"While I believe the direct impact on foreign investment will be limited, partly due to tax registration requirements for participating investors, the Government's decision indicates a more investor-friendly stance and it is this that is likely to boost sentiment.

"Perhaps more significantly, in 2012 we have already seen the release of PMI (Purchasing Managers' Index) data for December which, at a level of 54.2, indicates better-than-expected economic expansion. I believe that the fall in the equity index over 2011 (over 20% in local currency) alongside the depreciation of the rupee (down 19% against the US Dollar over the year) currently leaves equity valuations at a very attractive entry point for investors.

"I expect inflation to continue to reduce as energy and food price falls feed through, which should allow the Reserve Bank of India to cut rates significantly this year. Food inflation is already at the lowest level for four years and should decrease further in the next few weeks. We expect the overall level of inflation to fall by a further 250bps between now and the end of March 2012 to around 6.5%.

"In our view, given present economic conditions, the Indian central bank will have no choice but to cut interest rates soon and aggressively, however unwilling they have so far appeared to be. We believe that rates will fall by about 200bps this year.  They may fall significantly more than this if there continues to be turmoil in the global economy."

"Last year's fall in the rupee appears to be primarily due to a general sell-off of emerging market currencies, exacerbated by the Reserve Bank of India's oft repeated policy of not intervening in the currency markets. Poor sentiment is being exploited by markets.

"There is a fear that corporate profitability will be significantly affected by the fall in the rupee due to foreign currency borrowings by Indian companies and higher commodity prices, as they are dollar denominated. Indian corporates were generally able to withstand the 10% currency devaluation in the third quarter of 2011 without a significant negative impact, but clearly certain infrastructure companies and others with US dollar borrowings were affected.

"However, this is only a very small part of the overall Indian stock market. And, despite the negative currency impact, profits grew by roughly 10% year on year in the third quarter. So any repeat of the third quarter currency losses or indeed flat, even negative, growth in a single quarter's profits should not be a disaster by any means. One should also bear in mind that the companies with large dollar borrowings generally have significant overseas assets (e.g. Tata Motors owns JLR) and are generally hedged through foreign sales or receivables over a longer period of time. Historically, the central bank has kept a tight rein on foreign borrowings by local companies.
 
"There appears to be a significant concern, if valuations are a guide, that Indian banks could suffer unsustainable losses as a result of the slowdown. This is highly unlikely. Bank balance sheets in India are reasonably robust compared to most banking systems in the world today. The banks have a capital adequacy ratio of over 9%; an investment/deposit ratio of over 30% and a credit/deposit ratio of 74%.[1]
 
"There may well be an increase in non-performing loans, but this should not affect their book values negatively on a year on year basis, although it may reduce their profits for this year. In our view, banks represent perhaps the most interesting investment opportunity in India at the moment.
 
"Meanwhile, Moody's has recently upgraded Indian domestic debt. This is quite an interesting move given all the negative press around the apparently unsustainable Indian government debt. But it comes as no surprise to us as the Indian government debt is held locally and there is very insignificant foreign participation in this market as it is restricted.
 
"GDP growth forecasts for the financial year ending in March 2012 have come down from a consensus figure of 8% at the start of 2011 to approximately 7% now . There has been a clear slowdown in Indian growth as the central bank repeatedly increased interest rates in its attempt to tackle higher inflation. This has resulted in a slowdown of capital expenditure, causing a fall in GDP growth.  However, agricultural production is at a record high and consumer expenditure in most of the country, other than large metropolitan cities, is booming. The increased consumer expenditure is financed by earnings, not borrowings and is therefore sustainable. As the poor grow richer, the money is in the hands of the people with a higher propensity to spend.
 
"Politics has been India's weak point over the last few months.  The news flow has been dominated by corruption scandals and a number of people previously considered "untouchables" have found themselves languishing in prison cells. This has been brought to the fore by a non-political movement demanding constitutional changes to strengthen anti-corruption measures.

"The coalition government has been unable to muster enough support to pass legislation pending in parliament for some considerable time and has had to make "U-turns" on stated policies that would allow greater foreign investment in retail, insurance, etc.  The Chair of the Congress Party, Mrs. Sonia Gandhi, the de facto ruler of the country, has apparently been seriously ill and this has not helped the situation. In my view, it is this factor of weak government, which has been the main reason for recent investor antipathy towards the Indian markets, both equity and currency."

[1] Source: RBI

Note:
Jupiter Unit Trust Managers Limited (JUTM) and Jupiter Asset Management Limited (JAM) are both authorised and regulated by the Financial Services Authority 25 North Colonnade, Canary Wharf, London E14 5HS.  JAM and JUTM's registered address is 1 Grosvenor Place, London SW1X 7JJ.  The group is collectively known as "Jupiter".  The above commentary represents the views of the Fund Manager at the time of preparation and may be subject to change.  They are not necessarily those of Jupiter as a group and readers should be aware that they should not be interpreted as investment advice.  Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given.

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