Robust growth recovery, led by a V-shaped revival in investment, is expected to be a positive for corporate earnings. Strong revival in the services sector, a near double-digit growth in IIP and a likely improvement in consumer non-durables segment - following normal monsoons - will likely aid the recovery process.
But, at the same time, challenges will arise from a shift to a higher inflation trajectory following rising input costs and broad-based increase in prices; likely increase in cost of capital with base rate implementation and the recent rate hike by RBI; and the still-negative global risk environment.
Global commodity prices and, hence, input prices surged last year, the impact of which is visible in falling operating profit margins. The total impact of the recent fuel price hike is likely to be to the tune of 125 basis points (this includes the second-round impact of a pass-through to freight and transportation costs), which will imply a sharp shift in inflation trajectory and average inflation for the year.
We expect WPI inflation to continue to be in double-digits till October 2010, while inflation in 2010-11 is likely to average 9.3 per cent year-on-year. Rising non-food manufacturing inflation and the indirect impact of rise in fuel prices are likely to result in continued pressure on input prices. To the extent that the fiscal deficit goes down, this would reduce the crowding out of the private sector, leading to a positive impact on cost of capital.
Bank credit is expected to play a key role in financing growth, but shorter-end rates are expected to move up following the base rate implementation, liquidity tightening and policy rate hikes by RBI. It’s premature to comment on the exact impact, but the money market curve may shift upwards and also the commercial paper market may see increased activity.
Our expectations on external financing are mixed. Moderation in FII inflows in FY11 vs FY10 is expected. But a collapse in such inflows will be an exaggeration. FII outflows in the recent risk-aversion bout have been limited. In spite of the current volatility and depreciation bias, cumulative net foreign institutional flows in equity during last two months has been a small positive (against outflows of $4.5 billion in the two months after the Lehman collapse), which all the more highlights that investors haven’t really pressed the panic button on India and the broader risk-aversion trend is to be blamed for the damage.
Moreover, capital inflows, other than FII flows into equity, which are less correlated with broad risk aversion, are likely to stage a recovery. India - with eight per cent-plus growth - will likely be one of the top contenders for ‘real’ flows. Services have been the primary driver of FDI inflows (22 per cent of total from April 2000-December 2009). Optimism on FDI and ECB also stems from a likely ‘services’-led growth in FY11.
The author is Economist (Financial Markets), ING Vysya Bank
