1. Outlook For Year 2012
"Indian GDP Growth Could Moderate To 7% Level In 2012"
Saravana Kumar, Chief Investment Officer, Tata AIG Life Insurance
In near term, the Indian Rupee will continue to be sensitive to
the changes in investor risk appetite, on the back of the
sovereign debt crisis in peripheral Euro zone economies and
USD strength. External fundamentals remain key and will
remain a drag on the Rupee. However, over the medium to
long term, the rupee has appreciation potential on the back of
relatively strong growth fundamentals and improving
investment climate, which would attract greater capital inflows.
Rupee is expected to appreciate to 48 levels by March 2012
and 47 levels by December 2012. Mr. Saravana Kumar
CY 12 bets can be placed in IT, Telecom, Banks mainly in Private space, Auto, Agri input sector,
Select FMCG and Pharmaceuticals, by a long term investor who has a 2-5 year time horizon. We
at Capital Market interacted with Saravana Kumar, Chief Investment Officer of Tata AIG Life
Insurance, to know the factors which would lead the equities and fixed income markets in
Calendar Year (CY) 2011.
Here are the excerpts:
In Calendar Year (CY) 2011, growth across the world slowed down. Will CY 2012 be better
or growth will slow down further? More specifically will India growth fall to 6-6.5% with
policy paralysis and foreign capital flight continuing?
It is clear that the global growth in 2012 at sub 3% will be lesser even when compared to the
expected anaemic growth of 3% in 2011. Indian GDP growth could moderate to 7% level in 2012,
primarily on the back of weakening exports and muted industrial growth. We believe that the 7%
threshold will be maintained due the strong domestic consumption and a robust rural demand on
the back of higher minimum support prices and good monsoon. Additionally, services could help
lift the GDP growth to the 7% level offsetting the moderating exports and weak industrial sector
growth rate. In a slowing world, it is important to understand that a 7% growth is a still a good
outcome and the growth differential of India as against the Western world would ensure that there
would be adequate capital flows to finance our current account. As for policy paralysis you are
referring to, we believe that the market has largely discounted it in the current prices in many
sectors such as infrastructure, capital goods etc and going forward, any incremental good news
on policy can be a tailwind to the market.
Industrial capex seems to be showing mixed signs across various industries, what’s your
view on this theme’s market performance in CY 2012? Which are the sectors appearing
attractive to the fund managers going forward in CY12?

2. The market has divided itself into two clusters at the opposite ends of the valuation growth
paradigm. One, where growth visibility is strong as in Information Technology, FMCG, Agri input
sector and pharmaceuticals, but where the valuations not very cheap. The other cluster is beaten
down infra and capital goods space where there is less visibility of order book due to slowing
capex, lack of policy clarity as well as concerns on escalating interest costs.
We believe that CY 12 bets can be placed in IT, Telecom, Banks mainly in Private space, Auto,
Agri input sector, Select FMCG and Pharmaceuticals, by a long term investor who has a 2-5 year
time horizon. While IT companies will benefit from a weak INR and the outsourcing theme,
FMCG, and Telecom reflect the robust domestic consumption play. Pharmaceuticals will do well
due to both exports and domestic demand. Banks, mainly private space, could capture the
upsides created due to increased economic activity as they have a robust and scalable business
model.
In general, we prefer well-managed companies with low debt, stable operating margin, low capital
requirement, that operate in non-competitive spheres, with easy cash flows and trading at
reasonable valuations.
With Euro debt issues pressurizing global banks and NPAs piling up on Indian PSU banks,
how will the finance sector perform in the Indian markets in CY 2012?
We believe that the negative news flow from Europe has now peaked out. It is now a only
questions of stability and confidence coming back. Negative news flow from Europe is likely to
subside as it happened with the news flow from US after the downgrade of the US’s sovereign
rating.
Having said that, the PSU banks have rising NPA issues and that has resulted in their under
performance over the last 1 year. We believe that the NPAs concerns are baked into stock prices
to a large extent but would continue to remain cautious on this sector. However, we like private
sector banks selectively, due to their earnings profile and scalable business model and look to
add them in our portfolio on dips. In the medium term, as the financial sector is a proxy to the
Indian growth story and make up almost a quarter of the weight in the index, it is difficult to
remain bullish on Indian equity market while remaining bearish on financials. Any sustainable rally
in the equity markets would require financials participating in it at some point in the future.
Midcaps / smallcaps have been crushed very hard in CY 2011. What is your view on their
market performance in CY 2012? Which are the sectors within this space that investors
should invest or accumulate? What is your outlook?
Apart from Large cap stocks, there lies good opportunities in mid caps/ Small caps segments. We
would stick to quality names in this space which have demonstrated consistent earnings across
the business cycles & who score high on corporate governance. We believe that as the market
sentiment improves, they could be among the first to rebound. The recent few months have been
difficult for investors with a mid-cap portfolio but the severe correction has opened up a
substantial valuation difference as the CNX Midcap index trades at around 10 times one year
forward price earnings as compared to the Sensex valuation of around 13 times one year
forward.
A large number of Mid/Small cap companies with strong brands or franchises are available at
extremely cheap valuations. There is large number of Midcap/small cap companies available
today that can double or triple over three to four years.
What Sensex/NIFTY level do you foresee at the end of CY 2012 and which
stocks/sectors/themes will be the major drivers for the rise/fall vis-à-vis end-CY 2011?

3. I see equities giving positive return at least in the second half of FY 2013. This will be the base
case scenario. Interest rates in 2012 will surely come off from 2011 levels. Clearly the chances of
interest rates to sustain at these levels beyond six months appear low. They appear have peaked
out and at some point of time, will start to reduce. Inflation will come off to some extent in the first
half of the year due, to the base effect of last year. Coupled with this, we have policy measures
and Governments’ initiative to control the fiscal deficit for FY2013 in the budget. Thus , I expect
things to only improve here on and the pessimism for equity markets to reduce. A dip in
commodity prices will help.
In terms of specifics, we are of the view that the earnings for the companies making up the
Sensex are slowing but definitely not collapsing as feared by some market experts. We could still
look at close to 14% earnings growth in FY 12 and 17% in FY 13, though there is some downside
risks to these numbers. If we give fair multiples to the FY 13 Sensex EPS of around 1300, we
could see the Sensex higher by around 15% by the end of FY 2013 from the current levels of
16000 and believe that IT, Telecom, Private sector banks and selective FMCG and
Pharmaceuticals would lead the move as they still have reasonable earnings visibility for FY
2013. Some of the interest rate sensitive sectors could be the dark horses if the RBI resorts to
aggressive interest rate cuts in FY 2013.
In terms of downsides to the Indian equity market, the current level provides valuation comfort for
an equity market investor from a long-term perspective. I do not see the markets correcting much
below 15000 for the Sensex and 4500 for the Nifty, at which levels markets will be trading near
the lower range of the historical valuations.
How can investors choose between different avenues in the equity category? Also what
are the returns that can be expected from them going forward in CY12?
Equities have historically given returns for a long-term investor well above the inflation rates and
created wealth over the long term. Last 4 years have seen the Indian equity market providing
muted returns, primarily on the back of a weak global economic backdrop. We believe that equity
returns could head back to long term trend in 2012 as inflation falls off and the valuations
continue to be reasonable at around 13 times one year forward price earnings. Any improvement
in global macro will result in an increase in portfolio flows into India, primarily in large caps as
they are proxies to the India story. If this improvement is sustainable and the positive sentiment is
durable then we could see robust price improvement in quality midcaps across sectors, as they
trade at reasonable valuations.
In India, consumption theme has outperformed all other themes over the past couple of
years. Will the trend continue in CY 2012? Can India’s outsourcing theme outperform other
themes in CY 2012?
Going forward, apart from the consumption theme playing out on the back of a strong rural
demand, we could see the re-emergence of the Indian outsourcing story, more so now as the INR
has depreciated substantially to further enhance the competitiveness of the Indian exporters. That
is why we believe that IT sector is a key sector which could outperform the benchmark indices
over the medium term. Unlike the global financial crisis in 2008, this time around the corporate in
US have record cash levels in their balance sheet and this could be a catalyst in their increased
spending on IT as and when the business confidence improves. Large corporate across the
western world are consolidating their IT vendors and looking at more efficient IT services
providers to help them reduce costs. This again opens up large opportunities to the Indian IT
players, given their advantages in efficiently delivering quality at lower costs.

4. Infrastructure remains a major laggard. With policy/execution/reform paralysis in
government and high interest rates, what is your view on this segment’s market
performance in CY 2012?
The performance of infrastructure sector has been disappointing for last 3 years. The key learning
is that infrastructure is not just about constructing projects. It is about viable business with good
cash flows and investments. We would like to invest in more mature companies which have gone
through the initial learning cycle. The demand-supply for these products and services will again
catch up with the uptick in the economic activity. I don’t think Infra sector will touch the peak
valuation they had traded in CY 2006 and CY 2007. But, they will not remain at the level where
they are today.
With USD 1 trillion being the Planning commission’s Infrastructure target over 5 years, it is difficult
to see infra sector doing badly from these levels in the medium term. If RBI rate cuts are effected
throughout FY 2013, infra sector could get a boost in earnings as interest costs could reduce from
the current levels. Some clarity on policies from the Government’s side to de-bottleneck access to
land and natural resources as well as a pick up in corporate India’s capex cycle, going forward,
may help in the performance of the infra sector.
What’s your call on Indian rupee? Don’t you think if rupee continues to depreciate or even
remain at current depreciated levels for long, India’s growth story is as good as
suspended?
The Indian rupee has found a range in the 51-52 mark in the last few trading sessions after a
sharp fall over the last 8 weeks. The weak global macro and the persistent Indian current account
deficit act as gravity to any sharp appreciation from here on. The sharp fall in the rupee was
triggered off by the unexpectedly large October 2011 trade deficit close to USD 20 billion and a
sharp fall in export growth. What made the situation worse was that the market was largely
positioned one way, betting on INR appreciation as the INR had been very strong on a REER
basis over the 12 months, prior to August 2011.
In near term, the Indian Rupee (INR) will continue to be sensitive to the changes in investor risk
appetite, on the back of the sovereign debt crisis in peripheral Euro zone economies and USD
strength. External fundamentals remain key and will remain a drag on the Rupee. However, over
the medium to long term, the rupee has appreciation potential on the back of relatively strong
growth fundamentals and improving investment climate, which would attract greater capital
inflows. We expect Rupee to appreciate to 48 levels by March 2012 and 47 levels by December
2012.
Overall how will the commodities perform in CY 2012 vis-à-vis CY 2011? Which
commodities you are bullish and bearish on for CY 2012 and why?
In general, we believe that CY 2012 will be a difficult year for commodities as the global growth is
clearly slowing down to sub 3% levels and Euro zone is staring at a recession. The Chinese soft
landing scenario creates a further downward pressure on global metals.
The main risk to a weak commodity call in CY 2012 comes from a possibility of Quantitative
Easing-QE 3 in CY 2012 by the US Federal Reserve or an expansion of the balance sheet by the
ECB. In that scenario, the excess liquidity unleashed in both these scenarios could find itself
chasing commodities and inflating their prices.
Structurally, going forward I see an improvement in the demand supply equation in the global
crude market due to subdued growth of developed economies, a slow down in the emerging
markets, especially in China and improving supply from Libya. These factors could help crude

5. chart a lower trajectory in CY 2012 as compared to the current year. Any incremental correction
in the crude price would be a big positive for India.
Gold in India has been a great outperformed in CY 2011? What’s your view on gold for CY
2012? How much percentage one should allocate into it?
In an uncertain global market Gold has been historically a classic safe haven and a proxy to an
anti-USD trade. So higher the risk aversion, more is the headroom for gold to chart higher levels.
However, considering that USD itself is perceived as a safe haven in recent times, and gold
priced in USD, gains for gold could be capped in a risk-off scenario. However, if QE 3 gets
announced, then there could be a meaningful run up in all commodities, especially gold as Fed
expands its balance sheet resulting in the weakening the USD. As a retail investor, before
allocating a sizable part of their investible surplus, it is important to understand two aspects. One,
gold returns have historically been lumpy and so the run up usually tends to be very sharp and so
the entry point of investment is a critical issue. Two, because of this, there are long periods of
time when gold has remained sideways and underperformed other asset classes.
After remaining at high levels for past couple of years, can inflation come down in CY
2012? Will RBI be able to cut interest rate in CY 2012 or the rate will remain stable? What’s
your view on investment in debt in CY 2012?
We do expect inflation to come down in CY 2012, primarily on the back of base effects. We also
expect some moderation in global commodity prices which could further mitigate inflationary
pressures. This will help RBI in pausing interest rate hikes in the first half of CY 2012 and provide
some room for RBI to cut interest rates in the second half of CY 2012. This will be beneficial for
debt market investors with a 18 months view, to ride the falling interest rate cycle.
Gilt Funds category has been facing net outflows since December 2010, what has been the
reason behind it. Do you see any reversal in the trend in CY 2012?
Reason for reversal in flows in gilt funds is due to the series of rate hikes by the RBI resulting in
marked to market impact on the NAVs of these funds. The RBI has effectively tightened rates by
525 Bps in this rate cycle, if one considers the change in the width of the LAF corridor. Going
forward, we could see more inflows into the gilt funds as the interest rates stabilize and
subsequently chart a falling trajectory. The returns from gilt funds would get a boost from the
marked to market gains when that scenario unfolds in the second half of CY 2012.
What kind of debt funds would you be recommending to your investors right now and
what are the expected returns from them? Given your expectations of where interest rates
are headed next year, would you be advocating short term plans or longer term plans
which can take advantage of the double indexation facility?
Long tenure debt funds provide the fund manager more flexibility in managing the duration as the
higher duration maintained by the fund manager will accentuate the returns in a falling interest
rate scenario. An investor can look to invest in longer term debt funds depending on their risk
appetite to benefit from the lower interest rate environment in future, if they have an 18 month
horizon.