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Interest Rate Cuts In India Should Help Market Outperform China In 2013

|Includes:iShares MSCI India Index ETF (INDA)

India. January 25, 2013.

By Eric J. Ritter.

India's stock market has lagged China ytd on expectation that China's economy is recovering faster than India's. China's gdp growth of 7.9% last quarter is clearly higher than India's 5.3% but India has one advantage: it is likely to reduce interest rates from 8% by 100 to 200 bps this year starting at the central bank's meeting at month end. China, however, hasn't cut interest rates since last July and can't without pushing property prices higher.

Wholesale price inflation has eased from 10% to 7% last month and 4% on a 3 month moving average on lower commodity prices. This is the lowest inflation reading in the last 3 years.

In addition, with gdp growth falling to a 5.3% in 3q12, the Rbi needs to take action to boost growth. They have hesitated due to inflation worries, large budget deficits and the weak Indian rupee. However, surprise action by the Congress government to hike fuel prices and power tariffs and thus reduce the budget deficit may embolden the central bank to act. Moreover, deregulation to allow foreign direct investment in retail and airlines may help the rupee stabilize.

Another positive ingredient for India is the recovery in earnings growth with lower commodity prices and short term interest rates. Eps growth last quarter accelerated to 21% growth yoy after nearly zero growth in 4q11 to 1q12. After the Rbi cuts interests further, we expect companies to start to invest again and earnings to further improve.

Valuations are still cheap at 2.8x p/b compared with the historical range of 2.5 to 4x. I suggest investing in the India etf, Inda, which tracks the Msci index and has a 30% weighting to financials which should benefit from a lower cost of funds and faster loans growth.

India's return on equity, Roe (as shown below in red on the left hand scale) has averaged 20% the past decade despite falling to 16% last year. I expect a cocktail of lower interest rates, deregulation and the improving global economy boosts profits and Roe's back to 20% plus and p/b to 3.5 for a potential 20% gain this year.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I am a fund manager based in Hong Kong and have invested in Asia for last 20 years.

Stocks: INDA