The anticipation of an economic recovery in 2010 could drive up the market towards the end of 2009.

It doesn’t look good. The Indian stock market, which has been the fourth-worst performing market in Asia (ex-Japan) in 2008 so far, losing 54 per cent, may not fare too well in 2009 either. For one, the economic stimulus notwithstanding, the economy could continue to see weak momentum; a Citigroup report says that while the most recent GDP growth release may be at 7.5 per cent plus, the downside to growth is significant and the cycle has probably only just begun.

One reason for this is that interest rates, while coming off their peaks, are unlikely to drop to levels that encourage consumers to borrow; they will probably prefer to save what they can since deposit rates of banks and other fixed income instruments will remain fairly attractive. Companies too are likely to hold back expansion plans where possible unsure of the demand both in the home market and overseas.

Foreign capital, which has driven India’s growth story for the last four to five years, could continue to remain out of reach for the better part of the year. In 2007-08, India received $108 billion in foreign capital flows and cumulative inflows, over the past five years, are reported to have been of the order of $224 billion. Without access to capital at a reasonable cost, the private sector will find it hard to fund projects. So unless the government spends large sums on say, infrastructure, growth would most definitely slow down.

That means earnings of corporations are sure to be under pressure — indeed CLSA estimates the Sensex earnings for 2009-10 at just 3.6 per cent following the large number of downgrades. Even for a broader universe of 140-150 stocks, the growth in earnings, estimated by analysts is at just about 10 per cent.

The pressure over the next six to eight months, analysts point out, will be felt more on the top line rather than on costs, since prices of key inputs have started falling and continue to fall. So India is not going to be a growth story at least for the first half of the year. The second half of the year could be better though, partly because the low base effect will come into play and also because interest rates would have stabilised at lower levels.

Besides, by then the elections would have been over and hopefully, a stable government would be in place. An absolute majority for a single party or even a strong coalition would be a big positive for the market because reforms can be pushed through.

Despite having come off so sharply in 2008, India is not the cheapest market in Asia. It is cheaper than the Kospi, which is the best performing market in Asia(ex-Japan) having given up just 41 per cent , but more expensive than Taiwan.

According to a study based on the MSCI country index universe of stocks, India trades at a price-earnings multiple of 8.4 times estimated 2010 earnings. That is not expensive and indeed many Indian stocks may be trading close to floor valuations.

However, risk aversion remains high; foreign investors, who have sold more than $13 billion worth of stock in 2008, are unlikely to come back in a hurry. And domestic institutions, including mutual funds and insurance companies, that have supported the market this year, are unlikely to be able to participate to the same extent in 2009. Without liquidity, therefore, the markets are likely to move in a narrow range.

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