Here is what justifies being bullish on Indian stocks By SAURABH MUKHERJEA, AMBIT CAPITAL Whilst we have written extensively about the economic reform process over the past three months, even optimists like us have so far struggled to identify tangible signs of an economic recovery. That is gradually changing. Here are a few developments which suggest that the Indian economy might be bottoming out in Q2 FY13: We hosted a conference call this Wednesday with the SME Rating Agency of India. The CEO of this agency, Patki, said on the call that over the past couple of months he has seen the ratings of Indian SMEs improve largely because of better access to liquidity from banks (sometimes at lower rates of interest than have been offered anytime over the past year or so). Also on the call was the CEO of the India SME Asset Reconstruction Company, Mirashi. His view was that NPAs from the SME sector should bottom out in Q2 as from Q3 onwards better access to liquidity and the beneficial impacts of the SEB debt recast (announced by the cabinet on Monday) should start flowing through. Now, whilst I have a lost a lot of hair over the past decade trying to call turns in the cycle, one thing I have learnt is that SMEs tend to be leading indicators of an economic cycle. At the other end of the borrowing spectrum stand giants like Tata Steel and Hindalco, both heavily indebted firms in a beleaguered industry (hit both by the global downturn in metal prices and by policy paralysis). The front page of leading financial daily in India says that a consortium of banks led by SBI and HDFC Bank have agreed to lend $7 billion to Tata Steel and $2 billion to Hindalco. These are the biggest bank loans sanctioned in India over the past year and are clearly being used for capex (in the Tata Steel case for the mega Kalinganagar plan it is building in Orissa). Just in case people did not appreciate how significant this was, an HDFC executive told the newspaper, shows that there is a revival in sentiment. People are coming to us and looking for loans. This could be termed as a sign of confidence returning to Indian corporation. On a conference call with our clients on September 31, Dr Rao, the PM’s fiscal advisor, said he expects the SEB debt recast to make it easier for SEBs to agree to higher power prices in the PPA contracts they have signed with private power utilities. Lo and behold, earlier this week, Lanco announced that it had reached just such a settlement with MPSEB. It is not unreasonable, I think, to see this as a precursor to other SEBs moving to either putting PPAs up for rebidding (with the incumbent being given a right of first refusal) or simply agreeing bilaterally to hike prices. Our view is that the Indian economy will grow at 6.3 per cent in FY13 and 7.1 per cent in FY14. That in turn drives our Sensex EPS forecasts (5 per cent YOY growth in FY13 and 10 per cent growth in FY14). Our FY14 Sensex EPS of Rs 1,350 multiplied by a 17 times forward P/E (the average for the Sensex for the past 6 years) gives us our March 2014 Sensex target of 23,000. As would be logical at this stage of the cycle, we advocate clients increasing their portfolio weights on cyclicals, excluding banks. We are cognizant that the underlying economic realities in Europe and China seem be deteriorating by the passing month. However, we take comfort from two things: (a) The ECB has clearly articulated that it will intervene in sovereign debt markets to whatever extent is necessary to control bond yields; and (b) A Chinese slowdown will be a blessing for India by keeping a check on crude oil prices. Indeed this theme of a sustained slowdown in China, what it means for the commodity prices and hence for the Indian economy is something that we will explore in our Megathemes 3.0 note in Oct-Nov.