Expected changes in petroleum sector

In FY98, India imported around 18.8 mmtpa of petro products. However, this situation is expected to change dramatically in the next two years. IOC's 6 mtpa refinery at Panipat has gone on stream. Reliance Petroleum (27mtpa) is expected to go on stream by Aug-Sep, FY2000. Essar Oil refinery (15mtpa) should also start in FY2001. On account of economic slowdown, demand has not increased as projected. In a period of two years, a capacity addition of around 64.4 mtpa is expected.

This cannot be absorbed in the domestic market and India may be surplus to anextent of around 25-30 mmtpa of petroproducts by 2002 from a deficit of around 19.5 mmtpa in FY99 (estimated). There is a value addition to the tune of 50-60 per cent (in USD terms) over crude achieved in refining. Resultant savings in the import bill would be of the order of USD1.5-2bn (ie as compared with today our oil import bill would be lower).

Assuming a growth of 15 per cent in exports and a growth of 12.5 per cent in non-oil imports and around 20 per cent growth in invisible earnings on a base of FY99 (estimates of CMIE) could make India a current account surplus country by FY 2002. Current account balance as a percentage of GDP is expected to fall to insignificant levels in FY2001. (The assumption is that import of items such as consumer goods would continue to be discouraged. A big percentage of FY99 imports is gold. This again is sought to be discouraged through the gold deposit scheme proposed in FY2000 budget).

Given this scenario, the effect on currency, industrial profitability, and stockmarkets is analysed below.

Effect on the rupee

In the short term, pressures on the Rupee would be on account of current account balances and debt repayment obligations if any. However, foreign currency debt is not on the books of the RBI, rather it is on the books of various corporates. Many of these corporates would not be in a position to repay the forex loan without refinance. Given a scenario where the current account is in surplus (upward pressure on the Rupee), the probability of Rupee refinance being cheaper than USD refinance would be low. Hence, corporates would rather roll over USD loans rather than substitute USD loans with rupee loans. The other factor that can put pressure on the rupee is big FII sales. However, as experience with SE Asian countries has shown, stock markets in current account surplus emerging market countries perform better than those in current account deficit countries as these markets are perceived to be less risky as premium paid to insure against currencydepreciation is lower. We are therefore of the opinion that in the given scenario, there is a high probability that rupee may strengthen against the USD.

Effect on interest rates

Interest rates should fall. The reasons are as follows: n In a scenario of stable rupee, the forward premium on hedging USD borrowings would be low. Corporates would favour foreign debt to rupee debt if the cost of the rupee debt is significantly higher than forex debt. This would force interest rates down.

If RBI resorts to sterilisation (mopping up USD in exchange for rupee), liquidity in the system would improve. Excess liquidity would force/enable banks to charge lower rates of interest.

Effect on commodity firms/EOUs

Commodities such as steel, aluminium and copper are priced at import parity prices. In a scenario of depreciating rupee, the fixed rupee cost (such as depreciation, salary and wages, power and captive RM) of the commodity companies gets reduced (in USD terms) by the rupee depreciation. Thisenables them to absorb cost increases (mainly manpower and transport). However, if rupee remains stable, this would no longer be the case. Companies would find it tough to increase salaries or absorb higher transportation costs. A good part of the profits of EOU's presently comprise of gains made on selling dollars forward. If the expectations of rupee depreciation get reduced, the forward premium on the USD would also reduce and profits of exporters would get affected to that extent. However, business would benefit on account of lower interest rates.

Inflation expectations would get reduced. Availability of cheap credit would encourage companies to add capacities. Supply side pressures would keep prices low.

What would happen to valuations?

Valuations are affected by perceived risk attached to a country. With hedging costs expected to go down, valuations should improve. Valuations are also expected to improve because of expectations of lower interest rates. If interest rates on debt falls, thenequity becomes more attractive. Valuations are also a function of growth expectations. A scenario of cheap money, stable exchange rates and low inflation should encourage capital formation. Hence it is expected that the discounting of the stocks would improve.

Pick the winners

Working capital intensive businesses like trading, warehousing, software, entertainment, retailing and capital goods would gain from reduction in interest rates. Construction companies would gain from lower interest rates and higher demand for their services. Businesses where sales are mainly financed, would also benefit. Commodities which are expected to see demand supply gap tightening should benefit.

(The author is assistant vice-president, SBI Capital Markets, and the views expressed in this article are the author's own)