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"Correction may not be as steep as in 2008"

The European sovereign debt crisis and rate tightening

The European sovereign debt crisis and rate tightening in China may affect the Indian markets negatively in the short term, but not all sectors will be uniformly affected. Investors should stay away from commodities and shift their portfolios towards sectors driven by domestic consumption. Alternatively, you could invest in systematic investment plans of mutual funds to tide over the near-term volatility in the markets, says Anand Shah, Head of Equities, Canara Robeco Mutual Fund, in an interview with Sanjay Kumar Singh.

How do you see the sovereign debt crisis in Europe affecting the Indian equity markets? If the crisis assumes serious proportions, will we see a repeat of 2008 when funds flowed out of emerging markets such as India? Or will the Indian economy's greater resilience during the last crisis, and faster rebound in its aftermath, result in India being perceived as a safe haven, and hence result in lower outflows this time around?

The Indian economy is more resilient to a global crisis compared to other emerging market economies, but it is not absolutely immune. If the European crisis slows down growth in Europe, it will hurt the growth prospects of the Indian economy as well, albeit marginally. Last time around we overcame the US crisis with fiscal stimulus and monetary easing, but that option is not available anymore. Hence one will have to be cautious about equity markets in the near term.

In the event of a sovereign default in Europe, we will see outflows from the Indian equity markets. But the correction might not be as steep as it was in 2008. This correction will be an excellent opportunity for long-term investors. Use systematic investment plans (SIPs) to tide over extreme volatility in the markets.

The Chinese authorities are raising interest rates in response to rising inflation and the property bubble developing in the country. Will this provide relief to India on the commodity price front, since it is Chinese demand and speculative inflows that have buoyed commodity prices?
Yes. Tightening in China will ease speculation in commodities, leading to softening of commodity prices. This is good news for the Indian economy in the long term as inflationary pressures will ease. Falling crude price will reduce the government's fiscal deficit burden. However, tightening in China will also be a short-term negative for the equity markets globally and for a few sectors like Metals in India.

Could you elaborate a little more about the impact on Metals? Prices in this sector are internationally linked. Moreover, most producers are adding capacity at a time when the major source of global demand may be slowing down.

Developments in China will be a negative for the Metals sector over the medium to long term. We will be very cautious about this sector and will avoid investing in companies exposed to global commodities.

What would your advice to equity investors be in the light of the grey clouds gathering abroad?
Investors will have to tide over the short-term headwinds in the equity markets to benefit from the Indian economy's long-term growth story. Global liquidity is a short-term positive for the equity markets while the sovereign default worries are a short-term negative. However, in the long term, favourable demographics and a predominantly domestic consumption and infrastructure-driven Indian economy offers good long-term investment opportunities. SIPs are an efficient way of investing in the current environment.

Which are the sectors that will remain attractive and which are the ones that are likely to lose their sheen (besides Metals)?
In the event of debt crisis assuming serious proportions, global commodities sector (like metals, oil, etc) and export-oriented businesses will suffer a negative impact. The focus will shift towards companies thriving on domestic demand which will remain insulated from global developments. Thus, companies dependent on domestic consumers like FMCG, Pharma, Media, banking, utilities, retailing, food, leisure and entertainment will remain attractive.

Is it time for investors to move their portfolios predominantly into defensive sectors?
The market environment is poised for correction in the event of further bad news. We would recommend focusing on companies that are dependent on Indian domestic demand.

Will the decline be across the board, as in 2008?
Unlike 2008 this time there will be sectors where corrections will be large and there will also be sectors that will get away with just minor corrections. Thus stock and sector selection will be the key to investing in equities in the current environment.

A large part of foreign institutional investors' (FIIs) investments (about a third) in India in recent times have been through exchange traded funds (ETFs). How are they likely to respond if global risk appetite declines?
ETFs are used by investors who follow more of a top-down investment approach rather than a bottom-up stock picking approach. Inflows or outflows from ETFs will be driven more by macro economic factors affecting equity markets like GDP growth rate, reforms, European crisis, currency, etc.

In the event of a decline in global risk appetite and corrections in equity markets globally, part of the ETF money that came in may look to exit. This will create more selling pressure and add to market volatility.

Regarding your Canara Robeco FORCE Fund, why did you combine these three sectors - financial services, retail and entertainment - into one fund? What is the common underlying theme?
The Indian economy is poised to emerge as one of the most resilient and fastest-growing economies due to its inherent strengths arising from rising GDP and increasing per capita income. This increase in per capita income is resulting in a change in the Indian consumer's spending and savings behaviour. The Young, Urban & Middle (YUM) class consumer today occupies centre stage. Almost two-third of India's population is below 35 years of age. Urban population is expected to grow to 42 per cent of the total population by 2030, compared to 30 per cent currently.

The common underlying theme among the three sectors is the Indian consumer's rising disposable income which is expected to give further impetus to consumption demand in these three sectors.

The BFSI (banking, financial services, and insurance) space is under-penetrated in India. Rising income will lead to higher savings which will in turn contribute to the rise in banks' NII (net interest income), fee income, and to growth in the capital markets.

The retail industry has humongous long-term potential. Organised retail's share of the total retail industry is a very miniscule 5 per cent. The Indian consumer is just getting acquainted with the concept of organised retail; there is still vast untapped opportunity in the interiors. This will be the main revenue driver for this sector.

Media and Entertainment is transforming from unorganised to organised. Increasing revenues from DTH, digital cable, and increasing advertising revenues will be beneficial for this sector.

Moreover, most companies in FORCE Fund belong to the services sector, which offers secular growth opportunities with businesses that are not capital intensive.

At present, two forces are acting upon banks. The positive factor is credit growth which is picking up. At the same time, rising interest rates are likely to cause losses in banks' bond portfolios. What is your outlook for this sector?
Banking offers a long-term opportunity for the fast-growing Indian economy. As economic growth picks up, not only will credit offtake rise, concerns about NPA (non-performing assets) will also decline. Rising interest rates will augur well for banks that have a larger proportion of their deposits as CASA (current account savings account) deposits, as they will be able to expand their net interest margins (NIM) and core profitability. Further, banks with active treasury departments will be able to tide over rising bond yields with very little impact on their profitability.

How should investors play this sector?
Investors should focus on the strength of the business (especially liability franchise leading to high CASA deposits) and quality of management to invest in the secular growth opportunity provided by this sector and its allied services.

How is the outlook for the retail sector? What factors are expected to drive earnings here?
The Indian retail industry offers excellent investment opportunities with the organised retail space growing at a blistering pace. The Indian retail market is the fifth-largest globally. It is expected to grow from US $330 billion in 2007 to US $640 billion in 2015. The organised retail market is expected to grow from US $17 billion in 2007 to US $90 billion by 2015 - a compounded annual growth rate of over 23 per cent.

Large domestic corporate houses and major international retailers are exploring various formats and options to capture market share and ride the growth trajectory of the Indian retail market.

In future higher growth in same-store sales and more stores will lead to strong sales growth. In addition, lower rent, overhead costs and captive brands will lead to expansion in margins and stronger earnings growth.

Finally, how is the outlook for the entertainment sector?
The Indian Media & Entertainment Industry has outperformed the Indian economy and is one of the fastest-growing sectors in India. Economic growth and rising income levels are the key drivers of growth here. Regional media forms will emerge as one of the dominant categories in this sector. The shift of consumers from Analog Cable to Digital Cable or DTH is among the dominant themes here. By 2015, the share of Digital Cable and DTH is estimated to be more than 50 per cent from its current level of 15 per cent. Advertising revenue currently accounts for the lion's share of TV channels' revenues. In future, the increased penetration of Digital Cable and DTH Services will lead to subscription revenue contributing a larger share.

The Indian film industry is the largest in the world in terms of number of films produced per year. However, India possesses only 12 screens per million population compared to 117 screens per million in the US.

The opening of the film industry to foreign investment coupled with the granting of industry status has had a favourable impact, leading to many global production units entering the country. An increase in the number of screens in the country will lead to humongous wealth-creation opportunity. Another staggering projection is that by 2013 the size of the sector will touch an estimated Rs 1.05 trillion.