Reforms to accelerate, returns to moderate. We expect the government to accelerate reforms in 2015 with focus on land, labor and power sector reforms. Interest rates will likely decline led by further improvement in India’s fiscal position and lower inflation. However, returns may moderate to 15-20% given expensive valuations (FY2016 basis) after a large re-rating in 2014. Investment options seem to be between expensive stocks with strong visibility on earnings and stocks with relatively lower visibility on earnings.
Reforms: Expect reforms process to continue at both central and state levels with some hiccups
We expect the central and progressive state governments to implement more meaningful reforms in 2015. Fiscal reforms are underway with the government focusing on implementation of GST and direct cash transfer schemes. Investment reforms such as labor, land and power reforms may take longer and may be implemented by progressive states if the central government is unable to do so because of its minority position in the upper house of the parliament. Read Full Report

Rates: Fiscal consolidation, lower inflation and ongoing reforms to result in lower interest rates
India’s macroeconomic parameters will likely improve further in 2015 with FY2016 GFD/GDP and inflation declining from 2014/FY2015 levels. We expect FY2016 GDP growth at 6.1%, up from FY2015’s 5.5%. GDP growth will likely recover slowly as the investment cycle will take time to mend given extant funding and investment challenges. We expect the RBI to reduce policy rates by 50-75 bps through 2015 with the first rate cut (25 bps) in March 2015.

Risks: (1) Legislative challenges and (2) allocation, not availability, of funds
We see two risks to India’s solid medium-term growth story. (1) The government’s ability to implement reforms may be constrained by its minority status in the upper house of parliament and its limited influence over states. It is important for the government to ‘sell’ its economic vision for India to the opposition-ruled states. (2) Financial investors may be reluctant to provide funding to the critical investment-related sectors. Indian banks already have too much exposure to several weak infrastructure companies. The government may have to look at FDI and innovative alternatives to address the ‘funding’ gap.

Returns: Expect more moderate returns in 2015 versus in 2014 (29% CYTD)
We expect about 15-20% return for the Indian market in 2015. Valuations are reasonable for the Indian market with the BSE-30 Index trading at 15X FY2016E ‘EPS’ (15.6X FY2016 free-float ‘EPS’). We model 18.3% growth in net profits for the BSE-30 Index in FY2016 (16.8% for the Nifty-50 Index) but note risks to our earnings estimates from the cement, industrials, metal and power sectors. A large chunk (60%) of India’s earnings is also linked to global GDP growth, commodity cycles and government policies.