The Reserve Bank of India (RBI) has said the revival in demand for credit from the private sector could exert some crowding out pressures despite the fact that government borrowings are being front-loaded. In other words, interest rates are likely to move up if the private sector?s demand for money moves up to ?normal levels? even though 63% of government borrowings will be completed in the first half of the year.
That is good news neither for India Inc nor for the markets. So far, interest rates have been affordable given the huge amounts of liquidity both from abroad and from domestic sources. Although the RBI hasn?t indicated the extent to which rates could rise, there is reason to be cautious about the kind of earnings that companies will deliver.
At 17,400, the Sensex trades at about 16.5 times estimated 2010-11 earnings of Rs 1,050, and is not cheap. Also, while earnings are growing at a smart 20%-plus over 2009-10, the quality of earnings isn?t great because it is skewed towards energy and materials.
In fact, it?s not surprising that India is slightly less preferred at the moment; for one, the run-up has been sharp and for another, valuations are nudging the top end of the trading range. The dependence on earnings from commodity profits and better bank profitability seems unwise with both likely to turn vulnerable. Should bond yields rise sharply, banks will most certainly take a hit on their portfolios.
Already, there?s been a change in the emerging market pecking order. Morgan Stanley has downgraded India to equal-weight with the country?s ranking having fallen to the No.12 from No.6. In contrast, peer market Korea has moved up, grabbing the No.4 position from the 10th spot. It?s primarily on the back of valuations and earnings revisions that the Korean market has been upgraded to overweight.
Interestingly, there isn?t too much difference in the movements for the major indices of the two countries; the Sensex target is 19,400 levels, which would mean an upside of around 11.5% or so from Monday?s closing levels of 17,400. The target for Kospi is 1,900, again leaving an upside of 11.5% from Monday?s levels of 1705. Over the medium-term, Korea has under-performed India; in the past 12 months, Korea has underperformed India by about 18%. But Morgan Stanley believes that once correction sets in, India could underperform Korea in a falling market.
The pluses for India are the dividend yield and the business cycle. India doesn?t seem to have score as well on some other counts such as the trailing price-to-earnings (PE) multiples. On a forward basis too, the consensus anticipates 71% dollar earnings per share growth in 2010 from Korea and 28% from India. What have dragged down India?s position are the fund manager weightings, by which the market now ranks 20 of 20. At a macroeconomic level, the growth versus inflation mix appears more favourable in Korea than in India. With the RBI having talked of possible ?crowding out pressures? the macroeconomic outlook becomes that much less certain.