Foreign funds, rate cut could extend equities rally

With the Reserve Bank providing rather clear indications that it could finally give in to the clamour for a rate cut in its upcoming policy review on January 29, the new year could herald more cheer for investors.

Sectors likely to benefit from the fall in interest rates and consumer-oriented businesses are likely to be in pole position to capitalise on the impending rate cut. These are, therefore, likely to be at the forefront of the potential rally on the bourses in the coming weeks, which could set the tone for secondary market activity early into 2013, coming on the back of an extremely favourable, albeit volatile 2012.

The basis for optimism is this. Even as the markets have rallied sharply since the middle of this year, valuations continue to look attractive on a historical basis. The BSE Sensex trades at close to 16 times estimated earnings, compared with 11.6 for Brazil's Bovespa, 9.6 for China's Shanghai Composite and 5.5 for Russia's Micex, according to Reuters data for the first week of December.

THE FII FRENZY

Despite the sharp slowdown in the Indian economy this year, the benchmark 30-share Sensex has surged over 25 per cent till mid-December this year on the back of strong buying by foreign institutional investors and optimism surrounding the government's reform efforts.

During the current year, FII inflows of slightly over $22 billion drove up share prices sharply, compared to a 22 per cent dip in 2011. The surge in the benchmark equity indices came about despite sluggish factory output front, recalcitrant inflation and continuing bad news on the twin deficits — fiscal deficit and the current account deficit.

The broad consensus is that in 2013, the market rally is expected to be based more on expectations of a sharp improvement in the macroeconomic indicators — driven by the impending rate cut, rollout of more reforms and recovery in the broader economy — than on the prospect of improvements in the corporate profit growth on the ground.

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