The recent sharp depreciation in the Indian currency versus the US dollar and continued high commodity prices, for instance in crude oil, have only been able to make small dents when it comes to Indian equity investors’ confidence. If India’s macroeconomic position indeed deteriorates, as is being feared, in form of higher Current Account Deficit (CAD) and a weaker Balance of Payments, equity markets will not be able to look away for much longer. Celebrate March-2018 GST collections as much as you want to, but one number does not a market make. At the moment, the liquidity-fuelled equity market is trudging along nicely, displaying an almost saintly detachment from the macro troubles of the real economy. Therein, lies the danger.
When it comes to Indian stock market investors, it is as if no bad news is bad enough. There is a section of investors who see light at the end of the tunnel even as higher crude prices, the weaker rupee, and high commodity prices cast an ominous cloud over the long-awaited earnings recovery. A weaker rupee is good for exporters and hence EPS upgrades in IT stocks have happened. But, exports are not the only cog in the Indian economy wheel which imports 80% of its crude needs. If commodity prices were to sustain at current levels, it is difficult to imagine that a large part of the listed universe will be comfortably able to pass on the input price hikes as if nothing happened.
Banking on banks
The stock market may be ignoring the commodity price situation for a reason. India is no longer driven by commodities. It is fuelled by finance. Banks are the elephants of the Dalal Street! And no one wants to discuss the elephant in the room. PSU banks may be a pariah at the moment, but private sector banks are no different if one were to read the headlines carefully. Banks are expected to account for about 50% of all the projected incremental profits for FY2019 for the Nifty-50. Already, net profit estimates for the ‘corporate’ banks have faced some cuts. If loan-loss provision assumptions on stressed assets are higher than what is being pencilled in, the total earnings estimates of the Indian market will have to be relooked at. We can promise you, a relook at elevated valuations is never pretty as the Sensex stays perched atop 34,500 and the Nifty over 10,500. The Sensex equity index trades at 18.2 times one-year forward price-to-earnings ratio --- much higher than Brazil’s Ibovespa, China’s Shanghai Composite Index and Russia’s RTS Index which trade in 6-13 times range.
Oil remains on the boil. High oil prices are already putting pressure on the government’s fiscal position. In an election year, oil price hikes are a strict no-no. With growing clamour over high oil rates, any cut in excise duty on diesel and petrol to calm jittery consumers will add another layer of pressure. Do remember that it was low oil price and related smaller oil subsidies coupled with higher excise duties on fuel that helped India paint a better macro picture between 2015 and 2017. If the government has to give back some of those slippery fiscal gains as crude oil prices climb, things will look very different. It’s a season of politics and hence populism tendencies will overshadow rational economic approaches. Five states are due for elections before January 2019. And the mother of all, the general elections, are likely before May next year.
The perils of ignorance
If you have been following stock markets over the past 30-31 days, investors have tried to shake off macro negatives. The strong performance of IT stocks has been celebrated, with much elan. But the bearish implications of higher crude oil prices on the economy have been shrugged off. It is a large enough disconnect. The weaker rupee has been brushed beneath the carpet. Never mind the banking brouhaha. Too much hope rests on the weak shoulders of the elusive earnings recovery. It is always left to the 'next few quarters' when it comes expecting earnings upgrades. We do not know what exact trigger will start a chain of negative reactions, but understanding and respecting macros is a good exercise that even seasoned micro-investors must indulge in once in a while.
(The author is a financial journalist with over 13 years of experience)