Multiple Whammy’s’

The Indian markets and the way the government and various regulators seem to be working  are clearly testing the patient of most investors at this stage. The year started off with extreme pessimism and cheap valuations and we saw the markets move up sharply over the first few months in the hope of improvement in the domestic growth prospects and positive policy actions. The strong up move in other emerging markets as well as Western markets supported the move in the Indian markets. However in the recent past there have been several policy actions both from the government as well as some regulatory authorities that have shaken investors.
The entire issue of GAAR has been stretched so much that it is unbelievable. At a time when our trade deficit is at record highs, rupee is under pressure and we need more and more FDI and FII flows, such a huge uncertainty has been created. The major problem as always is that a particular policy is announced and then it remains vague for a prolonged period of time. Hopefully w see some sort of clarifications coming on GAAR, retrospective taxation etc. next week otherwise India will risk severely underperforming as we do not even have a higher economic growth angle at this stage which can make investors ignore other concerns. Most Private Equity as well as FII flows have stopped as a result of these uncertainties. Private Equity players have been big supporters and contributors to the India growth story over the years and we do need this growth capital to continue to flow strongly. FII’s are heavily underweight India due to issues of slower economic growth, lack of policy action or excessive policy action in some cases and also because of the extreme weakness of the Indian Rupee which has underperformed most Emerging Market currencies. Government inaction combined with slowing growth and a widening Current Account deficit has prompted S&P to downgrade India’s outlook. At the same time the outlook for countries like Philippines and Indonesia has been upgraded. India is slowly becoming the least preferred market for Emerging Market investors from being the darling of the last bull cycle.

TRAI recommendations on 2 G spectrum pricing are absurd and risk taking the biggest success story in Indiai.e. the telecom revolution down the path of bankruptcy. If spectrum pricing is so high then call rates will double or more. Finally the point is that if spectrum was given out cheap at the start of the mobile revolution in the early 2000’s then it has also resulted in extremely cheap telecom services for customers. We have also seen some other regulators suddenly becoming proactive after not doing anything for years. On the other hand there have been some positive too, with electricity tariffs being increased across most states the risk of NPA’s due to State Electricity Dues have reduced substantially.
Overall globally equity markets look very well placed to rally further. In most of the key developed economies companies have reported good results and a majority have beaten analyst expectations. Extremely cheap rates of interest combined with lower commodity prices and higher sales in high growth Emerging Economies has contributed towards this. On the other hand companies in India are suffering because of high interest rates and have not been able to capture the decline in commodity prices because of the depreciation of the Rupee. However going forward interest costs should stabilize and commodity cost pressure should subside for companies in India. This should lead to better gross margins and a lower impact of interest costs in reducing profitability. However the key will be demand growth and the overall growth of the economy, where we need a more aggressive policy environment from the government as well as a percolation of lower policy rates into the real economy. At this stage the downside as well as upside risks to earnings 2-growth in year 2012-13 seems to be well balanced.

The global shift from bonds to equities, about which I had written earlier seems to be imminent and well on its way to happening. The Dow Jones Index has already reached a new 4 year high. Infact who could have imagined in the year 2009 that the US Markets will recover and reach pre Lehman levels and infact the high flying BRICs economies and markets will underperform the developed markets. Overall the global equity market rally still has a long way to go. How well India will participate and whether we will underperform or outperform will depend more on how the policy environment shapes up in India and how aggressively RBI moves to support growth in the economy.

The results season started of in an unexpected fashion with Infosys coming out with results that did not inspire market confidence and also gave guidance for growth which disappointed most analysts. However subsequently most key IT companies have reported strong results. The most positive thing that I have seen out of the results that have come out till date has been the fact that a majority of Banks have come out with strong results with extremely controlled NPA levels. NPA’s were expected to move up sharply in the last financial year, however the asset quality of banks has held up pretty well. This in my view reduces the downside potential for the markets substantially. A majority of ocmapnies are still to report and we should see those results come out over the next few weeks.
Overall valuations do not seem to be of concern at this stage. It is all a question of confidence and a measure of the ability of the government to revive growth in the economy. I have often wondered why the government does not think of going in for a sovereign bond issue. A $ 20 billion long term bond issue will eliminate both of the major concerns in the short run i.e. crowding out due to higher government borrowing as well as the pressure on the rupee due to the high Current Account deficit. The low interest rates globally are the ideal time to lock in yields on long term government bonds.  In the absence of a proper clarification on the provisions of GAAR we could see a further selloff in the markets. However confidence in the governments intent or the postponement of this move could set the tone for an upward move. Next week will be interesting in that regard. 

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