After taking money off the table in the first two months of the year, foreign funds have picked up stocks worth nearly $2 billion in March and shopped for about $one billion worth of shares in the first few days of April. As a result the market has run up by 12% since the recent low on February 10, when the Sensex slipped to 17,463. After underperforming the Emerging Markets between October and February, India has outperformed since then. Not too much has changed though; the macroeconomic headwinds, that were threatening to slow down growth remain as gusty and are gathering force with crude oil prices nudging $122. Since India imports three-fourths of the oil that it needs, inflation, which has averaged 8% in the last year, is unlikely to come off below 7%.
In fact, if the government chooses to up diesel prices, it would keep inflation at above 7% and therefore, interest rates too are going to remain high. On the other hand, if the government chooses to take care of most of the hike in oil prices, by subsidising the oil import bill, our current account deficit, which has been funded primarily by portfolio flows, can only worsen. Economists had already penciled in another 50 basis points hike in key policy rates in 2011. Now treasurers are expecting to see a two-year high for the benchmark bond sometime in the next six months with the government expected to borrow more than the planned net R3.4 lakh crore. What can help is some action from the government on projects; although there?s talk of several road projects taking off and 32 bills were tabled for discussion in the budget session, the government needs to move ahead on reforms in sectors like power and energy and clear projects quickly. It?s not a happy situation when gross fixed capital formation, which contributes about a third of the GDP, after rising a smart 15% in the first half of 2010-11, slows to just single digits in the second half. True, consumption demand remains robust as seen from the spurt in personal loans which has risen to double digits. And at $66 billion in the three months to December exports have created a record.
However, corporate India will be hurt by the rising cost of wages, inputs and money causing factory output to moderate to sub-8% this year from just over 8% last year. The services piece, which grew 9.6% last year and pushed GDP to 8.5% could moderate somewhat because high interest rates typically hurt the banking and real estate sectors. So it?s not surprising that GDP estimates for 2011-12 have been pruned to levels of 8%, from 8.5% levels in 2010-11. That means the pace of growth in corporate earnings will slow down to around 17-18% this year. At just over15 times estimated 2011-12 earnings, the Indian market is not expensive but it?s not cheap either. However, will all the negatives, India seems relatively better off than peers like China?where the rate tightening is unlikely to end in a hurry?and which is not much cheaper than India. India?s also fortunate not to have an exposure to Japan like Taiwan and Korea whose investment-led recoveries could be delayed.
Nevertheless, unless corporate earnings, which were extremely disappointing in the December quarter, turn out to be better than expected, it?s hard to see how the Sensex could cross its high of 21,005.