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India’s position as an attractive emerging market investment destination got reinforced last week. Latest GDP estimates showed that the economy grew by 9.3% y-o-y in real terms during the first quarter of the current financial year. The growth was powered by a strong performance in all the three sectors. In comparison to other quarters, the growth was a tad lower than 9.6% during the same period last year, but higher than 9.1% growth in the previous quarter.

The most significant feature of the 9%-plus growth in the April-June period was that it came despite some solid cyclical pressures operating in the economy. The preceding quarter saw a sharp increase in interest rates, which dented the momentum of leveraged consumer spending in this quarter. Moreover, a sharp appreciation in the rupee versus other major currencies during the first quarter had a negative impact on exports of a number of sectors, thus adding to the downward pressures on growth. However, given that the investments and capacity expansion drive in the corporate sector is continuing at a brisk pace, the Indian economy was able to absorb these cyclical and structural pressures.

A higher capital formation rate of 29.6% of the real GDP in April-June 2007 compared to 27.9% in the same period last year indicates that the investment drive, which is now focused in the infrastructure sector, remains robust. The investment spending momentum is likely to underpin overall growth for the rest of the year and that offers resilience to our growth story.

The GDP numbers were cheered by both equity and currency markets. With global equity markets registering another strong but volatile week, local stock market also rallied. The BSE Sensex gained by 6% during the last week. Significantly, FIIs turned net buyers of stocks and bonds after offloading them earlier in the month. Their net purchases amounted to $534.8 million last week after net sales of $2.3 billion over the three preceding weeks.

On the back of buoyant equity market and dollar sales by FIIs and exporters, the rupee gained versus the US dollar last week. Month-end dollar demand from importers and volatility in the global equity markets, however, checked the appreciation of the Indian unit. The rupee-dollar rate moved in a wide range of 40.88-41.37 over the week, indicating that the trading activity in the pair is being driven largely by the conditions in the equity market. With growth fundamentals intact and with riskier assets, especially equities, slowly coming back in favour with the global investors, capital inflows to India are likely to pick-up over the medium term. And, that would help in the appreciation of the rupee.

In the near term though, investors would remain cautious towards riskier assets, considering that the problems in the US housing market and therefore the troubles of investors who had invested in mortgage backed securities, are far from over. The backlog of unsold US homes now stands at more than nine months’ worth of sales. Yet prices remain high relative to incomes after so many years of gains, and credit has been tightened or turned off completely for a significant proportion of the market. The peak in adjustable-rate mortgage resets is still to come. All that adds up to further fall in housing prices.

Factors such as US Federal Reserve’s moving to a damage control mode with a discount rate cut on August 17 and with hints of a Fed funds rate cut on September 18 are helping to soothe the frayed nerves in the financial markets across the globe. Investors were further comforted by the measures unveiled by US President George Bush to assist homeowners with subprime mortgages keep their houses on Friday.

On the same day the Fed chairman Ben Bernanke repeated promises to act as needed to provide liquidity and promote orderly functioning of markets. But he disappointed some market participants by stopping short of giving a clear hint about the likelihood of a cut in the Fed’s funds rate.

With the continuation of financial market volatility last week, there were relatively small changes in price levels on the currency markets, particularly among the major currency pair. The dollar rose 0.4% against the euro on the week and remained unchanged against the pound. The yen outperformed its major currency peers, but its gains were also small.

This week, cautious mood in the financial markets is likely to prevail but equities are likely to remain in favour among investors. That would be a positive sign for local stocks and the rupee. Downward pressures on the rupee from rising prices of commodities such as crude oil and agricultural commodities such as wheat, would negate the appreciation pressures to some extent. The rupee-dollar pair would continue to trade in a wide range of 40.75-41.20.

Views expressed herein are personal. gaurav.kapur@ in.abnamro.com