Indian Stocks May Extend Gains on GDP Outlook; Rupee Forecast to Advance

Indian stocks may gain 10 percent by the end of this year, extending the longest rally since 1979, as an unscheduled rate increase by the central bank won’t derail economic growth, Prudential Financial Inc. said.

While stock indexes may drop in the three to four weeks after the rate decision, strengthening domestic demand may lure funds to equities, Prudential said. Higher lending rates may also boost the rupee, according to FirstRand Ltd., helping the currency recover from Asia’s second-biggest loss.

“In the near-term, the latest rate hike is likely to have a negative impact on the Indian stock market,” said John Praveen, chief investment strategist at Prudential International Investments Advisers LLC, a unit of Prudential Financial, which oversees $693 billion. By the end of 2010, the benchmark Sensex index may rise to 19,200 as markets stabilize and the central bank is “seen as being ahead of the curve,” he said.

The Sensex, or Bombay Stock Exchange’s Sensitive Index, was the best performer among the world’s 20 largest equity markets last quarter, even after central bank Governor Duvvuri Subbarao raised rates while countries including the Philippines and Thailand left borrowing costs unchanged. Second-half buying of stocks by overseas investors is poised to surpass the first, said the nation’s biggest bank, as the government predicts the economy will expand at the quickest pace in three years.

Market Reaction

The Sensex fell 0.1 percent to 17441.44 at the close in Mumbai, after swinging between gains and losses at least 20 times. The rupee was little changed at 46.8050.

Benchmark 10-year bonds fell the most in more than a week, pushing yields to the highest since June 25. The yield on the 7.8 percent note due 2020 climbed seven basis points to 7.62 percent, according to the central bank’s trading system. The price fell 0.46, or 46 paise per 100 rupee face amount, to 101.20.

The Reserve Bank of India raised the reverse repurchase rate for a third time this year to 4 percent, the highest level since March 2009, from 3.75 percent. The move ahead of a scheduled meeting to decide on the rate shows the central bank’s confidence in the nation’s economic growth amid the global debt crisis, according to Prudential.

India’s $1.2 trillion economy expanded 8.6 percent in the three months through March, the fastest pace after China among Asia’s major economies.

Economic Growth

Gross domestic product will expand this year at the fastest pace since 2008, the government predicts. Net stock purchases by overseas investors climbed 32 percent in the first half to $6.7 billion, according to data compiled by Bloomberg, while foreigners raised investments in Indian debt by a record 78 percent this year, exchange data showed.

Subbarao raised rates a week after the government allowed fuel prices to rise, threatening to stoke inflation. The governor acted before the July 27 policy meeting as concerns of price gains now seemed to be “very much generalized and that demand-side pressures are evident,” he said last week.

The benchmark inflation rate unexpectedly accelerated to 10.2 percent in May, while consumer prices paid by industrial and farm workers rose 14 percent. Inflation is a political issue in a nation where the World Bank estimates more than three- quarters of the 1.2 billion people live on less than $2 a day.

More Rate Increases

In contrast, consumer-price gains are running at 2.9 percent in Australia, 5.1 percent in Indonesia and 4.3 percent in the Philippines. Australia, South Korea, Indonesia, the Philippines and Thailand kept borrowing costs unchanged last month to gauge the effects of the Greece-led debt crisis.

Kaushik Das, an economist at Deutsche Bank AG, expects India’s interest rates to climb by another 25 basis points at the July 27 meeting and by “at least” 50 basis points through the end of 2010. A basis point is 0.01 percentage point.

Praveen expects borrowing costs to rise 50 basis points by the end of the year, and advised investors to hold cash in the next three to four weeks before buying for the rest of 2010, the Newark, New Jersey-based investor said in an e-mail.

The Sensex climbed 1 percent in the past three months, its sixth straight quarterly advance, the longest winning streak based on data going back more than three decades.

The central bank’s first interest-rate increase this year was on March 19, and the unscheduled decision drove the Sensex 1 percent lower a day later before the gauge ended the week 0.4 percent higher. The second rise came after an April 20 policy meeting, and the stock index measure climbed 0.3 percent as the 25 basis point increase was less than some economists expected.

‘Ideal Entry Points’

“We don’t think it will have much direct negative impact for most stocks,” said Seth Freeman, chief executive officer of San Francisco-based EM Capital Management LLC, who in May correctly predicted the gain in small and mid-cap Indian stocks. “Knee-jerk stock-price dips due to sell-off may be ideal entry points for investors.”

Buying by overseas investors may also boost gains in the rupee, drawn by higher yields on local assets. The rupee’s 3.2 percent decline in the quarter ended June was the most among Asia’s 10 most-actively traded currencies after the South Korean won, according to data compiled by Bloomberg.

The rupee may rise as high as 46.50 in the next few days, said Krishnamurthy Harihar, treasurer at the Indian unit of FirstRand, South Africa’s second-largest financial services company. “46.79 looks a good level for exporters to buy the local currency,” Harihar said.

‘Natural Reaction’

The rate increase may also push the benchmark 10-year bond yields to as high as 7.7 percent, the most in two months, Kotak Mahindra Bank Ltd. said in a report. Bonds fell today “as a natural reaction to the policy rate hike,” according to analysts Indranil Pan and Shubhra Mittal.

Foreign investors raised investments in Indian debt to $13.5 billion on July 1, after touching an all-time high $14.5 billion on June 24, according to data released by the Securities and Exchange Board of India.

“RBI feels India’s domestic economy is relatively less affected by uncertainty in global financial markets,” said Praveen from Prudential, which operates in India under the brand name Pramerica. “Once the European debt crisis is resolved and global financial conditions stabilize, Indian stocks should recover and post solid gains.”

To contact the reporters on this story: Rajhkumar K Shaaw in Mumbai at rshaaw@bloomberg.net; Anil Varma in Mumbai at avarma3@bloomberg.net

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