Geopolitical worries and concerns about global economic activity triggered a sell-off in Indian equities on Friday, but the downswing in share prices in one of the world’s top performing markets this year is bound to draw fresh investors waiting in the wings to grab a foothold in an economy that is picking up pace of growth.

On the radar in the coming week will be the Reserve Bank of India (RBI), which is scheduled to review monetary policy on Tuesday. Although official and private-sector data indicate a revival in the manufacturing sector and slowing inflation pressures, the central bank is unlikely to lower interest rates with monsoon rains still below par despite a mark-up in the momentum in recent weeks.

“We expect the RBI to keep policy rates unchanged in its bi-monthly monetary policy review … with a neutral to dovish guidance,” Edelweiss Securities Ltd said, noting that the central bank had said in June that further tightening was unwarranted given the disinflationary forces in place and it could even contemplate a rate cut if disinflation manifested itself faster than anticipated.

“The latest inflation prints were surprisingly mild, but the battle against inflation is not over. With many regions facing drought-like conditions, weak monsoons will be the main concern for the central bank,” HSBC economist Frederic Neumann wrote in a report.

“It’s a close call,” he said. “We think the RBI is likely to pause again in August to get a better sense of the inflation trajectory.”

For the stock markets any soothing comment by the central bank about inflation and the rates outlook would be sufficient to spark a new rally. A private data released on Friday showed that factory activity in July grew at its fastest pace in 17 months while Maruti Suzuki, the country’s biggest car maker, said its sales jumped 21.7 per cent in July.

Pressure points

“Although the RBI appears non-committal about the course of monetary policy in the coming months, saying its actions are likely to remain data dependent, almost all the policymakers and market watchers we met clearly believe the RBI has finished raising rates,” Barclays Bank said.

“While weak economic growth should keep core inflationary pressures manageable, pressure points, such as food and, potentially, global commodity prices amid renewed geopolitical tensions, are clouding the outlook for inflation over the next three to six months. On balance, most of the experts we met expect the central bank to leave rates unchanged in the near term, but see the possibility for the RBI to lower policy rates in 2015,” it said.

Waiting in the wings

Big foreign investors, the prime driver behind the Indian markets 20 per cent rally this year, took some profit off the table after Argentina’s default caused unease for riskier assets worldwide. The sell-off clipped 2.5 per cent off the top-30 Sensex this week. The benchmark index shed more than 400 points on Friday to close at 25,480.84.

The profit-taking spree and geopolitical worries also hit the rupee on Friday, weakening the currency 1 per cent to 61.1850 against the US dollar, its biggest single-day loss since the last week of January.

However, global appetite for Indian assets should remain robust given the sub-continent’s growth potential and rising returns.

“We sensed that there is considerable global money on the sidelines awaiting to buy the dip while hedge funds are, generally speaking, net long the market. In summary, this is the most bullish we find investors on India in a while,” Morgan Stanley analysts Ridham Desai, Sheela Rathi and Utkarsh Khandelwal said in a report after meeting more than 300 investors in Singapore, Japan, the US and Europe.

Emerging market data

“The distinction from the previous bull market cycle is that investors think the India story is more idiosyncratic this time around, that is, not an emerging market beta trade.”

The US investment bank said there was considerable upside to current earnings estimates for Indian companies and investors were taking stock of the longer term potential.

“For our coverage universe, if the ROA (return on assets) reverts to mean, earnings estimates would need to be lifted by about 45 per cent in aggregate,” the analysts wrote. “Looking at it another way, the share of profits in GDP is starting from a multi-year low of 4.3 per cent.”

“A reversion to mean in the coming three years and assuming nominal GDP growth at an average of 12 per cent implies a profit CAGR [compounded average growth rate] in excess of 18 per cent over three years — well above the current consensus expectations.”

DSP Merrill Lynch, which has also been talking to investors, said in a recent report that the “overwhelming consensus” was bullish on India.

“There was practically no debate on our view that re-rating would drive markets to our year-end [Sensex] target of 27,000. Near term, some investors agreed that we could see a slight pullback on global concerns and a possible monsoon failure; but most wanted to buy the dip,” the brokerage said.

Mid-caps

The BSE Mid-Cap stock index has leapt 36 per cent so far this year, way ahead of the 20 per cent rise in the Sensex. Clients, said DSP Merrill, agreed that mid-caps would do better than large caps.

The brokerage, which is overweight on autos, cement, banks, energy and industrials, said its top mid-cap picks were Eicher Motors with a price objective of Rs8,825, Yes Bank with Rs700, Aurobindo Pharma with Rs880, Bharat Forge with Rs715, Bharat Electronics with Rs2,070 and Prestige with Rs280.

Saying corporate profits can double over the next four years, it favoured Maruti Suzuki, ICICI Bank, State Bank of India, Oil India and UltraTech Cement among large caps.

The HSBC Manufacturing Purchasing Managers’ Index (PMI), compiled by Markit, climbed to 53.0 in July from 51.5 in June, its highest since February last year, thanks to a sharp rise in new orders sub-index to 55.9, its biggest monthly jump in eight months.

Quaterly earnings

“A flood of new orders from both domestic and external sources has led to a surge in activity,” said HSBC’s Neumann. “Details within the survey show that all monitored categories witnessed a rise in output and order flows.”

Shares that will be in focus would include State Bank of India, Mahindra and Mahindra, Power Grid Corp, Hero MotoCorp, Apollo Tyres and Jubilant Foodworks, all of which would release their quarterly earnings in the coming week.

The writer is a journalist based in India