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Tax code helps but outlook cautious
August, 14th 2009

Indian share prices gained the most in three weeks on Thursday after the government signalled its reform intent with its new taxation plans and local and global industrial data reaffirmed recovery hopes.

Analysts, however, advised caution, citing stretched valuations and the weak monsoon.

Indias bellwether equity index, the Sensex, gained 3.32%, or 498.33 points, to close at 15,518.49. The broader 50-stock Nifty closed 3.31%, or 147.5 points, up at 4,605.

With this gain, the Sensex has recouped some of the 5.68% losses it incurred since the beginning of last week, after concerns of weak rains triggered a fall from the years highest value of 15,924.23 points.

The new direct tax code is an indication that the government may come up with more reforms which are pending, like FDI (foreign direct investment) in key sectors which the market has been expecting, said D.D. Sharma, vice-president of research, retail, at brokerage Anand Rathi Financial Services Ltd. The consistent uptrend seen during the day suggests buying by large long-term investors who have been encouraged by the IIP (Index of Industrial Production) numbers, he added.

Indias industrial output expanded at its fastest pace in 16 months in June at 7.8%, beating forecasts by a wide margin.

On Wednesday evening, the government released a new tax code that suggested significant tax cuts for individuals and companies and removed exemptions while doing away with the tax on equity transactions.

The unexpected 7.8% gain in June manufacturing output, also released on Wednesday, helped in quelling fears of a weak monsoon derailing economic growth even as global markets rose after the US Federal Reserve signalled the recession was ending in the worlds largest economy.

In Asia, Hong Kong, Indonesia and Taiwan markets all vaulted by about 2% on Thursday. In the US, the Dow Jones Industrial Average rose 120.16, or 1.3%, to 9,361.61 points as chairman Ben Bernanke announced overnight that the Fed would keep rates unchanged for some time. On Thursday, the Dow was up 14 points at 9376.12 at 8.30pm IST.

While this means that liquidity in the global financial system would remain unaffected, it could also lead to valuations running ahead of fundamentals. We are ready for a big downside except for the global liquidity, said Anand Shah, head of equities at Canara Robeco Asset Management Co. Ltd that has Rs7,854 crore worth of assets under management. People have forgotten what happened in 2008. If the liquidity turns, we will be a sitting duck.

Shah was referring to the $13 billion (Rs62,530 crore) pullout by foreign institutional investors, the largest investor category in Indian equities in 2008, which sent the market into a tailspin, wiping off 52%.

Its all liquidity driven, said Andrew Holland, chief executive, institutional equities, Ambit Capital Pvt. Ltd. As long as liquidity is there, the market will go up. It will get more volatile as it goes higher and any untoward event or bad news will be met with a sharp correction.

An impending drought in some parts of India could be bad news.

On Thursday, global rating agencies Standard and Poors (S&P) and Moodys added their voices in painting a scare story over deficient monsoons.

A deficient monsoon has darkened Indias economic outlook, pronounced Sherman Chan, economist with Moodys Economy.com in a weekly newsletter on Thursday. Farmers are struggling, putting pressure on the government to extend financial assistance.

The India Meteorological Department early this week said that rainfall this year is likely to be around 87% of the long-term average as opposed to a 93% forecast earlier, as it made an unprecedented third revision in its predictions.

Standard and Poors also feels monsoons could be a threat to the rural income theme, which is key to its India economic growth forecast of 6% for 2009, but prefers to wait awhile before it freezes its numbers.

Its a little bit difficult to put a number on this impact at this stage as there are significant regional differences, Subir Gokarn, chief economist, S&P Asia Pacific, told reporters at a conference call. We will wait for the August (rainfall) numbers before we run our forecasting models to gauge the impact on agricultural production.

To be sure, the share of agriculture in Indias economic output has shrunk to 17.5% now, compared with 34% in the early 1980s.

But monsoons remain important as nearly 55% of the labour force is employed in farming. For companies such as Hindustan Unilever Ltd, Bharti Airtel Ltd and Hero Honda Motors Ltd, rural customers account for half their revenues.

Valuations in India are also stretched.

The Sensex, for instance, trades at 18 time estimated earnings for fiscal 2010, well above its historical average. Valuations are not cheap and one has to be very cautious, said Dharmesh Mehta, head, equities, Enam Securities Ltd.

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