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Performance of Indian Stock Market during 2011 After a smart post-2008 crisis recovery in the equity market over

2009 and 2010, when the Indian equity market went up 81% in 2009 and 18% in 2010, 2011 was a disappointment. While global factors such as the European crisis and slow recovery in the US were the main triggers, inflation in India as well as delay in government policy-making were the main reasons behind Indias disappointing year on the stock market. The benchmark Sensex index fell around 23% since the beginning of the year. That markets were in distress is reflected by volatility. On at least 30 occasions, the Nifty of the National Stock Exchange moved at least 100 points in a single day, a daily move of about 2%. While foreign institutional investors (FII) stayed away for most of the first half of the year because prevailing valuations didnt enthuse them, they continued to stay away even in the second half when markets fell by 10%. Simply put, FIIs found Indian equities risky. Global and domestic factors weighed down markets FII net flow into the Indian equity markets for the first six months of 2011 was $0.5 billion (R2,636 crore) compared with $4.66 billion for the same period in 2010; in the next five months FIIs were net sellers (they sold more than they invested) to the tune of nearly $1 billion. We have failed to deepen the equity markets, said Vivek Mahajan, head (research), Aditya Birla Money. We dont have large domestic long-term funds to counter FII outflow and hence markets have suffered. Indias inflation was the biggest worry from the start of the year and the Wholesale Price Index remained consistently above 9% throughout 2011 touching a high of 9.78% in August. To counter rising inflation, the Reserve Bank of India (RBI) raised interest rates six times by a total of 225 basis points (100 basis points is 1 percentage point) in the year. The repo rate now stands at 8.5% and base rates for the largest private and government-owned banks are close to 10%. The impact of a series of hikes can be seen at various levels. According to October figures, the Index of Industrial Production (IIP) contracted by 5.1%, the worst fall since March 2009. Gross domestic product for the second quarter of 2011-12 declined to 6.9% compared with 7.7% in the first quarter. RBI data for scheduled commercial banks shows that credit growth has slowed from 24% in January to 18% in November (provisional figures).

High interest burden and raw material cost on the back of rising commodity inflation has also taken a toll on companies profits. Companies are losing out on pricing power and are not in a position to pass on the increase in input costs. The situation has got compounded by the sharp increase in financial costs. This is hitting earnings, said Mahajan. Additionally, the rupee saw a record fall against the dollar in 2011. The fall in rupee was inevitable on account of the high current account deficit, said Vaibhav Agarwal, vice-president (research), Angel Broking Ltd. As capital flows dried up, matters became worse. On 23 December, it was trading at Rs. 53.0 per dollar. At the end of November, with the announcement of opening of foreign direct investment in the retail segment, there was a ray of hope that government may finally act on policy matters. However, this retracted within days. Investor confidence got battered, leading many domestic and global brokerages to lower the Sensex target for 2012. Global factors have affected the performance of our market to some extent, but mainly domestic factors have come to haunt us. Policy inaction is possibly the single-largest factor, said Mahajan. Adding pressure were external factors such as the ongoing European debt crises; confusion remains despite the bailout package for Greece and liquidity infusion by central banks. Then there are concerns that the US will record a slower-than-expected growth. All this put together led markets lower throughout the year; it declined at a greater pace in the last three months. The Indian equity market on account of its domestic issues along with global chaos was one of the worst performers with at least 23% decline in 2011. MSCI World Index declined 11% and MSCI Emerging markets index declined 21%. Turbulent markets shook the MF street as well. Equity diversified funds lost about 22% on average. Mid- and small-cap funds lost a bit more; their average loss for 2011 stands at about 26%. As markets and funds slipped lower and lower, interest rates rose and other asset classes, such as gold and bonds, saw investor inflows and higher returns. NCDs and infrastructure bonds At least seven companies issued retail non-convertible debentures (NCDs). The prominent ones included State Bank of India and Shriram Transport Finance Ltd; Muthoot Finance Ltd, Religare Finvest Ltd and India Infoline Investment
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Securities Ltd were first-time issuers. Given the dismal state of equity markets, NCDs presented a good opportunity to balance portfolio returns and add income with returns of 9.95% at the start of the year to 12.5% in the second half. In most cases, the credit rating for companies was AA or higher, indicating low credit risk. In addition to NCDs, infrastructure finance companies, including IDFC Ltd, IFCI Ltd and LT Infrastructure Finance Ltd, issued infrastructure bonds. Along with high rates, these bonds provide an additional tax deduction of up to R20,000 under section 80CCF. So if you invested Rs. 20,000 in an IDFC infrastructure bond with an annual coupon rate of 9%, the post-tax compounded annual growth rate yield on the five-year cumulative option would be as much as 14.7%. The issuers in this space, too, were rated AA or higher. Interest income of both NCDs and infrastructure bonds is taxable. Gold Amid volatility in risky assets and poor outlook for the dollar, gold prices saw a sustained rally in 2011; MCX gold prices have increased 33.8% year-to-date. Global growth fears and uncertain economic outlook spelt good news for gold demand. Buying was up not only from investors through commodity and exchange-traded funds (ETFs), but also from countries looking to increase their sovereign holdings. On the domestic front, assets under management (AUM) of gold ETFs went up from Rs. 3,581 crore in January to Rs. 9,568 crore at the end of November. December saw some volatility in gold prices. Even so, experts remain bullish; weakening global scenario, economic uncertainty and risk aversion is likely to keep gold demand high. Some, however, are cautious. We believe that gold has probably touched its peak in dollar terms, said Gopal Agarwal, CIO, Mirae Asset Global Investments (India) Ltd. This is because the Euro zone is refraining from purchasing bonds. On the other hand, the US is witnessing improved data points, which augurs well for the economy. In this scenario, there would be limited scope for gold to regain its peak.

Performance of Indian Stock Market during 2012 Investor wealth soared by 27 per cent to around Rs. 67.7 lakh crore in 2012 with the stock indices gaining nearly 25 per cent on hefty capital inflows and of late a slew of reform measures even as concerns remain over economic growth and rising fiscal deficit. Indian bourses made a dramatic turnaround after a meltdown in 2011, leaving behind strong optimism about a bullish 2013 in hopes of RBI rate cut, hefty capital inflows, a recovery in global economy and excellent earnings growth in the third quarter of 2012-13. The smart recovery helped investor wealth to soar by over Rs. 14.5 lakh crore to Rs. 67,78,609 crore on December 21, 2012 against Rs. 53,12,875 crore at the end of last year. The Q3 earnings, which are most likely to beat the market pundits, indications of more reforms by the UPA government and hopes of increase in retail participation in quality IPO/FPO and OFS in the near future expected to augment the bullish fervour in 2013, an analyst said. The BSE sensitive index Sensex posted impressive gains of 3,787 points, or 24.5 per cent, at 19,242 on December 21, 2012, against preceding year-end's close of 15,454.92 points. The Sensex had lost 5,054 points, or over 24 per cent, during 2011. The National Stock Exchange's Nifty also spurted by 1,223 points or 26.5 per cent to 5,847.70 on December 21, 2012 from previous yearend's close of 4,624.30. Investors ignored dwindling industrial output, declining exports, ballooning fiscal deficit, overall gloomy economic atmosphere in domestic and international markets amid fear of European debt crisis to spiral over worldwide. Foreign institutional investors (FIIs) made the second largest investment in the Indian capital market in the year under review.
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As the Sebi data, FIIs pumped in Rs. 1,21,652 crore or $23.15 billion this year till December 21. Previously, they had made biggest investments of Rs. 1,33,266 crore or $29.36 billion in equities during 2010. Kishor P Ostwal, CMD of CNI Research Ltd said a few big investors made a large profit in the market as select stocks scored new highs in view of paucity of floating stocks. However, retail investors were not benefitted either in the secondary market IPO market and were seen selling their holdings, as a result the public ownership in the India Inc. came down to 6-7 per cent as against a high of 15 per cent 2007, he said. Though the Sensex could not surpass its all-time peak registered in 2008, the sectoral indices like BSE-FMCG, BSE-HC, BSE-CD and BSE-Auto logged their historical highs during the year on hectic buying by foreign funds. Analysts said at the beginning of 2012 investors feared of further slide in view of corruption scams. However, the market surprised everyone by rising almost 1,739 points or 11.25 per cent, largest monthly rise in absolute term in the month of January in any calendar year, following hectic buying by Foreign funds. It was also the biggest monthly performance since September 2010 when it had gained by 2,098 points or 11.67 per cent. The rally in the month was driven by strong global cues on hopes of some stabilization in the Europe and gradual improvement in the US economic data. On domestic front, the government's decision to allow Qualified Foreign Investors (QFI) to invest directly in local equities from January 15, 2012 and signs of more foreign funds inflow also underpinned sentiment. The Union Budget, which was delayed this year due to the Assembly polls in
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five states, presented by then Finance Minister Pranab Mukherjee on March 16 failed to enthuse the investors and plans to revive the economy. The market then turned negative and remained dull for the next few months due to slowdown in GDP growth, worries over macroeconomic conditions due to higher global crude oil prices, as India imports two-third of its oil consumption, rising trade deficit, weakening currency and global uncertainty. Fears that reform process may take back seat after the ruling Congress party suffered a setback in some states in March and cut in China's growth target also weighed on the market sentiment. Revival of monsoon at the fag-end and Moody's retaining stable outlook on India supported the weak stock markets. Moreover, announcement of reform measures such as allowing FDI in multi-brand retail and downsizing the LPG subsidy by the government later pushed the Sensex higher since September. The Sensex moved in a range of 19,612.18 and 15,358.02 before ending at 19,242.00 on December 21, 2012, displaying a rise or 3,787.08 points or 24.50 per cent. The wide-based S&P CNX Nifty of the NSE also flared up by 1,223.40 points or 26.46 per cent to settle at 5,847.70 on December 21, 2012. On the global front, barring China which ended in the red, rest of the other Asian markets ended firm. European as well as US stocks too exhibited strong trend this year.

Future Predictions for 2013 Morgan Stanley has argued in one of their recent reports that the Indian stock market is likely to perform well in 2013 as it remains the most attractive relative to other countries. In other words, while the Indian economy is in doldrums it remains more attractive than the United States and European Union as the last two undergo economic upheaval, and this is the reason why investors and foreign institution investors (FIIs) pour easy money into India. Morgan Stanley calls this the TINA factor or There Is No Alternative. It also said, Our topdown forecast is higher than the consensus, putting earnings in an even better light. Since India is relatively better off than the rest of the world, Morgan Stanley cites Indian stock markets as an attractive destination even if there are plenty of headwinds as far as Indian economic fundamentals are concerned. It said, Global investors argue that India is a place where they would like to put money to work because the other options do not seem attractive enough. This is a peculiar approach because if nothing is attractive, investors wouldnt investors be better off waiting and watching. Despite this, it believes the Indian stock market offers good opportunities in terms of diversification and stock picking because it believes its corporate fundamentals seem more stable. Consider the chart below:

As you can see, Indian companies are at the top because they exhibit steady growth in earnings, without too much variation. Even the coefficient of variation is low which implies that earnings growth between all the companies across the years is not that widely dispersed. India has the lowest standard deviation of EPS growth at 13%, while US it is nearly three times volatile. Even Indias growth rate since 2001 trumps that of US as well as developed markets as a whole. This is one reason why global investors would prefer stable Indian shores rather than foreign ones. The report said, Over time, not only has earnings growth been comparable with that of the rest of the world, but the earnings stream has also exhibited markedly lower volatility. Apart from this Indias recent performance, which has been one of the best performing stock markets YTD, has caught the eye of investors worldwide. This means more investors are keen and keeping an eye on upcoming corporate earnings, not to mention the slew of economic reforms and whether theyll be passed in the parliament. Further more, Morgan Stanley has cited, Unlike in 2011, the earnings trend in 2012 mirrors Indias long -term record in earnings.

Having said this, Morgan Stanley believes stock picking opportunities exists, especially for passive investors. Diversification hinges upon having several stocks, with each having low degree of deviation within each other in order to reduce volatility. Diversification also will work if the stock market is not dominated by one sector alone. For instance, look at the table below:

You can clearly see that Russia has nearly 60% of the weightage in one sector aloneenergy. It is billed as a gas and oil superpower rivalling to Saudi Arabia. From a top-down perspective, it makes little sense to diversify even if stock picking opportunities maybe there. Indias standard deviation across sector weights remains one of the lowest across emerging stock markets. It said,
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Indias sectoral diversification seems the best across major emerging markets, with low standard deviation on sector weights and low degree of single-sector Working 2011-2012
It is quite amazing but true that the year 2011 has been the second worst year in the history of Indian markets with a decline of 25% in the Nifty and 35% in the Mid cap indices(since the 1980s at least). No prizes for guessing which was the worst year i.e. 2008. In USD terms the performance was even more disastrous with losses of 44% given the 19% decline in the value of the INR. The year began with cautious optimism after the fall that the markets had seen post peaking off in November 2010. However a sequence of events, foreseeable and unforeseeable made this a disastrous year for equity investors. A lot will be written on the year ahead and I have touched on some subjects in my previous articles a few weeks back. However sentimentally one thing is very apparent from all the strategy reports that I read today, as well as the commentary in various media.

1. 2012 will be a very tough year for equity investors and it is unlikely that there will be significant returns during this year. 2. India will continue to underperform given concerns on inflation, high interest rates and poor governance.

I have infact not read more pessimistic commentary on India for a very long time as we see today. The same brokerages/research houses that were predicting Sensex at 23-24000 by the end of 2011 a year back are now forecasting markets at 12000 (at the lower range) to 18000 (at the median of the upper range). There are some who, albeit apologetically are predicting a move above 20,000 levels this year. However this is being done with a lot of caveats. The funniest are those reports where there are bull case, base case and bear case views where the difference between the bear case and the bull case is over 50-60%. My take on the markets in 2012 is that we will see the Nifty/Sensex return anywhere between 15-25% and the broader markets by 25-35%. I believe that sentimentally the markets have bottomed out and the bottoming out, value wise will happen over the next few days or weeks. This should lead to a durable bottom being formed for the markets. I have touched on the logic for the same to a large extent in my article on the 5th of December, an updated version of which I will present in brief and then more on the domestic situation and the markets. The Euro zone Crisis The Euro zone crisis and the debt issues related to Greece, Italy and Spain have been the main contributory factors to the nervousness in the global equity markets over the last several months. The crisis has got accented by a lack of faith in the political system and its ability to resolve the issues. This issue has been discussed a lot so I will not go into the details of all of this, however I do have a contrarian view on the future direction of news flow from Euro zone. We now have new governments in Italy, Spain and Greece i.e. all the troubled countries. Two of them are lead by technocrats and one by the right wing party. As such, in my view the worst of the news flow from Europe is now in and we might not get incremental negative news flow over the next 45 weeks. This is likely to be similar to the negativity due to news out of the US around 3-4 months back, which suddenly died out as the economic data started to improve. The entry of the IMF in the entire discussion combined with greater urgency to resolve the issues is also
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encouraging. Overall I do not expect Europe to create any deep cuts in the markets going forward. This was the view that I had put out a few weeks back and seems to have played out well. It seems clear now that although Euro zone will go through a cycle of deleveraging, slow growth, intermittent issues related to fiscal issues of troubled countries etc, the probability of a Euro zone breakup seems remote at this stage. Intermittent occasions of bond issuance of Italy and Spain will create volatility on those days. Infact if investors were so concerned on the Euro it would not have fallen by just 2-3% against the USD in the year 2011. As I wrote a couple of weeks back Europe has clearly avoided its Lehman Moment US News flow The news flow from the US has been mixed. Over the last few weeks there seemed to be clear indications of an improvement in economic activity. The Fiscal issues will keep on creating volatility periodically, however low borrowing costs and an improving economy could lead to a Fiscal surprise next year.Overall economic activity seems to be improving, albeit at a slow pace in the US and there does not seem to be the likelihood of a double dip recession at this stage. Most corporates in the US are cash rich and market valuations are at just around 11X P/E for next year. Earning expectations for the year 2012 are pretty low with earnings growth forecast in the range of 0-5%. As such US news flow will create volatility but it does not look that it can create a fresh down move at this stage. Infact US has not only created conditions for a down move, but it has actually supported global markets due to continuously improving economic data, especially related to employment numbers. Technically too the movement of the key indices above 200DMAs and the breakdown of the similarity of the move from 2008 indicates further gains for US equities. The breakdown of VIX below 23-24 levels also indicates reduced risk aversion and greater confidence. Typically such breakdowns are followed by multiweek up moves. GOLD As I have written in detail in my previous article I expect 2012 to be a difficult year for gold. I expect a 20-25% correction before prices come to a level where actual demand rather than pure investment demand can support prices. Since I have written in detail earlier I will not repeat, however the most fancied asset class will have a tough time holding on. China China is one aspect about which I have not written earlier mainly due to the fact that it is difficult to analyze it. However pessimism on China seems to be at its peak with the Chinese markets trading at valuations that are at multiyear lows. The expectations of some, of a hard landing in China do not seem to be playing out. The move from investment to consumption led growth seems to be moving slowly. By letting the Yuan appreciate in light of pressure on exports seems to have played out well. Inflation has also been controlled well by demand & supply led measures as well as administrative dictates (which can only work in that country and not in countries like India). The moderation in economic growth has been happening at a steady pace. However the key challenge will be holding up growth in light of falling export demand, controlling excessive investments in unproductive areas and the biggest factor will be the asset quality of Chinese banks and how they will hold up in light of increasingly challenging environment and pressure on profitability of Chinese corporates. The corporate sector in China is likely to be hit on two fronts i.e. higher wage costs due to rapidly increasing salaries as well as the strong up move of the Yuan against most other competing currencies. Just as an example, over the last one year the Indian rupee is down 20% against the USD and the Yuan is up nearly 6%. The way things look to me it seems the base case will be a soft landing rather than a hard landing for China in the near term. The two big surpluses that China has i.e. Current Account & Fiscal are vastly undervalued by the markets in my view. Officially China seems to be aiming at an 8% growth next year which is extremely strong in the current environment. The challenge is health of the banking system and how much it needs to be capitalized in order to support this growth as well as the state of health of the Provincial Governments about which there is very less transparency.
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India domestic factors & outlook The Indian markets had to make do with not only global issues but also several domestic issues in the year 2011 making it one of the most turbulent years in recent memory. Although 2008 was challenging for India, it was generally perceived at that stage that the factors are largely external and as such should not have a lasting impact on the performance of the economy. We had also started giving lesser importance to the government as the economy became more and more open. However 2011 was a year which showed the importance of governance in promoting and sustaining economic growth as well as macroeconomic stability. The year 2011 was a year of high inflation, high interest rates, lack of policy making as well as the most challenging year for the Indian rupee since 1992 (ex of 2008). The Rupee - The fall in the rupee is being attributed to high current account and fiscal deficits, which is true to some extent. However it is more due to a lack of confidence in the economy in the near term as well as cash flow mismatches on exports and imports. This aspect is extremely important to understand. Given the way the rupee fell and the continuous statements by policy makers that we are helpless in managing the rupee all importers have run to hedge their positions and no exporter is hedging. This creates a very huge mismatch in the short run. Let me try to explain. India has exports of broadly USD 20 bn a year and imports of USD 30 bn. Now this is a gap of USD 10 bn which is bridged by invisible flows, capital receipts, foreign borrowings, FDI etc etc. Now in a situation where everyone believes that the rupee can only fall all importers want to hedge, however no exporter wants to do the same. This creates a huge mismatch in the short run till the export proceeds flow in after a period of 90-120 days. This also creates a tendency to delay export inflows in order to realize a better rupee value. This actually makes me believe that the first quarter of 2012 can be a good period for the INR as the panic fall period now seems to be over and export realizations will start to come in. Other measures like reduction in holding period of Government and Infrastructure bonds as well as higher interest rates on NRI deposits should boost inflows. My base case view will be for a 3-4 % rupee appreciation in the first quarter of 2012 unless and until there are huge capital outflows. Policy making Initially we had a period in late 2010 and early 2011 when a large number of projects got held up on environmental issues. Later on after the 2G issue we have seen a significant decline in project approvals, takeoffs etc. This has got exacerbated by the continuous increase in policy rates by the RBI which has made lot of projects unviable. Reform measures have also got stalled. I believe that we are now at the absolute nadir of the decision making cycle and things can only improve from here on. I expect this to happen post election in February after which things would be much better. Inflation would have come off much more sharply had it not been for the decline in the rupee. However the absolute correction in commodities and food prices combines with the strong base effect will take inflation down to nearly 5% by March 2012. In case the rupee also appreciates as I expect it too the overall scenario could be much better in 2012. As such we should have improving liquidity and much lower interest rates as we go through 2012 and this will provide a tailwind for economic activity to pick up.

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Markets Taking most things into account and also taking into account the market psychology as well as valuations I am of the view that the current situation of the markets is akin to early 2009 where one could see only negativity and that was the time that markets bottomed. Valuations, especially of the broader markets are today nearing historic lows and the overall market is also trading at 12X 2013E earnings which is very attractive. My view of the markets over the next one year is that of a worst case of 14500-14800 for the Sensex (at 12X P/E) and 26000 as the best case (on a 20x P/E.) The markets are today trading at a Mcap/GDP of 50%; in the beginning of 2008 this had gone up to as high as 160%. The Profits to GDP ration of corporates goes through phases of compression and expansion. Right now both gross margins as well as net margins are suppressed due to the huge input cost pressure that we have seen over the last 18 months as well as high interest costs. This is likely to reverse over the next two years. Eventually the Market capitalization will move towards the 100% level to GDP, if not more. This will provide strong returns over the next 3-4 years. Markets seem to have taken most negatives in their stride as of now. The risk reward is strongly in favor of investing into equities at this stage. As inflation falls and interest rates come down there will be a revival in the economy and growth prospects will start improving. The timing of the bottom formation is difficult to predict, however it will happen in weeks not months. Markets should be able to return 15-25% at the middle of the pessimistic/optimistic range over the next one year.

YEAR 2013
(The views expressed in this column are the authors own and do not represent those of Reuters) If calendar year 2012 was the year of scams in India which helped induce some much needed government reforms, the year 2013 is expected to be a year of hope and expectation for India and India Inc. There are expectations on better political governance, fall in inflation levels and hence interest rates, creation of an investment friendly business environment and lots more. Its also the year with the last finance budget before the 2014 general elections. Towards the fag end of 2012 the inactivity on the part of the government appeared to have been shrugged off in terms of policy action. This helped improve business confidence a shade. However, there still appears to be near total inaction on the part of corporate India to kick start the investment cycle in any major way. Are high interest rates the hurdle? Is lack of government decision making still a big hurdle? Is the business environment conducive to a larger domestic capex commitment? The answers appear to be almost obvious. It did appear peculiar that at a time when scam after scam was being detected and there was complete policy paralysis in the government for the first nine months of the year, FIIs invested more than US $ 23 billion in the Indian capital markets in 2012. If consistently more reforms are announced by the government, one can expect close to this figure being invested again by FIIs in 2013.
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The key to greater global investor confidence and domestic business confidence will lie in the urgency that the government will show for labour reforms, land reforms, implementation of the new Direct Tax Code (DTC) and the Goods & Services Tax (GST). All this can help bring fiscal deficit under control but most importantly, it can raise the governance bar to an extent that India Inc has greater confidence to create larger capacities within the country. To expect a runaway rise in Indian equity markets during 2013 would be a folly. There are too many areas of concern in the domestic and global economic environment for that to happen. Much of domestic middle class savings continue to be diverted towards a passive asset like gold or to post office savings which are utilised relatively inefficiently by the state

and central

governments.

A pre-election subsidy heavy finance budget could derail fiscal deficit sharply. Globally, Europe is unlikely to be out of the woods before mid 2014 and the United States has its own serious fiscal issues to grapple with. On the economic front, a 6-6.5% GDP growth during FY 2013-14 and sustained policy reforms should be considered a possibility. For the equity markets, a potential 10% to 15% rise during 2013 taking the Sensex in the vicinity of 22,000 based on continued FII flows can be expected. SECTORS IN 2013 The valuation gap between private sector banks and mid-sized PSU banks has widened considerably during the last quarter. One can expect this to be bridged to some extent. The asset quality concerns of PSU banks are likely to gradually diminish over the next couple of quarters. The IT sector may continue to underperform, but old economy sectors like cement, metals will gain further momentum. 2012 favourites like pharmaceuticals and the consumption stocks can be expected to continue their upward march, but at a slower pace. Essentially any upward swing in economic scenario hinges on the political will to set things right. Corporate India is ready out there to up their stakes if the government creates the environment. The ball is clearly in the governments court.

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