Inflation concerns rise despite India's quarterly growth spurt

Despite India's latest quarter's impressive gross domestic product, concerns around inflation and widening fiscal deficit remain. So what does the long-term future have in store for the Indian equity market?

India's longer-term growth potential remains intact given strong fundamentals. The country's long-term growth story is an inter-play of infrastructure and consumption themes.

With attractive opportunities across sectors in the consumer and investment spaces due to rising disposable income, we believe sectors that can piggyback on the domestic consumption and investment themes are good opportunities from a medium- to long-term perspective.

India remains underserved in terms of financial services, but the strong growth in personal incomes has led to increased demand, providing the Franklin Templeton India team with opportunities to invest. Given the low penetration of banking and financial services in India, we believe companies in this sector have huge growth potential. For instance, well established large private banks, such as HDFC Bank and Kotak Mahindra Bank, are well placed to take advantage of this growth opportunity.

The Indian markets have been among the top global gainers in 2009. In recent months, news flow on the economy and earnings has been encouraging. Corporate India's healthy track record in terms of RoE as well as greater proportion of domestic demand component in earnings is a positive, helping India enjoy a valuation premium over other emerging markets. There are also clear signs of higher demand for consumer durables and capital goods, which would suggest that earnings growth is likely to be positive. However, investors need to watch out for overpricing of growth in certain pockets.

Impacting Asian markets

Undoubtedly, India is having an impact on other Asian markets. Within Asia, India is one of the fastest growing economies, with strong domestic demand and a large consumer base. This will eventually bring forth opportunities for a wide range of businesses in the region. Not only this, but India has recently signed trade agreements with South Korea and the Association of South East Asian Nations, which will work towards reducing trade barriers and enhancing intra-regional trade.

Despite overall optimism in the country, from a near-term perspective, the building of inflationary pressure and a possible change in global sentiment are key concerns. The large equity issuance pipeline could also cap the market upside. India also has a high fiscal deficit and it is critical for the government to focuses on fiscal consolidation.

Though the opportunities outweigh the short-term risks, we are positive on the long-term future of the Indian equity market. With corporate earnings and economic recovery underway, the case for India remains strong over the medium- to long-term; a positive policy environment will aid the reform process and should enable the country to sustain higher growth rates. Structural growth drivers, such as favourable demographic trends and rise in government and corporate spending, will support growth in the long term.

The writer is chief investment officer of Asian Equities and sub-adviser of the Franklin India Fund.