveness to markets like Korea and Taiwan. It has set a modest target of 21,600 for the Sensex by December 2011. In an interview with Samie Modak, Credit Suisse Securities India director Ashish Gupta said foreign flows, crude and inflation pose major risks to the Indian markets. Given that there will be too much paper supply, he says India needs about $30-40 billion of foreign inflows in 2011 to just have a flat market.

What is the earnings outlook for the current and the next financial years? Where do you see the markets in 2011?

We believe India still offers good growth potential. We are looking at over 25% earnings growth in the current fiscal year and over 20% growth in the next financial year. In valuations, India is expensive relative to the region, but still not at its peak relative to its history. We therefore have an index target of about 21,600 that offers about 8% upside from current levels. Our call on the Asian markets is for the 20%-plus rise, therefore, India relatively is an underweight.

Is the Indian market looking overbought at this point in time?

India has been attracting a disproportionately high share of inflows compared to its index weight. This has been on account of the fact that global growth outlook had softened in the second half of 2010. We are seeing all global industrial lead indicators recovering and therefore markets like Korea and Taiwan coming back in vogue, and which will mean more domestically driven markets like India, Indonesia will lose some of their charm.

Will FII flows in 2011 be as robust as we had in 2010?

Compared to the pace at which it has come to India or the share India has had to total flows to Asia, we expect moderation. But given the global liquidity environment we are hopeful that foreign inflows into Asia in absolute terms will be larger than last year. We expect 2011 inflows into Asia to be better than inflows of 2010. Although India?s share in that will come down, we are not expecting a major slowdown in the absolute level, at least. We are not expecting foreign flows to turn negative. If that was our expectation, then we would have had a large downside target for the market because that is what is supporting the markets. Next year?s current account deficit is expected to be over $5 billion. And the current account deficit is supported by the strong capital inflows. So we actually need about $4-5 billion of capital inflows into the market each year to just balance out the current account deficit. We are confident that because of the growth India offers, capital flows will continue. But we don?t see in absolute terms as much upside in India relative to some other countries.

Do you think scams are making foreign investors wary of inves-ting in India?

We haven?t seen that as yet. And I think the reason for that has been that none of them seem to pose a systemic risk. If there is something which escalates further and starts posing as systemic risk then we can see some volatile inflows.

How much new paper do you see coming in 2011 and what impact will it have on the secondary markets?

These numbers keep moving up or down depending on the trend in the secondary markets. As of now, the pipeline we see is about $20 billion, including $6-7 billion coming from the government. Given that there will be so much paper supply, we need about $30-40 billion of foreign inflows in the year just to have a flat market.

Do high crude oil prices pose a risk to Indian markets?

Definitely that is a big risk as it is something which will add to the inflationary pressures. We have had average oil price for our import basket in the first half of this year at about $74 per barrel. Last year it was less than $70. Now already oil prices are at $84. So that as well as the rest of commodities is going to pose pressure on inflation in India. Foreign flows, crude and inflation are the three major risks, according to us, to the Indian markets.

You are expecting a 75 basis points rate hike in 2011. Is that also a risk to the market?

Actually, that is one of the reasons we expect the GDP growth to come down to from 9% levels to 8% levels next year. While RBI has raised rates by 150 basis points we should also note that because of the liquidity crunch most of the deposit and lending rates have already moved up by 250-300 basis points. So the market has already kind of reacted to it in some sense and has factored that in. I am not sure whether that 75 basis points hike in policy rate will feed into 75 basis points rise into deposits.

In the midcap space what are the themes that are looking attractive?

Actually, midcap as a basket has re-rated over the past four months. Their discount to large caps has gone down. Given the fact that corporate governance issues have again come to the fore, people will be very selective and we do not see the discount between midcaps and large caps narrowing. Within midcaps, the sectors we will favour are investments and consumer discretionary.

There has been a sharp correction in infrastructure and realty stocks right now due to the scam and high debt levels. How do you view these two sectors?

There are definitely selective opportunities that have come up. Within the two sectors we will favour infrastructure sector because we believe those are projects that are more bankable and the future flow of credit is more likely to be restricted to that sector compared to the real estate sector. Within real estate, our approach is to look at companies which have a lower level of gearing. So there are actually companies which are net cash, and which have got sold down. We would recommend investors to take this opportunity to look at those stocks.

Given the current scenario, do you think telecom will give you good returns?

In telecom, we actually believe that the current news flow will actually mean that the regulatory moves maybe in favour of the incumbents. So I don?t think this necessarily is going to reflect badly on any of the major stocks that we are recommending. The primary reason for the overweight in telecom is that it is an oversold sector. It is a sector where competitive dynamics are improving. And we are also actually positive on the rollout of 3G by the operators because most of the expenses for the rollout in terms of spectrum fees have been paid. And in 2011, we can actually see the revenues and the business contribution starting to come.

The marriage between Hero and Honda will be called off very soon. How do you look at this stock particularly?

In the case of Hero Honda we are very positive on the business outlook. We also believe that both the market share and margins for the company have bottomed out. The company had been seeing some pressure on both for the last four quarters. There has been an ownership issue but this is something that has already been in the news for the last six months. So I don?t think this will come as a surprise to anyone. In the medium term there is little risk but the technology is likely to remain with the company. So they can continue with there existing model. The technology agreement in terms of introduction of new models will continue till 2014 for sure. And we still need to see in what shape and form it takes after 2014.