The Incremental Capital Output Ratio or ICOR is a useful tool. ICOR indicates how much must be invested to generate each extra unit of production. Investors use it to compare investments for efficiency of capital allocation. The lower the ICOR, the more the productivity of capital.
It is a reasonable way to judge macro-economic efficiency. For a while, it was the only parameter on which India beat China. Between 2004-08, India had an ICOR of about 4. By investing national savings, then at about 32-33 per cent of GDP and running a Current Account Deficit of about 2.5-3 per cent, India hit GDP growth rates of 8.5-9 per cent. China had higher GDP growth, but only by investing a much higher percentage of GDP.
India's ICOR is now 7 or more. National savings have fallen to around 30 per cent in 2012-13 from a high of 36.9 per cent in 2007-08. The CAD was almost 5 per cent last year with a GDP growth rate of about 5 per cent. This is because capital is stuck in multiple stalled projects, along with being wasted in populist schemes and nurturing wholesale corruption.
The government is projecting a CAD of 3.7 per cent in 2013-14. Assuming that this is ballpark and also assuming national savings doesn't drop too much, India will invest about 33-34 per cent of GDP at an ICOR of about 7. GDP growth in 2013-14 should drop by 0.25 per cent to 0.5 per cent at the very least.
This calculation suggests GDP growth will be in the range of 4.5-4.75 per cent and growth was already down to those levels in the second half of 2012-13.
The recent BNP Paribas projection of 3.7 per cent GDP growth in 2013-14 assumes ICOR will rise further as capital will be even more unproductively used in an election year. Every paisa spent on populist schemes will raise the ICOR.
This is a grim scenario. But there is nothing illogical about the basic premises and it doesn't sound improbable. Growth may be more than 3.7 per cent but it is unlikely to recover to significantly above 5 per cent and it will probably be lower than in 2012-13.
From a bottom-up perspective, based on Q1 corporate results, consensus earnings growth projections for the Nifty have been slashed from an weighted average of Rs 411 for the basket to Rs 381. The current EPS is Rs 370. That is a nominal rise of about 3 per cent. Net of inflation, it will be a negative return from India's biggest corporates.
The Nifty basket is broad and reflects business trends across about 85 per cent of the Indian economy (all manufacturing and services and some agriculture). There would need to be a dramatic recovery in the next three quarters to change the trends seen in Q1.
Does the gloom and doom make you want to emigrate? It shouldn't. There is every chance that prices will fall even more than justified by the awful fundamentals. Sentiment-driven trends always overshoot in both directions and sentiment is clearly very downbeat.
There is a valuation point at which even zero growth becomes attractive. Suppose that the Nifty does hit a weighted average EPS of Rs 381 for 2013-14. What would be an attractive PE valuation? We don't have strong growth visibility for 2014-15 either.
However, we can compare with possible returns from debt. If you can get a return of about 9 per cent from debt, you should be looking for a PE ratio of not more than about 12 or 13. That works out to 4,550-4,950 Nifty levels. We are almost there with the Nifty having tested 5,150 levels.
The bear market began in May from a top of 6,230. Indian bear markets usually correct by at least 35 per cent and often by more. That would imply that we will see index levels of 4,000 or lower before the market bottoms out. That gives a long-term investor some targets to aim for. Hoard your cash until sub-5,000 levels, and then start index-buying systematically. Increase your purchases the lower the market falls.
There isn't a timeframe unfortunately. The bear market may end in nine months, or it may last several years. Recovery timeframes depend both on global factors and the competence or otherwise of India's policy-makers. Eventually there should be decent returns if you can keep your patience and hold your nerve.
It is a reasonable way to judge macro-economic efficiency. For a while, it was the only parameter on which India beat China. Between 2004-08, India had an ICOR of about 4. By investing national savings, then at about 32-33 per cent of GDP and running a Current Account Deficit of about 2.5-3 per cent, India hit GDP growth rates of 8.5-9 per cent. China had higher GDP growth, but only by investing a much higher percentage of GDP.
India's ICOR is now 7 or more. National savings have fallen to around 30 per cent in 2012-13 from a high of 36.9 per cent in 2007-08. The CAD was almost 5 per cent last year with a GDP growth rate of about 5 per cent. This is because capital is stuck in multiple stalled projects, along with being wasted in populist schemes and nurturing wholesale corruption.
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Nothing much will get done to improve the ICOR until the 2014 elections. In the absence of policy action, the market has started to correct imbalances by pushing the rupee down. This makes imports more expensive and helps to make exports more competitive. So the CAD will reduce.
The government is projecting a CAD of 3.7 per cent in 2013-14. Assuming that this is ballpark and also assuming national savings doesn't drop too much, India will invest about 33-34 per cent of GDP at an ICOR of about 7. GDP growth in 2013-14 should drop by 0.25 per cent to 0.5 per cent at the very least.
This calculation suggests GDP growth will be in the range of 4.5-4.75 per cent and growth was already down to those levels in the second half of 2012-13.
The recent BNP Paribas projection of 3.7 per cent GDP growth in 2013-14 assumes ICOR will rise further as capital will be even more unproductively used in an election year. Every paisa spent on populist schemes will raise the ICOR.
This is a grim scenario. But there is nothing illogical about the basic premises and it doesn't sound improbable. Growth may be more than 3.7 per cent but it is unlikely to recover to significantly above 5 per cent and it will probably be lower than in 2012-13.
From a bottom-up perspective, based on Q1 corporate results, consensus earnings growth projections for the Nifty have been slashed from an weighted average of Rs 411 for the basket to Rs 381. The current EPS is Rs 370. That is a nominal rise of about 3 per cent. Net of inflation, it will be a negative return from India's biggest corporates.
The Nifty basket is broad and reflects business trends across about 85 per cent of the Indian economy (all manufacturing and services and some agriculture). There would need to be a dramatic recovery in the next three quarters to change the trends seen in Q1.
Does the gloom and doom make you want to emigrate? It shouldn't. There is every chance that prices will fall even more than justified by the awful fundamentals. Sentiment-driven trends always overshoot in both directions and sentiment is clearly very downbeat.
There is a valuation point at which even zero growth becomes attractive. Suppose that the Nifty does hit a weighted average EPS of Rs 381 for 2013-14. What would be an attractive PE valuation? We don't have strong growth visibility for 2014-15 either.
However, we can compare with possible returns from debt. If you can get a return of about 9 per cent from debt, you should be looking for a PE ratio of not more than about 12 or 13. That works out to 4,550-4,950 Nifty levels. We are almost there with the Nifty having tested 5,150 levels.
The bear market began in May from a top of 6,230. Indian bear markets usually correct by at least 35 per cent and often by more. That would imply that we will see index levels of 4,000 or lower before the market bottoms out. That gives a long-term investor some targets to aim for. Hoard your cash until sub-5,000 levels, and then start index-buying systematically. Increase your purchases the lower the market falls.
There isn't a timeframe unfortunately. The bear market may end in nine months, or it may last several years. Recovery timeframes depend both on global factors and the competence or otherwise of India's policy-makers. Eventually there should be decent returns if you can keep your patience and hold your nerve.