<b>Demonetisation impact on markets:</b> Shadow over earnings hit sentiment

Demonetisation seems set to slow the economy in the near term, says expert

It has been almost a one-way street for stock market indices since the announcement of demonetisation of Rs 500 and Rs 1,000 notes by Prime Minister Narendra Modi on November 8. For the markets, which had taken the global fears of the UK’s exit from the European Union (Brexit), and the Federal Reserve's rate hike and Presidential elections in the US in their stride, this was a telling blow.  

Worse, the markets are yet to digest the adverse impact of the move even as we approach 50 days of the announcement. In the initial few weeks, headline indices came off by 7 per cent, before recouping some of the losses. Even broader markets weren’t spared as real estate, cement and automobile sectors took a serious hit. For instance, the BSE Realty index has lost 14 per cent since November 8, while the Auto index is down 10 per cent in two weeks. 

Manishi Raychaudhuri, Asia equity strategist, BNP Paribas, says, “Demonetisation seems set to slow the economy in the near term. 

It could be beneficial in the longer term by bringing a significant part of the economy into the formal or ‘white’ sector.” 

Although the negative impact will be felt directly by the informal economy, which deals largely in cash, its effect could be widespread because of its close connection to the formal sector. Naveen Kulkarni, co-head of research at Phillip-Capital, says: “Real estate probably has the highest overlap while information technology and pharma  have no overlap. Most consumer-facing businesses have overlaps ranging from 30-100 per cent, depending on size and nature.”

Earnings estimates for the September-December 2016 and January-March 2017 quarters have already been cut by analysts. The consensus earnings per share (EPS) estimates for Nifty companies have been cut by four per cent for 2016-17 and around two per cent for 2017-18. Prior to demonetisation, Nifty EPS was expected to grow by 12 per cent but now analysts expect a modest 5 per cent year-on-year increase in 2016-17. The sluggish growth in earnings has led to de-rating of the markets, with analysts scaling back their Sensex and Nifty targets. 

Analysts at ICICI Securities, led by Ravi Muthukrishnan, say nearly 60 per cent of the country’s top 100 companies (BSE 100 index) have seen their earnings expectations downgraded. “Demonetisation has negatively impacted aggregate consumption, manufacturing and disrupted the distribution supply chain while the recovery in commodity prices and infrastructure development remains largely unaffected,” says Muthukrishnan.

In the near term, discretionary spending and sectors reliant on the cash economy will see a sharply negative impact. “We may even see the autumn harvest and the winter crop sowing to be impacted, which may lead to a slower-than-anticipated growth in agricultural production impacting the macro economy over the next two quarters, before recovering in March 2018 quarter,” says Abhay Laijawala, head of research, Deutsche Equities India.

However, despite the correction, analysts are hoping  that the move would yield positive results going ahead. “With recent reform measures — Goods and Services Tax (GST) and demonetisation of large currency notes — India seems to be making increasing attempts to move from an informal to a more formal economy. It’s obviously going to be a long process but the foundation stones appear to be laid,” says Raychaudhuri.

The good news: some analysts see the recent correction as a buying opportunity as the one-year forward price to earnings of the Sensex is currently 14.5, making it an attractive bet. The bad news: given the uncertain outlook in many sectors, it would have to be a leap of faith.