Overview
Led by US Fed rate cut and global markets rally thereafter, the month of September 2007 ended with the BSE Sensex index closing at 17291 up 12.9% over the previous month's close. India outperformed emerging markets, Asia and many other markets during September making India the third best performing within the emerging markets universe. Large cap stocks outperformed mid and small cap stocks during the month. Foreign funds were strong buyers with net inflows for the month at USD4.6bn compared to outflows of USD1.8bn in August 2007. Domestic funds were net sellers at USD200mn. For the month ended September 2007, foreign funds buying stands at USD12.23bn versus appx USD 8 bn for the entire calendar year 2006.

Last week saw the Reserve Bank of India introduce a number of key changes in foreign exchange regulations. While measures are in line with Tarapore committee recommendations toward capital account convertibility, the timing of the move was clearly aimed at encouraging capital outflows and taming the rupee's recent appreciation.

On the macroeconomics front, year-to-date tax collections have risen by 24%, ahead of the full-year government budget estimate (BE) of 17%. Direct taxes rose by 41% during April-August, ahead of budget expectations of 17%, driven by corporate tax (+46% YoY) and personal income tax (+34% YoY) collections. Growth in fiscal deficit has normalized in August. The impact of the State Bank of India stake transaction was neutralized in August as profit from the sale transaction was transferred back to government accounts.

For the week ended September 21, 2007, India's foreign exchange reserves increased to USD229bn. The Indian rupee appreciated by 2.8% against the US dollar and depreciated 1.1% against the Euro. Inflation fell to 3.23% for the week ended September 15, 2007. Monsoons continued to remain positive, with rainfall for the week ended Sept 26, 2007 coming in 40% above normal.

Outlook
India's real GDP growth averaged 9.2% per annum in the last two years fueled by strong domestic demand. While high interest rates have clearly affected consumer spending, especially in buying real estate and automobiles but, are not expected to derail investment spending. The single most encouraging factor responsible for the current rapid economic growth is the strength of the upturn in investment spending. WPI inflation has fallen significantly in recent months and after hitting a high of 6.3% earlier this year, it has dropped to a five year low of 3.2%. While rising global oil prices and local food prices are key risks to the overall inflation but given the early elections outlook, domestic fuel prices are unlikely to be hiked. Also, good monsoon rainfall this year means a bumper crop is expected to bring down domestic food prices as well.

With the markets rallying strongly during the month of September, mainly on the back of strong fundamentals and foreign fund buying, we believe that the second quarter FY2008 corporate results to be announced during October, will likely determine the direction of the market. Global markets will also be looking at the Fed action to be announced on the last day of October.

We continue to maintain that the "long-term growth story" of India based on the core themes - outsourcing, consumption, favorable demographics and investment upturn - is intact. However the near term risk to the rally may come from a reversal of foreign flows to the region or the political situation at the centre becoming more fluid.