Devangshu Datta: Watching for oil slicks

BEATING THE STREET

If one goes by the first quarter results, Indian stocks are under-valued. Big stocks have seen profit growth at 30 per cent-plus with triple-digit growth in many cases. At current values, the Sensex has a trailing (2003-04) Price-Earnings discount of about 15.

The chance of capital appreciation appears excellent. Let's assume EPS growth is flat through the next three quarters. Corporates will still end 2004-05 with EPS growth of 30 per cent. If the PE ratio is maintained, that's a 30 per cent upside. So, with minimalist assumptions, the stock market ought to be a buy.

But most analysts have pessimistic rather than minimalist macro-expectations at the moment. So apparently does the FM, who cautioned that GDP expectations may need to be pared down to the lower end of official expectations of 6 per cent to 7 per cent growth.

The lower projections are sensible because of soaring crude prices, a less-than-satisfactory monsoon and rising inflation. It's impossible to model such events.

The quagmire in Iraq, coupled to problems with Russia's biggest oil company could push crude prices up further and keep prices high for an unpredictable period. Political uncertainty in America will add to global risk-perception "" nobody knows how either Bush or Kerry intends to sort out Iraq.

India's in a strange position vis-à-vis rising crude prices. It is substantially exposed with a fuel-inefficient economy that depends on imports for 70 per cent of its needs. Balancing that, India has excess refining capacity and it could see higher product exports.

There wouldn't be serious problems meeting import bills though, unlike in 1991, when the first Gulf War sparked the balance of payments crisis that led to reforms. India has huge reserves and if inflows continue at current, reserves could rise despite a scenario of high crude prices.

The crisis would be in the domestic economy rather than in overseas BoP. Somebody has to absorb the cost of rising energy prices. It might be the PSUs in the refining/ production sectors if the government refuses to let costs be passed on. It might be the economy at large if price rises are passed on without subsidies.

In practice, rising crude prices would probably be translated into smaller hikes on retail product prices. The retail hikes would cause inflation without fully absorbing the impact. So refiners/ producers would also get hit and eventually the government would also lose out "" if only to the extent that the Navratnas would deliver lower profits.

How vulnerable is the Indian economy to rising crude prices? Well, it's easy to write disaster scenarios where crude jumps to, say, $50 a barrel and stays there, inflation spikes to double-digits and interest rates are hiked sharply. But the only way to learn what the breaking strains are would to live through them and I really wouldn't want to do that!

The paradox is that in this uncertain environment of twitchy rates and crazy oil prices, stocks remain a better haven for capital than debt. Of course, the traditional reaction to high inflation is to buy and hoard gold or silver. Maybe that's what we should be doing. There could be a big bull-run in precious metals over the next year or two.