Surjit Bhalla

From its peak, reached just a few weeks ago, the Indian stock market is down more than 12%. This is in keeping with the trend in markets around the world, with most showing declines of between 10% and 15%. But January 2008 will be remembered not just for market declines; it is also the month when the US Federal Reserve decreased the overnight lending rate (Fed Funds rate) by a rather large 125 basis points, the largest such cut since 1982.

Given this global turmoil, the Reserve Bank of India (RBI), somewhat surprisingly, chose to stay put at rather elevated levels of real interest rates. No change in policy, said YV Reddy, the RBI governor. Meanwhile, investments by FIIs in India, after scaling a peak of $17 billion in 2007, have dropped by about a fifth, or $3 billion, in January.

What is the implication of this selling for the Indian stock market? Is it time for the Indian investor to pack her bags, pocket her gains and put the money in fixed deposits? No. On the contrary, it’s time to be fully invested. The reason for this is simple—most of the worst news, both for India and the world economy, is behind us.

So far, the bad news has consisted of the subprime crisis, where a lot of banks have lost a lot of money. The housing market in large parts of the world, and especially the US, has peaked. This has led analysts to call for a recession in the US, which, it is argued, would hurt all stock markets badly. The recession (defined as two successive quarters of negative growth in GDP) in the US has not yet occurred, but the stock markets have fallen as if this has already happened.

This is one argument to be fully invested in the Indian market: if the worst case scenario has already been discounted, how much worse can the news from the US get? The key in markets is news versus expectations; markets adjust some three to six months before the event. So, the surprise to the market would be not if the US recession happens but if the recession is deeper than expected today.

In probability terms, that is less than a 20% chance, and so not worth making the bet. There are several reasons to be fully invested in the Indian stock market (at approximately 5150 on the Nifty and 17700 on the Sensex). Interest rates are likely to fall this year; the RBI, stuck in its monetary manhole, will have to accept the irrelevance of blind monetarism over the next few months. It is only for so long that one can march to a discordant tune.

The government has also realised the folly of letting the rupee appreciate to an extent that makes industry, and the economy, uncompetitive. Looking ahead, one hopes and expects that things will improve on this front. Internationally, except against a few mercantilist Asian economies, the US dollar should appreciate from its current historic lows.

All these factors suggest that the future environment for Indian equities is positive. There is also an additional reason. The Indian economy today is more dependent on investment than exports. The latest GDP data releases from the Central Statistical Organisation indicate that the investment rate in 2006-7 was 36% of GDP. Just a few years ago, this was 24% of GDP.

In 2008-9, the investment share in GDP is likely to be close to 40%. Thus, GDP growth in India next year is likely to be close to 9%, or earnings growth close to 25%. Very soon, possibly by 2010, the Indian economy could grow faster than China’s. Given these factors, is there any reason to stay out of the Indian stock market, especially when it is trading at 17 times future earnings? Nope.

Surjit S Bhalla, chairman and managing partner, Oxus Investment