India- The most leveraged bet on global risk-on and risk-off

Last month, RBI was full in its policing action in Indian financial markets to introduce liquidity and contain the Rupee depreciation; RBI took a bold step and bought around US$2.3bn of government bonds. With this annualized purchases by RBI would imply2.1% of GDP. In FY 12, RBI had bought US$25 billion of government bonds implying 1.5% of GDP. Generally RBI is seen to purchase bonds in the 2nd half of the year when credit demand picks up seasonally, but this time, an earlier intervention of RBI clearly shows the rising liquidity stress in the economy.
Issue is not that whether Rupee is falling or Indian equities are falling due to global risk off. Issue is - India has the best demography in the world and has second highest GDP growth rate. So, in this moment of global risk off, India had all the potential to become the most attractive investment destination of the world. But here, policy makers in India in last two years have done one mistake after another to let us deprive of our moment of glory. In fact our Finance minster in his latest budget did what can be described purely as – ‘Penny wise Pound fool’. In principle, we agree with concept of GAAR and taxing Vodafone type cases. But the issue of this kind should not have been touched now.
India has to pay within next one year US $137 billion, this is 60% of all the total non rupee foreign claims that overseas banks has on India. This can eat up half of the $293 billion foreign exchange reserve that India has. That simply implies –we require strong foreign inflow this year to keep our macro health strong.
Moreover here we have a European connection- European banks account for over 40% of India’s total foreign dues. That’s makes us vulnerable to any contagion or even a risk –off in Euro Zone. In fact, India has also become the most leveraged bet on global risk-on and risk-off due to its alarming high levels of twin deficit of trade and fiscal at 11% of GDP.
World since 2008 is passing through a de-leveraging process. The latest statistics from Bank of International Settlement (BIS) show that the cross-border fund flow has currently come down to around US$3.5–4.0 trillion (or5.5-6.0% of global GDP). Remember, it was about US $ 6 trillion (around 10–11% of global GDP) back in 2007.

India with its strong investment appeal was a large beneficiary during the boom of cross border fund flow between 2002 and 2007. But now with reversal of the same India is also bearing the pain of this global de-leveraging. Though, fact remains that, if our policy makers were little pro-active, we by now would have built other natural source of our growth financing.
Recently, Some expectation has got built up that Indian government will take some tough policy measure shortly and so the longevity of the recent out-performing trend by India at least in short-term  will largely depend on whether these expectation are met or not. But if one takes, say, a three month view, market direction will primarily be dependent on events unfolding in Europe.
For long term investors, we think just the way we had opportunity to buy into good stocks around December of last year; we will get another good opportunity going forward. Only question is whether that will be around current levels or say 10% lower from here and that will purely depend on liquidity situation globally. Sensex presently is trading at 13.5 times FY13 earning with FY13 ROE of about 15%. Interestingly, in recently concluded quarterly results, net profit margins of all companies taken together have gone up to 8.6% from last quarter’s 6.7%. Improvement in margin gives sign that there is good probability that post June 2012 results; we may see upward revision in Sensex EPS estimate.

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