Euro Zone Cues: Trigger For Markets
3/7/2013 9:03 PM Thursday
Dr V K Vijayakumar
Geojit BNP Paribas Financial Services
The Q3FY13 results were quite disappointing. The results broadly reflected the pronounced slowdown in the economy.
India’s trade deficit is currently above 10 per cent, while the current account deficit is likely to be in excess of five per cent for FY2013. This bodes ill for the INR.
At the Sensex level of 19500, the Indian markets are trading at around 16x of their estimated earnings in 2013-14. These valuations are in line with the historical average of around 15.5x for the last 15 years. A PE of 16x is certainly not cheap, neither is it too expensive. Considering the long-term growth potential of India vis-à-vis other emerging markets, the current valuations are attractive for investors with a long-term horizon.
The Q3 results were quite disappointing. The results broadly reflected the pronounced slowdown in the economy. A sample study of 1941 companies reveals that India Inc.’s revenues expanded only by 6.9 per cent during Q3FY12 on a YoY basis. This is the lowest rate it has reported in the last three years. In Q2FY12, its revenues expanded by 8.5 per cent. This suggests a clear deceleration. The fact that revenues have grown only by 6.9 per cent with the WPI inflation ruling at above seven per cent and retail inflation standing above 10 per cent, indicates a decline in revenues in real terms and a contraction in volumes. This sample study showed a mere 3.8 per cent growth in net profit. This looks like a serious issue.During any slowdown, some sectors buck the trend. The December 2012 quarter was no exception. The IT, Private Sector Banking and Pharmaceuticals sectors stood out. These sectors are likely to continue their relatively superior performance in the next quarter too.
The inflation trend is now quite clearly downward. The RBI’s tough monetary stance has certainly succeeded in taming core inflation and anchoring inflationary expectations. Food inflation, however, continues to remain high. But this is largely due to the rising rural wages and supply side issues. Monetary policies will not succeed in calming food inflation. The WPI inflation for January 2013 has come in at 6.62 per cent. This is a welcome relief. The RBI can be expected to cut policy rates by 25 basis points in the monetary policy review scheduled for March 19, 2013 in the light of this downtrend in inflation.
The interest rates are headed south. There is no doubt that the RBI will cut rates this year; the question is by how much? Another 100 basis points reduction in policy rates this year is highly desirable. But the RBI’s hands are constrained by the twin deficits. But bringing the current account deficit down from the present high level of five per cent is a formidable task.
On the INR front, its value depends on a host of factors such as the trade deficit, the current account deficit, capital flows and expectations. The fundamental factor determining the exchange rate is the current account situation, whether the account is in deficit and by how much? India’s trade deficit is currently above 10 per cent, while the current account deficit is likely to be in excess of five per cent for FY 2013. This bodes ill for the INR. India received USD 24.2 billion as FII inflows in the year 2012. And the FII inflows this year so far are around USD 8.5 billion. But for these huge capital inflows, the INR would have depreciated substantially from the current levels of around Rs 54.
An area of concern regarding the INR is that its value is highly prone to the vagaries of these ‘hot money flows’. India has been receiving substantial quantities of FII inflows for the last several months. These inflows have been facilitated by the ‘risk on’ in global financial markets following the stability in the ‘Euro zone’. But the recent events in Italy tell us that the ‘Euro zone debt crisis’ is not yet over and that instability can resume at any time initiating a period of ‘risk off’. If this happens, India with its high current account deficit will be highly vulnerable. A capital flight from India initiated by a ‘risk off’ can lead to a major correction in the value of the INR.
Investors should watch out for the emerging global economic environment. Any sign of a global ‘risk off’ should be considered with caution. Buying quality stocks in the sectors mentioned earlier can fetch handsome rewards, going forward.
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