India is not fully insulated from the global turmoil and could see FII outflows to less risky asset classes, says Sashi Krishnan, chief investment officer of Bajaj Allianz Life Insurance. A reversal of FII inflows could even impact the capital raising plans of India Inc, in his opinion. Thankfully, this may just be a temporary blip. With strong growth visibility, a less threatening fiscal situation and the return of the investment cycle, Krishnan tells Ashley Coutinho that India continues to be on a firm footing. Excerpts from the interview:

The market has been in a volatile phase for quite some time now. What is your short and long-term outlook?

There could be accentuated volatility in the short term. This is because global markets have been going through some turmoil and it is but inevitable that India will be somewhat impacted. However, the long-term outlook is more sanguine. This is because of the fact that India?s long-term secular growth story remains more or less intact. We should see GDP growth in the range of 8-10% over the next few years and corporate earnings should be able to grow at a compound annual growth rate (CAGR) of 25%. While equity performance in the first half of 2010 may be a little muted, the second half should see stability returning as the markets will take greater cognisance of the strong India growth story and corporate earnings.

What are the key risks for the Indian market in the short to medium term?

In the short term, Indian equity markets could be susceptible to shocks, primarily emanating from Europe and the US. The European sovereign debt crisis and the possibility of a double-dip in the US will impact our equity markets. The immediate impact could be in terms of increased foreign institutional investor (FII) outflows as money starts moving to less risky asset classes. The risk of this taking place appears greater at this point of time as large foreign inflows have come in through the exchange traded funds (ETF) route and this money is sensitive to the strengthening of dollar or weakening of rupee. The Indian equity market is heavily dependent on FII inflows and any reversal in them could impact the capital raising plans of India Inc as well as PSU divestment.

The other big threat to global demand is deceleration of China?s economic growth. China?s May manufacturing numbers indicate the country’s growth is slowing. China is tightening its monetary policy and has initiated measures to cool its property markets by raising mortgage rates and down payments. A slowdown in China will have ripple effects on growth across the world, with a serious impact on some areas like commodity prices.

On the domestic front, the perceived risks are much less severe now. GDP growth of 8.6% for the fourth quarter of fiscal 2010 was encouraging. The economy could very easily clock an 8% annual growth for the next few years, driven by strong domestic consumption and the return of the investment cycle. Inflation, though a worry, should get some respite because of the easing commodity prices and a good monsoon. The fiscal situation is less threatening, as the 3G auctions have been better than expected and tax revenues are likely to be buoyant, given the growth momentum.

Which sectors are set to do well and which ones would see a downside?

Sectors that are riding the strong domestic consumption story can be expected to perform well. These would include two-wheelers & passenger cars, consumer durables & staples, and pharmaceuticals. Infrastructure is another sector that should do well from a long-term point of view. This is because we are seeing the return of the investment cycle and increased government spends in this area. Commodity stocks could have a bad run for some time.

What is your assessment on the earnings season? Did it meet expectations?

This earnings season has thrown up a good set of numbers. The numbers are better than consensus estimates. Aggregate topline growth is in the region of 25% and growth in profitability in the region of 20%. The Sensex earnings for 2010-11 should grow at 25%.

Insurance companies have invested heavily in the markets in the last two months. What are the reasons? How is the current market volatility affecting their investments?

Insurance companies receive large subscriptions in the January-March quarter by way of new business as well as renewals. Many insurance companies would have had reasonable cash exposures in their ULIP equity funds which they would have deployed as the markets corrected. Insurance funds essentially attract long-term investors who are driven by the fundamentals. So, short-term volatility is not much of a concern for them. In fact, any sharp correction in the market is as an opportunity to obtain more reasonable valuations.

What is your take on the divestment target set out in the Budget?

The disinvestment target of Rs 40,000 crore envisaged in the Budget is quite ambitious. The list of PSU stocks to be divested, however, is being expanded with a number of heavyweights like Steel Authority of India Ltd and ONGC being added to the list. There could be some temporary setbacks if market conditions are not favourable, but given the quality of the PSUs being divested, the programme should go through successfully.

Is the global economy out of the woods yet? Which are the global cues to watch out for?

I don’t think that the global economy is out of the woods yet. In fact, the situation may worsen. Austerity measures suggested by the IMF/European Union could be self-defeating as it could lead to a downturn, or another recession. The US is in danger of a double dip and any premature cutback in fiscal stimulus will be damaging for its economy. Unemployment, at 9.9%, is a big challenge for the US. A weakening euro resulting in an appreciating dollar will make US exports uncompetitive. The global aggregate demand is weakening and this is reflected in easy commodity prices.

On the whole, this is a pretty tough situation. One would have to carefully watch the policy responses to the emerging situation before taking an investment view.

FIIs have been on a selling spree in recent times. Will they continue to remain bearish on India? Or is this just a temporary blip?

As a lot of the recent FII inflows came in through the ETF route, some of this money will find its way out of the Indian markets as the risk appetite reduces and dollar appreciates. This could, however, be a short-term phenomenon as India continues to be one of the few countries with strong growth visibility. Once risk aversion abates, we should see renewed flows into our markets.