Bankers say high interest rates have begun to hit consumer demand and going by the food inflation numbers, for the week to August 13, which have come in at 9.8%, consumers are either going to have to eat less or cut back further on other spends. Clearly, it?s not just the tardy pace of investments that?s going to hurt growth. The macroeconomic headwinds, instead of abating, remain as strong as ever ?watch how crude oil prices have bounced back to $110. While that may reflect some amount optimism on the part of speculators as the Federal Reserve chief Ben Bernanke heads for Jackson Hole given that expectation is equally divided on chances of a QE 3, it?s a fact that that prices of commodities haven?t eased meaningfully.
Moreover, the global economy is going from bad to worse; Citi has just trimmed its 2011 global GDP growth forecast from 3.4% to 3.1%, and the 2012 global growth forecast by a steeper 50 basis points from 3.7% to 3.2%. And, while there may not be a hard landing there, China should grow at 9% this year lower than previous estimates. That?s probably what?s holding up oil prices, at least partly. Until crude oil prices retreat substantially, the Reserve Bank of India (RBI) is not going to relent on monetary policy so whether or not growth comes off sharply, interest rates will head higher. Although the central bank, seems to have turned a tad more bearish on growth than it was about a month back, it is nonetheless clear that interest rates need to stay high so as not to allow the current levels of inflation to become the norm.
As such, we could see the repo rate at 8.25% very soon. That means capacity addition could be pushed back further; policy paralysis and environmental related issues have already driven down fixed capital formation from 17.4% in the June quarter to 0.4% in the three months to March 2011.
The central bank has pointed out that investments need to be stepped up by 2.5-3 % while the gross domestic savings rate needs to be at 37% or more if GDP is to come in at 9.5% ; it also says household savings have stagnated in recent years, largely reflecting the reallocation between financial and physical assets.
The worse bit of news is that the government has lost another session of Parliament in which it could have moved ahead on legislation. At this rate free capital formation will not come in at even 5% this year compared with 8.6% in 2010-11.
So, what was supposed to have been a year of two halves in which the tepid growth of the first half was to have picked up substantially in the second six months may end up being one year reporting an increase in GDP of just over 7%.
That cannot mean good news for the stock market already reeling under rising risk aversion; so far revenues have been robust but if that changes, earnings downgrades, so far have been driven by margin disappointments, will come in faster than they have.
The impact of higher interest costs is yet to be fully felt and if the quality of earnings deteriorates, the market could well start trading at lower multiples. So the current valuation of 13.5 times forward earnings may not be as attractive as it seems.