'Worst-case scenario: Indian rupee could drag BSE Sensex to 16,000-mark'

Written by fe Bureau | mumbai | Updated: Aug 30 2013, 19:30pm hrs
SensexWe get a stress case index level of 16,000 for the BSE Sensex, says BofA-ML. Reuters
Even as the stock market (BSE Sensex, NSE Nifty) staged a strong comeback in the past two trading sessions, Bank of America Merill Lynch on Thursday outlined its worst-case scenario for Indian equities and reiterated the pressing need to stabilise the Indian rupee to the US dollar. The US-based financial services major warned that the BSE Sensex could fall to the 16,000 level in a stress or crisis-like situation. In the base-case scenario, however, BofA ML expects the 30-share index to trade in the range of 18,500 to 20,500.

In its note, the brokerage said: The market is trading slightly below the long-term average forward PE of 14.1 times. However, at its low, the market tends to go to 10 times whenever there is a global crisis. Given that the developed world is recovering, we are assuming current valuations for the export companies and 1SD (standard deviation) below mean for the rest of the universe. Based on this, we get a stress case index level of 16,000 for the BSE Sensex.

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The report also stated that rupee can come under further pressure if foreign institutional investors (FIIs) expedite their selling in Indian equities. Even though the FII outflows in equities have been minimal, Sensex has corrected nearly 10% in the current calendar year. However, the US-based brokerage observed that FII holding in Indian equities stood close to its all-time high at 21% (45% of free float). It further warned that India remains vulnerable to any global emerging market (GEM) selloff.

The report also highlighted the near-term shocks in the form on geo-political tensions arising out of Syria that could lead to spike in oil and gold prices, which could put additional burden on the current account deficit and compound the weakness in the rupee. Data show the rupee has depreciated over 20% since the third week of May. In a scenario where the rupee is weak, the brokerage prefers sectors that are direct beneficiaries of a weak rupee. The brokerage remains bullish on export-oriented sectors like pharma and IT, it said.

One of constructive argument for the rupee was the stable crude prices leading to manageable oil imports. However, with Middle-East tensions rising, Brent prices have rallied approximately 14% since April. This would again likely keep the twin deficit problem of India in focus, leading to a weakness in the rupee, stated the report.