Behavioural scientists warn against confirmation bias, which essentially means cherry-picking data to fit an already-formed hypothesis. Unfortunately, one doesn’t have to cherry-pick the numbers that appeared over the past fortnight to conclude that the economy is still southbound. All the data point in the same direction.
The index of industrial production (IIP) suggests that manufacturing and, more broadly, the secondary sector has gone bust. Manufacturing was down three per cent in June 2012 compared to June 2011 and also down in the April-June 2012 period. The IIP was also down over the first quarter of 2012-13 versus the same period of 2011-12. Looking deeper, the deep 20 per cent decline in the capital goods component can only be interpreted to mean that India Inc is holding off on fresh investment.
Consumer durables have also fallen according to the IIP, confirming a couple of recent surveys and quarterly financial results that suggest consumption demand is weakening. A drought has been more or less confirmed, implying poor agricultural performances, which will have a lagged effect extending into Q3 (Oct-Dec 2012) going by historical patterns.
Services haven’t been hit yet but weak agro-performance could have an impact. Exports fell in June as well, while imports are likely to rise now given the ominous uptrend in crude prices. In short, no given segment is performing and there could be contraction across agriculture and manufacturing in the first two or three quarters of 2012-13.
All this has meant further downgrades in 2012-13 GDP growth projections. The Reserve Bank of India (RBI) cut its estimates by almost one per cent while releasing its latest credit policy that essentially maintained status quo. The International Monetary Fund also cut GDP estimates as did Citi, Indicus and a host of investment houses. The Planning Commission Deputy Chairman is talking about six per cent and, informally, Dalal Street is speculating about sub-five per cent GDP growth.
The Q1 numbers nail one of the principal culprits for corporate under-performance and ennui. A study of the Q1 financials of 1,500 companies (released today in this paper) shows that interest costs are up 30 per cent year-on-year and net profit margins have dropped to a nominal four per cent.
| Current (Aug 10) | Value 14 days ago | Change % | |
| Nifty value | 5320.4 | 5099.85 | 4.32 |
| Index PE | 17.34 | 16.68 | 0.66 |
| Index dividend yield | 1.51 | 1.58 | -0.07 |
| Index Book value | 3.01 | 2.89 | 0.12 |
| USD/INR (RBI Ref rate) | 55.344 | 55.413 | 0.12 |
| FII net buys/sales(Aug 1-10)* | 3949.66 | 1363.08 (Jul 14-27) | |
| DII net buys/sales Aug 1-10)* | -1049.89 | 171.24 (Jul 14-27) | |
| * Rs crore, Aug 10 provisional figures | |||
Consumption demand has definitely been hit by the same hammer of high interest costs. Bank financials, especially public sector bank financials, have seen deterioration in terms of non-performing assets (NPAs) and this is actually understated because corporate debt restructuring requests don’t show up as NPAs.
On the infrastructure front, the power industry just set new world records for blackouts and the telecom industry is reeling at the thought of paying more for 2G spectrum than it did for 3G. The roads ministry has just acknowledged that it lacks the capacity to build 20 km a day, which is a target it’s been promising to meet since 2008-09.
Balanced against all the gloom, you have another Cabinet reshuffle and the new finance minister, P Chidambaram, offering assurances that things will change for the better. This hasn’t cut much ice with domestic investors who have sold in the past fortnight.
But Chidambaram’s appointment seems to have put some heart into foreign institutional investors (FIIs) since they’ve accelerated the pace of buying. Much of the FII inflow is money that had fled India at the thought of General Anti-Avoidance Rules and retrospective tax amendments. But some fresh FII investments are based on a comparative analysis that suggests India could remain among the three fastest-growing economies despite all the bad news. The global implications of that are frightening.
If RBI refused to cut rates in August, it probably won’t cut rates for several months but it won’t raise rates either. Core inflation is down to the levels the central bank claims to target but the wholesale price index won’t fall further due to food inflation (poor monsoon) and high crude prices. The government won’t rationalise subsidies on diesel and kerosene (farmers must run pumps). GDP targets will be missed (revenue and expenditure targets were missed in Q1). The fiscal deficit will be much higher than budgeted.
So, what sort of valuations does the stock market deserve? If bank fixed deposits are paying eight to nine per cent and so are treasuries, and revenue and earnings projections are flat, the broad market should be at fair value at a PE of 12-13. The Nifty is currently at PE 17. That implies a big valuation downside now exists.
The anticipated crash won’t happen if there is dramatic policy action, or deep interest rate cuts, or if FIIs continue to be steady net buyers. The first two appear unlikely. The third could happen. FIIs have bought a net Rs 55,000 crore of equity since August 2011 balancing off about Rs 8,000 crore of net sales by domestic institutions in the same period.
Incidentally, a look at rupee debt suggests an interesting possibility. FIIs bought Rs 46,000 crore of rupee debt in the past 12 month and domestic institutions bought an unbelievable Rs 3.8 lakh crore of debt. This is a pointer to the size of the borrowing programme. But it also boils down to a massive bet on rates falling soon. There would be staggering capital gains available on the debt segment as and when, RBI does cut. It may be worth taking modest exposures in medium-term debt funds. This looks to be low risk since RBI is unlikely to hike.
On the technical side, the market is range trading Nifty 5100-5400. It has been unable to break past resistance in the 5350-5400 zone. But it has held above the 200-day moving average, which is around 5100. The rupee has hardened owing to USD inflows from FII action. Things could get interesting only if there’s a breakout in either direction from the 5100-5400 range.
