1

Thema – Thematic Focus

India in 2011
Strategic Focus
January 2011

1
Sustainable Swiss Private Banking since 1841.
India in 2011

It gives me great pleasure to introduce our publication “India in 2011”. India is a key market for the Sarasin Group
and we at Sarasin-Alpen are proud to be at the forefront of the Group’s expansion in the region.

As the report will demonstrate, the prospects for the Indian equity market remain appealing. The market has per-
formed nicely for many years, reflecting the country’s strong economic growth and remarkable wealth creation over the
period. Indeed, with a USD return of 19.7% p.a. over the last ten years, India has been one of the strongest equity
markets in the world.

Although this performance is impressive, India is at the beginning of its “journey” not the end. Income per capita is
estimated to be just USD 1,176 which, according to the International Monetary Fund, ranks India 137th in the world -
just behind the Solomon Islands and Yemen. It is the prospect of further rapid economic development and wealth
creation that makes India such an interesting long-term investment opportunity.

Please feel free to contact your relationship manager in case you require more information on our India offering.

Best regards,

Rohit Walia
Executive Vice Chairman & CEO
Bank Sarasin-Alpen Group
Contents

Foreword 1
India in 2011 1

Economic Outlook 3
India – soft landing for the economy in 2011 3
The global economy will weaken in 2011 3
Upswing in India is losing momentum 4
Fiscal and monetary policy 6
India's role in global rebalancing 8

Currency 11
Indian rupee for long-term investors 11

Equities 13
Equities – upside potential still exists 13
Review: India top in absolute terms, mid-table relatively 13
Outlook: earnings the driving factor 13
Valuation is expensive, but still not unattractive 15
Opportunities outweigh risks in 2011 16

Contacts 19
 Foreword

Foreword

India in 2011

Dear Client, In terms of valuation, the Indian equity market is by far

According to our cyclical research approach we are firmly
convinced that economic performance is the main driver
of the financial markets. It is not necessarily the absolute
level of growth that is important, but rather the expected
change in the pace of growth. This results namely in posi-
tive and negative surprises for economic growth and cor-
porate earnings. As a consequence of the increasing
globalisation, the economic cycles worldwide are syn-
chronised with small deviations.
Our expectations on the global economy and the future
performance of the Indian economy are described in de-
tail in the first part of this publication. In the second part,
we consider the outlook for the Indian rupee. Finally, the
third part contains our outlook for the Indian equity mar-
ket.
the most expensive in Asia. However, the high price is
justified by the best earnings trend. The question is
whether India can maintain the growth momentum of re-
cent years and earnings can therefore continue to grow at
above-average rates in the future. Even if the pace of
growth slows somewhat, it should still remain high com-
pared to the other emerging markets. We see upside po-
tential of 15-20% in 2011.
For a more detailed overview of the most important global
economic regions and financial markets, we recommend
our publication «Global View». We hope this outlook gives
you a good overview of the opportunities offered by one
of the world's largest countries and the challenges it
faces.
Best regards

In 2010, the Indian economy again grew very strongly. Af- Your Sarasin Research Team
ter 6% in 2009, growth accelerated to about 9% in 2010.
The Indian central bank tightened monetary policy in re-
sponse to rising inflation. The monetary policy measures
are likely to slow growth in 2011 to some extent. How-
ever, India's long-term potential is undisputed.

If India masters the two main challenges – education and

infrastructure – in the medium term, the country's econ-
omy can develop into a cornerstone of a new global eco-
nomic equilibrium with strong final demand.

There is growing international pressure on the emerging

markets to allow their currencies to appreciate faster.
The Indian rupee is undervalued and the Indian central
bank will therefore permit a gradual appreciation. How-
ever, the rupee is highly volatile and usually suffers heavy
losses when risk aversion in the financial markets rises.
This raises the risk in a portfolio. The Indian currency is
suitable for long-term investors that are willing to accept
short-term losses.

1
 Economic Outlook

Economic Outlook

India – soft landing for the economy in 2011

India will not escape the global economic downturn that we expect in 2011. Continuing robust domestic growth
can cushion the Indian economy from weaker exports. Consumption and capex will remain the key growth drivers.
We expect growth to fall back from about 8.5% - 9.0% in 2010 to 7.5% - 8% this year. This moderate outlook for
economic growth means the Indian central bank will no longer be able to continue last year's aggressive rate
tightening in 2011. If India masters the two main challenges – education and infrastructure – in the medium term,
the country's economy can develop into a cornerstone of a new global economic equilibrium with strong final de-
mand.

The global economy will weaken in 2011
Robust global economy in 2010…
The global recovery, which picked up pace in the second
half of 2009, continued in the first half of 2010. In the
global recession at the start of 2009, industrial invento-
ries were run down more than the decline in sales. From
renewed upturn until 2012. It is only when the labour
markets in the main regions have recovered that con-
sumers can again be potential drivers of the economy.
Powerful upturn in the global economy
5 104

the second half of 2009 on, industry- and export-oriented 4 102

companies were the main beneficiaries of inventory re-
3
100
building. By mid-2010, the gap between inventories and
2
sales had been closed and confidence in the global 98
1
manufacturing sector began to wane again. The OECD's
96
global leading indicator (which covers all OECD members 0

and the six most important non-members, namely Brazil, -1

94

China, India, Indonesia, Russia and South Africa) had 92

-2
reached a turning point in mid-2010. For the second half
-3 90
of 2010, everything seemed to point to a slowdown in the 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
World GDP growth (%)
OECD global leading indicator (R.H.SCALE)
global economy. However, the US government and the US Sourc e: T homs on Reuters Datas tream

central bank helped the upturn in H210 to develop new
momentum. With a huge tax-cutting programme and a fur-
ther easing in US monetary policy, the outlook for the US
economy improved significantly towards the end of the
year. This should also impact positively on the global
economy.
…but there will be a slowdown in 2011
Thanks to the US measures, the upturn will certainly con-
tinue in the first quarter of this year. However, the global
economy is then likely to cool sharply. The labour mar-
kets in many western economies, especially in the US,
are still in a poor state. Consumers will no longer be able
to maintain the economic upswing once the initial eupho-
ria on fiscal and monetary stimuli has faded. The second
half of 2011 is likely to be marked by a sluggish global
economy. This downturn will probably not give way to a
Source: Datastream
Powerful upturn of Asia's export nations
Asia came through the recession far better than the
western industrialised states. In the first place, the bank-
ing system in Asia was more robust than in the US and
Europe. Secondly, the region is profiting from the struc-
tural catch-up process in many emerging Asian countries.
However, Asia was not totally immune to the global re-
cession. The highly export-oriented “newly industrialised
Asian countries” (Hong Kong, Korea, Singapore and Tai-
wan) and the Asean-5 countries (Indonesia, Malaysia,
Philippines and Thailand) were especially hard hit by the
loss of demand from the western industrialised nations.
It was these countries that recovered the most strongly in
2010 on the back of inventory rebuilding. The following

3
Economic Outlook

chart shows the pronounced cyclical swings in Singapore Upswing in India is losing momentum
and Thailand over the last two years. Domestic supported upturn in 2010
As in China, economic growth in India was supported by
Strong downturn and upturn in Singapore and Thailand robust domestic demand in the 2009 global recession.
14 20 Robust consumption and a major fiscal programme have
12
been providing the necessary tailwind, as the following
10 15
chart reveals. Moreover, in contrast to China and other
8
10
Asian economies India is much less export-oriented. The
6
rate at which Indian GDP grew hardly ever fell below 6%
4
5
2
(yoy), as the left-side chart shows. The resilience of the
0 Indian economy in the global recession meant that the
0
-2 upturn in 2010 was less spectacular than in the heavily
-4 -5 export-oriented economies such as Singapore and Hong
-6
Kong. Nevertheless, growth in India returned to the rates
-8 -10
2005 2006 2007 2008 2009 2010 achieved by the economy prior to the global recession.
India real GDP growth y oy (%)
Singapore real GDP growth y oy (%) (R.H.SCALE)
Thailand real GDP growth y oy (%)Sourc e: T homs on Reuters Datas tream Economic growth in 2010 should be between 8.5% and
Source: Datastream 9%.

Asia is unlikely to escape the global slowdown Strong upturn in Indian investment
However, economic activity in these export-oriented 20 60

states is expected to slow in 2011. The trigger is likely to 18

50
16
come from weaker growth in the industrialised states.
40
14
China also benefited from a pick-up in export demand in
12 30
2010. Domestic demand in China is also strong. The re-
10
cession in 2009 hardly impaired domestic demand in 20
8

China. On the contrary, a huge stimulus package led to 6 10

an acceleration in domestic demand. However, China is 4

0
now grappling with the fall-out from these measures. The 2
-10
liquidity available to the economy is far higher than de- 0

-2 -20
sired and inflation is also clearly in an upward trend. The 2005 2006 2007 2008 2009 2010
India consumption y oy (%)
India inv estment y oy (%)
Chinese central bank is therefore in the process of rein- India gov ernment consumption y oy (%)(R.H.SCALE)
Sourc e: T homs on

ing in monetary policy. Stricter monetary policy and lower Source: Datastream
demand from the industrialised states will result in a
slowdown in Chinese growth at a high level in 2011.

4
 Economic Outlook

Capital expenditure the most important driver Slowing in the US points to weaker confidence in India
As in the pre-recession years, investment remained the 16 65
15
key driver for the economy. Historically low interest rates 60
and a huge need for investment in India's still underde-
10 55
veloped infrastructure have ensured buoyant investment
activity. Consumption has not quite managed to regain 50

the high pre-recession growth rate. As consumption was 5

45
relatively robust in the recession, there was simply no
need to catch up. Moreover, the high food prices at the 0 40

start of the year probably dampened the consumers’ 35

mood. In line with the recovery in the global economy, In- -5
-6 30
dian exports also picked up strongly. However, in the 98 99 00 01 02 03 04 05 06 07 08 09 10
India leading indicator y oy (%)
US ISM manuf acturing(R.H.SCALE)
course of 2010 we already saw the first signs of weak- Sourc e: T homs on Reuters Datas tream

ness. Not surprisingly given the background of strong Source: Datastream

domestic demand, import grew at a faster pace than ex-
ports. India's trade balance therefore deteriorated sharply We expect the US ISM manufacturing index to drop to
during the year. about 50 during the course of the year. For India, this
also means a further decline in the OECD leading indica-
India's imports grow faster than exports tor, as the above chart illustrates. The following charts
4000 4000 show how pronounced the slowdown may be. The OECD's
leading indicator is closely correlated with the trend in In-
3500 3500 dian industrial production. A further decline in the leading
indicator points to industrial output growing by 6.0% to
3000 3000 8.0% in 2011. The correlation between industrial produc-
tion and GDP growth in turn points to economic growth of
2500 2500
some 7.5% to 8.0% in 2011. The expected growth in In-
dia is therefore lower than the average rate of about 9%
2000 2000
over the last few years.

1500 1500
2005 2006 2007 2008 2009 2010 Downside potential in India's industrial production
India exports
India imports
Sourc e: T homs on Reuters Datas tream 16 18

Source: Datastream 14 16

14
12
Indian growth below eight percent 12
10
In 2011, Indian foreign trade should feel effects of the 10
slowdown in global economic activity that we expect. This 8
8
will also have an impact on the domestic economy in In- 6
6
dia. Despite the strong domestic sector, the confidence 4
4
of Indian companies is based on the global cycle. The fol-
2 2
lowing chart shows the close correlation between the In-
0 0
dian OECD leading indicator and the US business climate 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
India leading indicator y oy (%)
India industrial production ex construction 3m mav (R.H.SCALE)
index for the manufacturing sector (ISM manufacturing). Sourc e: T homs on Reuters Datas tream

The ISM manufacturing index can be viewed as the en- Source: Datastream
gine for the global economic cycle. Thanks to its domi-
nant financial market, the US economy still exerts a sig-
nificant influence on the global economy.

5
Economic Outlook
Weaker industrial production slows GDP growth
0.50 18
0.00 16
9.50
14
9.00
12
8.50
10
8.00
7.50
7.00
6.50
6.00
5.50 0 78
2005 2006 2007 2008 2009 2010
India real GDP growth y oy (%)
India industrial production ex construction 3m mav (R.H.SCALE)
Sourc e: T homs on Reuters Datas tream
Source: Datastream
Consumption will cushion downturn in 2011
Investment will no longer be able to grow as fast as in
the previous year. There is no longer a need to make up
for inventory losses, as in 2010. In addition, the interest
rate level has now risen. However, given the huge gaps in
Indian infrastructure investment will again make a posi-
tive contribution to growth in 2011. Consumption should
be the main growth driver. The robust and stable growth
numbers in recent years have supported the income of
Indian households. A stabilisation in food prices helps
real income. With stable domestic demand and a weaker
global economy, net exports should again lower Indian
growth in 2011. In view of India's high debt and high fis-
cal deficits in recent years, the state cannot be expected
to contribute very much either.
India a ray of light in 2011, despite slowdown
Given this economic outlook, India should again be one
of the growth engines in 2011 both in Asia and globally.
As most of the Asian economies are more reliant on ex-
ports than India, they are likely to be hit hard by the
global slowdown. We believe that only China can achieve
a stronger economic growth performance in 2011. How-
ever, the growth risks are higher in China. For one thing,
China's economy is more export-oriented. In addition, the
tightening of Chinese monetary policy in 2011 is likely to
be more pronounced than in India.
Fiscal and monetary policy
Debt-to-GDP ratio continues to fall
In the 2009 crisis year, the state deficit increased
sharply following fiscal measures aimed at stabilising the
economy, which resulted in India's debt rising further. In
2010, the situation improved considerably. Higher growth
and the attendant higher tax revenues led to a significant
reduction in debt. This trend should continue in 2011.
The government deficit will again be below expected eco-
nomic growth, which will lead to a further decline in debt
as a percentage of GDP. However, debt will fall at a far
slower pace.
8
6
Debt (as % of GDP) is declining
4
-2 82
2
80
-3
76
-4
74
-5 72
70
-6
68
66
-7
64
-8 62
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
India public def icit (%)
India debt-to-GDP(%)(R.H.SCALE)
Sourc e: T homs on Reuters Datas tream
Source: Datastream
Focus will be on debt reduction
Compared to other emerging nations, India's debt is very
high. The massive debt problems in the Euroland have
raised investor awareness regarding sovereign debt. In
the future, investors will demand a higher yield for higher
debt. For this reason, it should also be in India's own in-
terest to reduce its debt significantly. Given the strong
growth, India will also succeed in doing so. Even a gov-
ernment deficit of less than 8-9% leads to lower debt
relative to economic growth. In the medium term, how-
ever, India will be faced with conflicting targets. Building
up the infrastructure requires government funds, which
makes it harder to reduce debt. India will have to achieve
a balance between these goals.
RBI freed itself from low rate policy in 2010
The Indian central bank (Reserve Bank of India, RBI)
manages monetary policy by setting the repo rate and re-
verse repo rate. The repo rate represents the rate at
which the RBI takes liquidity out of the capital market.
The reverse repo rate is the rate at which the RBI pro-
vides liquidity. By setting the rate at which banks can ob-
tain liquidity from the RBI, the reserve bank manages
short-term interest rates. The chart shows that 3-month
Libor (3-month loan without collateral) is generally be-
6

tween the reverse repo and the repo rate. In 2009, the
RBI cut the key rates to a record low to support growth in
India in the global economic crisis and provide the banks
with sufficient liquidity. It continued the low interest rate
phase into the first quarter of 2010. In spring 2010,
however, it became apparent that a powerful upswing
was in progress in the Indian economy. As a conse-
quence, the RBI gradually raised its key rates to 5.25%
(reverse repo rate) respectively to 6.25% (reop rate). The
movement of 3-month Libor interest rates shows that to-
wards the end of the year liquidity became tight and
short-term rates rose above the band defined by the RBI,
which prompted it to inject money into the banking sys-
tem with unconventional instruments.
RBI raises key rates considerably in 2010
13 13
12 12
11 11
10 10
9 9
8 8
7 7
6 6
5 5
4 4
3 3
2005 2006 2007 2008 2009 2010
India repo rate (%)
India rev erse repo rate (%)
India 3-months Libor (%) Sourc e: T homs on Reuters Datas tream
Source: Datastream
Inflation in an uptrend
Besides the improved economic situation, Indian inflation
was a further reason why the RIBI ended its low rate pol-
icy. Measured by wholesale prices, inflation was well
above the RBI's target of 5% to 5.5%, as is shown by the
following chart. Inflation in India remained at a high level
throughout 2010. The main driver of inflation was the
powerful upward trend in food prices to the middle of the
year. This is also illustrated by the following chart. In In-
dia, food prices are the most important component of
consumer prices. For this reason, changes in food prices
have a big influence on overall inflation. However, to-
wards the end of the year food price inflation – and hence
overall inflation – subsided. In 2011, inflation is expected
to drop further. Indian growth is below the long-term aver-
age, which should have a damping effect on prices. How-
ever, we expect food prices to remain at a high level in
2011, which will slow the decline in inflation.
Economic Outlook
Food prices drive inflation in 2010
25 25
20 20
15 15
10 10
5 5
0 0
-5 -5
2005 2006 2007 2008 2009 2010
India wholsale price inf lation (%)
India wholsale price inf lation f ood (%)
Sourc e: T homs on Reuters Datas tream
Source: Datastream
Monetary policy only marginally more restrictive
The restrictive monetary policy will probably not be con-
tinued in this form. Economic growth is likely to slow in
2011 and inflation has moved closer the RBI's comfort
zone from its high of more than 10%. In addition, there is
a risk that, as a result of the large interest rate differen-
tials between the short-term interest rates in India and in
the US or Europe (where we expect a continuation of the
zero rate policy), the Indian rupee could appreciate fur-
ther. In a year, in which exports will already suffer from
soft global demand, this is certainly undesirable. Last but
not least, the current tight supply of liquidity available to
the Indian banking sector could deter the RBI from con-
tinuing to raise rates aggressively. This year, we expect
short-term rates to remain unchanged or rise only slightly.
Food prices could become a problem
A further rise in commodity prices represents a risk for
the RBI. This could result in further increases in food
prices, leading in turn to inflation remaining well above
the comfort zone in 2011. For the RBI, this should mean
more rate hikes even though the Indian economy is slow-
ing. This would increase the risk of a hard landing. The
consequences especially for households at or below the
subsistence level could be drastic. On top of rising food
prices (by far the largest item in such households' budg-
ets), there would be a potential loss of income. For this
reason, the Indian authorities are more likely to take ad-
ministrative action than tighten monetary policy again if
food prices continue to move higher. Such administrative
intervention could take the form of subsidies for food
production and price caps on individual products.
7
Economic Outlook
Virtually no movement in long-term rates
In 2009, long-term rates had already anticipated a rise in
short-term rates. As a consequence, the increase in rates
in 2010 was moderate. Yields on 10-year Indian bonds
moved more or less sideways. Stable long-term interest
rates and rising key rates resulted in the yield curve in
India flattening considerably. This trend should remain in
place in 2011. While short-term rates are hardly likely to
rise any further, yields – above all towards the end of
2011 – could fall slightly at the long end. A weaker econ-
omy combined with weaker inflation points to lower inter-
est rates.
Yield curve flattened markedly in 2010
10 10
9 9
8 8
7 7
6 6
5 5
4 4
3 3
2005 2006 2007 2008 2009 2010
India treasury y ield 1y ear (%)
India treasury y ield 10y ear (%)
Sourc e: T homs on Reuters Datas tream
Source: Datastream
India's role in global rebalancing
Consumption excesses and export boom not sustainable
In the coming years, the dominant theme for the global
economy will be «global rebalancing». This means correct-
ing the current imbalances. On the one hand, «deficit
countries» such as the US, UK and Spain have exces-
sively expanded consumption for years. This was made
possible by huge current account deficits and a sharp in-
crease in lending to households. On the other hand,
there were the «surplus countries», which financed the
consumption boom in the deficit countries with their capi-
tal exports and at the same time profited enormously by
exporting to those countries. In Europe, such surplus
states include Germany and Switzerland for example and
in Asia China and the «newly industrialised countries of
Asia» such as Singapore and Korea. The banking crisis
and the resultant recession have shown that this imbal-
ance will no longer be tenable in the future and that the
global economy will have to return to a more sustainable
growth path.
India's important role in the new equilibrium
The western deficit countries will have to raise their sav-
ings rates, which also means that consumption in those
countries will decline. However, this means that the sur-
plus nations will lose their most important export markets
and will have to turn increasingly to consumption. This
«global rebalancing» is not without risks. A situation could
arise in which the deficit countries (have to) reduce their
consumption, while the surplus countries are not pre-
pared to shift from export-driven growth to more con-
sumption. This could lead to a global shortfall in demand.
In this connection, India can play a key role in the new
equilibrium. India is one of the few countries whose
growth is not based on an export bias and whose con-
sumption is also not excessive. On the contrary, the
strong population and income growth forms the basis for
strong consumption growth in the coming years. The
chart below shows the expected growth in the labour pool
in China, India and the US over the coming 15 years.
Growth is likely to take place solely in India. Accordingly,
India will assume a key role in the global rebalancing
process, as it can offset the lower demand in the tradi-
tionally high consumption western countries.
India's labour market should grow strongly over the
coming 15 years
900 900
800 800
700 700
600 600
500 500
400 400
300 300
200 200
100 100
1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025
India labour f orce
China labour f orce
US labour f orce Sourc e: T homs on Reuters Datas tream
Source: Datastream, Economist Intelligence Unit
Can India fulfil its potential?
India's potential is not in dispute. The key question in the
medium term is whether India will be able to exploit its
potential. In this regard, two issues will be crucial. 1.
Education - while India is already an international leader
in information technology, there are enormous shortcom-
ings in the education sector. A growing middle class
needs investment in a solid basic education. 2. Infra-
8
 Economic Outlook

structure - to maintain high economic growth in the long

term, the infrastructure must also keep pace. Today,
there are huge shortcomings in India's public infrastruc-
ture; huge efforts are required. If India manages to mas-
ter these two challenges, the country should stand out
not only in terms of high economic growth in the short
term, but should also lay the foundation for sustainable
economic growth in the long term.

Dr. Alessandro Bee, Economist & Fixed Income Strategist

9
 Currency

Currency

Indian rupee for long-term investors

There is growing international pressure on the emerging economies to allow their currencies to appreciate faster.
The Indian rupee is undervalued and the Indian central bank will therefore permit a gradual appreciation. However,
the rupee is highly volatile and usually suffers heavy losses when risk aversion in the financial markets rises. This
raises the risk in a portfolio. The Indian currency is suitable for long-term investors that are willing to accept short-
term losses.

Emerging market currencies in G20 focus
The last G20 meeting paid a great deal of attention to the
smouldering currency dispute. The US believes the cur-
rency policy of the emerging markets is the main reason
for the global imbalances. The criticism levelled by Wash-
ington at the emerging economies is that they are keep-
ing their currencies undervalued and obtaining an unjusti-
fied competitive edge in international trade. Indeed, in-
ternational currency reserves have grown rapidly in recent
months; more than one half of the worldwide rise in forex
reserves is attributable to the emerging markets. India's
foreign exchange reserves have also risen again. The
a «fair» current account balance for some emerging mar-
kets. Accordingly, in considering whether a currency is
undervalued the relevant point is whether the current ac-
count balance exceeds its fundamentally justified level. If
the surplus is higher than the amount calculated by the
IMF, a currency is undervalued. Conversely, a currency
should trade even lower.
The Indian rupee is undervalued: the current account
balance is higher than the fundamentals warrant
Current account balance minus the "fair" balance
10.0

emerging market nations appear to be increasingly inter-

5.0
vening in the currency markets. In the G20 summit's final
statement, the 20 largest industrialised and emerging
0.0
market economies had agreed not to devalue their cur-
rencies to gain competitive advantages. In the future, -5.0
therefore, the emerging markets are likely to be less op-
posed to currency appreciation. A trade war would cause -10.0
Brazil

Israel

Egypt
Turkey
Korea

Indonesia

Thailand

South Africa

Chile

Argentina

India

China

Mexico

Malaysia

huge damage to all economies. For this reason, the

emerging economies will to some extent bow to interna-
tional pressure and allow their currencies to appreciate.
Currency valuation crucial
How much pressure the G20 exerts on individual coun-
tries will probably depend on the respective valuations of
the currencies. If a central bank attempts to hold a cur-
rency below its fair value, it can hardly defend itself
against criticism that it is manipulating its own currency.
The level of the current account balance is a suitable
measure for assessing whether a currency is undervalued
or overvalued. However, focusing solely on the level of
the current account balance is not enough. This depends
also on the demographics, economic cycle and fiscal pol-
icy of the economy in question. On the basis of these fac-
tors, the International Monetary Fund (IMF) has calculated
Source: IMF, Sarasin
India will permit a gradual appreciation
Our calculations show that the Indian rupee is below its
fair value (see upper chart). The G20 will therefore pay
close attention to India's monetary policy. The Indian
Central bank (RBI) will thus probably intervene less in the
future and allow the rupee to appreciate. How quickly it
takes to complete the adjustment is likely to depend
largely on China's currency policy. The Chinese renminbi
is also clearly undervalued and must strengthen in the fu-
ture if the currency dispute with the US is to be defused.
However, China is hardly likely to accede to US demands
for a considerable appreciation. If the adjustment pro-

11
Currency

ceeded too quickly, this would threaten the existence of Indian rupee is highly risk sensitive
Chinese export industries with low margins. China will Correlation vs. USD & MSCI World
therefore spread the appreciation over several years. In- 0.8
0.7
dia too is likely to permit the rupee to gain in value only
0.6
gradually. 0.5
0.4
But the Indian rupee is very volatile… 0.3
0.2
From a valuation perspective the Indian rupee offers an
0.1
attractive investment opportunity. In the short term, how- 0.0

Israel
Brazil

Singapur Dollar

Turkey
China
Argentina

Taiwan
Philippines
Chile
Indonesia

Korea
India

South Africa

Mexico
Thailand
ever, it fluctuates very strongly. Compared to other Asian

Malaysia
currencies, the Indian rupee is more volatile against the
US dollar (see chart below). The Hong Kong dollar is
pegged to the dollar under the currency board system and
the Chinese renminbi is also closely linked to the dollar. Source: Datastream, Sarasin
By contrast, the Indonesian and Korean currencies are
even more volatile than the Indian rupee. The Indian rupee is one of the currencies that profits from
a rise in risk appetite in the financial markets. By con-
Indian rupee is more volatile than other emerging mar- trast, if risk aversion grows, international investors with-
ket currencies draw from India and the rupee suffers severe losses. Dur-
Implied volatility vs. USD ing the financial crisis in 2008 and 2009 the trade-
16 weighted external value of the Indian rupee weakened by
14
some 20 percent. As a consequence, the India rupee
12
raises a portfolio's risk profile. If the financial markets
10
correct, investors suffer currency losses on top of equity
8
6 losses.
4
2 Good environment for the Indian rupee in 2011
0 Accordingly, for investors with a longer time horizon that
Israel

Brazil
Singapur
Hong Kong

Philippines

Turkey
China
Taiwan
Thailand

Argentina

India
Indonesia

Mexico
Chile
Korea

South Africa
Malaysia

are prepared to accept short-term setbacks, the Indian

rupee is a suitable currency. However, losses should be
limited in 2011. We expect that the recovery in the global
Source: Datastream, Sarasin economy will prove to be sustainable in 2011. In recent
months, the economic risks have fallen considerably. We
…and correlates with equities therefore expect no massive rise in risk aversion and the
The Indian rupee is also a highly risk-sensitive currency. environment for the Indian rupee should be good in
This is reflected in the high correlation with equity per- 2011.
formance (see chart below). The Indian rupee correlates
more closely with equity market trends than other Asian Ursina Kubli, Economist & Forex Strategist
currencies. Only the Singapore dollar is more dependent
on sentiment in the financial markets.

12
 Equities

Equities

Equities – upside potential still exists

In terms of valuation, the Indian equity market is by far the most expensive in Asia. However, the high price is justi-
fied by the best earnings trend. The question is whether India can maintain the growth momentum of recent years
and earnings can therefore continue to grow at above-average rates in the future. Even if the pace of growth slows
somewhat, it should still remain high compared to the other emerging markets. We see upside potential of 15-20%
in 2011.

Review: India top in absolute terms, mid-table relatively a mid-table ranking in the 2010 performance table for
Indian equities sharply higher in 2010 emerging markets.
In 2010, the Indian equity market developed very posi-
tively and seamlessly continued the good performance of Emerging markets performance in 2010
the previous year. After a subdued first half of the year, Thailand
Chile
the BSE Sensex index moved out of the tight trading Malaysia
range in the second half and nearly hit a new record high Indonesia
South Africa
at 21,000 points (previous high: 21,200 in January Mexico
Korea
2008). The full-year performance was 17%. Thanks to the India
slight appreciation of the Indian rupee against the US dol- Turkey
Taiwan
lar, a dollar investor with exposure to Indian equities even Russia
EM
achieved a return of 22%. Poland
World
Brazil
Indian equities: absolute & relative performance 2010 China
000'S Israel
22 112

0 10 20 30 40 50 60 70
21 110

Source: MSCI, Sarasin

108
20

106
19 Outlook: earnings the driving factor
104
Global economic momentum in focus
18
102 According to our cyclical research approach, we are firmly
17
100
convinced that economic performance is the main driver
16
of equity markets. It is not necessarily the absolute level
98
of growth that is important, but rather the expected
15 96
JAN FEB MAR APRMAY JUN JUL AUG SEP OCTNOV DEC change in the pace of growth. This results namely in posi-
India Bombay SE 30 Index
MSCI India relative to MSCI Emerging Markets(R.H.SCALE)
Source: Thomson Reuters Datastream tive and negative surprises for economic growth and cor-
Source: Datastream porate earnings. As a result of increasing globalisation,
the economic cycles worldwide are synchronised with
No decoupling from emerging markets small deviations. Our expectations regarding the global
In the first half of 2010, the Indian equity market outper- economy and the performance of the Indian economy are
formed the emerging markets overall (see chart above). described in detail in the first part of this publication.
However, in the consolidation in Q4 2010 all of the In-
dian equity market's outperformance was lost again. Lo- Local growth drives earnings
cal factors such as the aggressive monetary tightening of A good growth forecast also enables one to predict the
the central bank (RBI) and corruption cases led to a set- trend in earnings growth. The chart below shows that
back. As a result, the Indian equity market achieved only

13
Equities

earnings growth follows growth in industrial production Only temporary slowdown in growth
with a time lag of 6-12 months. As we expect a renewed global upturn towards the end of
2011, the slowdown in earnings growth over the coming
Earnings growth trails industrial production quarters should merely be temporary. In recent months,
18 50 earnings growth momentum has declined markedly. Ac-
16 40 cordingly, the consensus of analysts has been reacting to
14 this trend by revising expectations downward for some
30

12
time.
20
10
10
Earnings revisions have been negative for several
8
0 months
6
0.80 0.60
-10
4
0.60 0.40
2 -20

0.40
0 -30 0.20
2004 2005 2006 2007 2008 2009 2010
India industrial production ex construction yoy in %
India trailing earnings yoy in %(R.H.SCALE) 0.20
Source: Thomson Reuters Datastream 0
0
Source: Datastream
-0.20
-0.20

As we believe that economic growth will slow in H1 2011, -0.40

-0.40

earnings growth is likely to slow further. However, we ex- -0.60

-0.60
pect growth to stabilise at around 6-8%, i.e. there will be
-0.80 -0.80
a soft landing and a similar scenario as in 2005. In such 2006 2007 2008 2009 2010
India EPS revision ratio 1M
India EPS revision ratio 3M avg(R.H.SCALE)
a scenario, earnings growth is likely to stabilise at a level Source: Thomson Reuters Datastream

around 15-20%. Source: Datastream, Sarasin

New record earnings in 2010
In recent years, corporate earning growth in India has
been far higher than the average. In the wake of the
global financial crisis, earnings came under strong pres-
sure in 2009. However, they recovered astonishingly fast
after the financial crisis. For example, listed Indian com-
panies already posted new record earnings during the
course of 2010 (see chart).
India: earnings (trailing/forward 12M)
260
240
220
The above chart reveals that the balance of earnings es-
timates (positive minus negative earnings revisions) has
been in negative territory for some months. To some ex-
tent at least, weaker growth is being anticipated. How-
ever, negative earnings revisions should continue to im-
pact negatively on the Indian equity market in H1 2011.
Earnings expectations high, but not unrealistic
Looking forward, the key question is whether this strong
earnings growth is sustainable. After growth well in ex-
260 cess of 20% in 2010, the consensus also expects earn-
240 ings growth of some 20% for the coming two years.
220

200 200

180 180

160 160

140 140

120 120

100 100

80 80
2005 2006 2007 2008 2009 2010
MSCI India trailing earnings
MSCI India forward earnings
Source: Thomson Reuters Datastream

Source: Datastream

14
 Equities

Expected earnings growth 2010-2012 (%) Compared to the emerging countries, it is rather the rela-
35 tive growth momentum that plays a role. Higher earnings
30
growth is also reflected in the price that investors are will-
ing to pay. The Indian market is currently trading at a
25
premium of some 30-40% to the MSCI World index and to
20
the MSCI Emerging Markets index.
15

10 Valuation premium relative to MSCI World and EM

1.80 1.80
5

0 1.60 1.60
2010 2011 2012
India Emerging Markets 1.40 1.40

Source: Datastream, Sarasin 1.20 1.20

1.00 1.00
However, if the usual forecast margin of error is deducted
from this 20% (on average earnings are overestimated by 0.80 0.80

5-10%), we arrive at a quite realistic estimate. The chart 0.60 0.60

also shows that India has the highest earnings growth
0.40 0.40
among the emerging economies. This also justifies an 98 99 00 01 02 03 04 05 06 07 08 09 10
MSCI India forward p/e relative to MSCI World
MSCI India forward p/e relative to MSCI EM
above-average valuation. Source: Thomson Reuters Datastream

Source: Datastream, Sarasin

Valuation is expensive, but still not unattractive
Indian equity market relatively expensive
In recent years, the valuation of the Indian equity market
has increased considerably. Compared to the industrial-
ised nations, this is mainly due to the fact that the valua-
tions of the equity markets in the industrialised countries
have declined.
This premium is about twice as high as the average over
the last 12 years. Both in relative and absolute terms,
i.e. compared to its own past, the Indian equity market is
expensive (see chart below). Such a valuation is justified
only as long as growth remains at an above-average level.

15
Equities

Valuation expensive historically and relatively High correlation between India and emerging markets
0.95 0.95
50%
0.90 0.90
40%
0.85 0.85
30%
0.80 0.80

20%
0.75 0.75

10% 0.70 0.70

0% 0.65 0.65
Forward PE Trailing PE
0.60 0.60

India current valuation relative to 12y average 0.55 0.55

India current valuation relative to Emerging Markets
0.50 0.50
India vs. Emerging Markets (12y average relative valuation) 2008 2009 2010
MSCI India / MSCI Emerging Markets, weekly correlation
MSCI India / MSCI World, weekly correlation
Source: Datastream, Sarasin Source: Thomson Reuters Datastream

Source: Datastream, Sarasin

We believe India will be able to maintain above-average
earnings growth in the coming years thanks to the posi-
tive growth momentum. The premium therefore also ap-
pears justified. However, as expectations are already
high, there is only limited scope for positive surprises. On
the other hand, there is considerable potential for disap-
pointment if growth expectations are not fulfilled.
Higher valuation unlikely
Given the already high valuation and premium over other
equity markets, the valuation is unlikely to rise further.
This means that equity market performance is limited to
the level of earnings growth. Accordingly, we expect the
Indian equity market to move in line with expected earn-
ings growth of 15-20% in 2011.
Opportunities outweigh risks in 2011
Global risk aversion the biggest risk
As the significance of foreign money flows is relatively
high, we believe an increase in global risk aversion repre-
sents the biggest risk for the Indian equity market. While
we expect global risk aversion to continue to trend down-
wards in 2011, the Indian equity market remains vulner-
able. The money flows that India has attracted in recent
years are highly volatile and can quickly dry up. If many
investors wanted to exit at the same time, there could be
a major setback.
The Indian equity market's close correlation with the
MSCI World and the MSCI Emerging Markets index shows
that global factors are more important than local ones for
the performance of the equity market. In view of the In-
dian equity market's especially high correlation with the
emerging markets, China in particular is extremely signifi-
cant for the performance of the Indian market.
Positive surprise in China an opportunity
We believe that concerns of a sharp slowdown in growth
in China are overdone and expect positive surprises.
While growth should slow to about 9% in 2011, the Chi-
nese economy appears unlikely to suffer a hard landing.
The Chinese equity market, which investors are currently
steering clear of, is our top recommendation among the
emerging markets for 2011 from a contrarian standpoint.
Good news from China and a good performance on the
part of the Chinese equity market should also be positive
for Indian equities.
Double-digit return expected in 2011
We are optimistic for the Indian equity market in 2011
and again expect a double-digit return. However, given the
high valuation the upside potential is limited and the In-
dian stock market is therefore hardly likely to outperform
the emerging markets overall. But investors that are able
to ride out strong fluctuations should profit from exposure
to Indian equities.

Philipp Bärtschi, CFA, Chief Strategist

16
 Abbreviations

A actual value
abs.ch absolute change
ASW asset swap spread
avg. average
bn billion
bp basis points
corp. corporate
CPI Consumer Price Index
Div. yield or DY dividend yield
E estimate
EBIT earnings before interest and taxes
EPS earnings per share
EV/EBITDA enterprise value to earnings before interest, taxes,
depreciation and amortisation
excl. excluding
FY financial year
GAAP Generally Accepted Accounting Principles
GDP gross domestic product
GNP gross national product
gov. government
m million
M&A Mergers & Acquisitions
mavg moving average
N.A. not available
p.a. per annum
P/B price-to-book ratio
P/E price-to-earnings ratio
P/NAV price/net asset value
R&D Research & Development
R.H. Scale right hand scale
ROE return on equity
SAA Strategic Asset Allocation, long term strategy based on investment profiles
TAA Tactical Asset Allocation; short term strategy based on return/risk expectations
vs. versus
yoy year over year

17
 Contacts

Contacts

Research
Dr. Jan Amrit Poser Tel. +41 44 213 92 81
Head of Research jan.poser@sarasin.ch

Economic Research
Dr. Jan Amrit Poser Tel. +41 44 213 92 81
Chief Economist jan.poser@sarasin.ch
Dr. Alessandro Bee Tel. +41 44 213 92 83
Fixed Income Strategist alessandro.bee@sarasin.ch
Ursina Kubli Tel. +41 44 213 92 80
Forex Strategist ursina.kubli@sarasin.ch
Benoît Robaux Tel. +41 44 213 97 91
Corporate Bond Analyst benoit.robaux@sarasin.ch

Strategy Research
Philipp Bärtschi, CFA Tel. +41 44 213 95 72
Chief Strategist philipp.baertschi@sarasin.ch
Peter Bezak Tel. +41 44 213 90 80
Portfolio Strategist peter.bezak@sarasin.ch
Eliane Tanner Tel. +41 44 213 92 54
Commodity Strategist eliane.tanner@sarasin.ch
Dr. Jianyong Wen Tel. +41 44 213 97 40
Quantitative Analyst jianyong.wen@sarasin.ch

Fund Research
Irene Huber, CFA Tel. +41 44 213 93 13
Fund Research irene.huber@sarasin.ch

Equity Research
Rainer Männle, CFA Tel. +41 44 213 94 99
Head of Equity Research rainer.maennle@sarasin.ch
Sector Strategist, Industrials
Patrick Hasenböhler Tel. +41 44 213 94 81
Head Swiss Equity Research patrick.hasenboehler@sarasin.ch
Consumer Goods, Media, Misc. Services
Daniel Bischof Tel. +41 44 213 94 83
Financials (International) daniel.bischof@sarasin.ch
Dr. Philipp Gamper Tel. +41 44 213 94 97
Capital Goods, Chemicals, Construction, Automotive philipp.gamper@sarasin.ch
Ute Haibach Tel. +41 44 213 96 76
Metals & Mining ute.haibach@sarasin.ch
Dr. David Kägi Tel. +41 44 213 94 82
Health Care david.kaegi@sarasin.ch
Michael Romer Tel. +41 44 213 94 84
Energy, Utilities, Consumer Goods michael.romer@sarasin.ch
Oskar Schenker Tel. +41 44 213 94 88
Chemicals, Construction, Technology, Industrials oskar.schenker@sarasin.ch
Rainer Skierka Tel. +41 44 213 94 98
Financials (Swiss) rainer.skierka@sarasin.ch

19
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