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August was witness to sharp sell offs in global as well as domestic equity
markets. While this undoubtedly makes domestic markets inexpensive on
several parameters, headwinds (mostly global) such as growth scare in
advanced economies, the European crisis spreading to core European
countries, and recognition of the fact that policy actions (both fiscal and
monetary) are reaching their limits, continue to linger. Domestically, the
Q1FY12 GDP data indicated that growth is weakening, but not falling off
sharply. Inflation, meanwhile, remains elevated although prices pressures
are receding. In September policy meeting, the RBI may hike rates by 25
bps but expect a pause thereafter.
Global economic conditions deteriorate sharply
The incoming macroeconomic data from the western economies point towards
significant weakness in economic activity. Q2 GDP data, both in the US and Europe,
have been lower than expected, with momentum stalling even in core European
countries such as Germany. More worryingly, leading indicators are hinting at further
deterioration in the coming months. In such a backdrop, recognition that policy support
may be reaching its limits is rattling markets. Notably, in Europe, lack of political will on
the part of creditor governments to extend meaningful support to weak countries and
ECB’s reluctance with regards to any aggressive policy support are adding to the
jitteriness in the financial markets.
India’s growth moderates but does not falter
Real GDP grew ~7.7% Y‐o‐Y in Q1FY12, broadly in line with expectations. On the sector
front, mining was weak and construction slumped, reflecting the ongoing monetary
tightening and government policy paralysis. On the expenditure side, consumption
eased and investments rebounded after a prolonged soft patch, although the
momentum was well below trend. Meanwhile, exports grew strongly, but firmer
imports led to a sharp widening in trade deficit. In a nutshell, though growth has turned
softer, it is not falling off sharply. Going ahead, the weakness is expected to persist
through Q2FY12 with some improvement thereafter. We, therefore, maintain our FY12
GDP growth forecast at ~7.7%. On the rate front, the RBI may hike the repo rate by
25bps in September, but we anticipate a pause thereafter.
Earnings trajectory continues to soften; valuations become cheaper
FY12 and FY13 earnings expectations continue to be scaled down with downgrades
more pervasive than upgrades ‐ two thirds stocks in the Sensex universe being
downgraded during the recently concluded Q1FY12 earnings season. Within the larger
BSE‐100 universe, downgrades were most sharp within cyclical sectors with IVRCL, JSW
Steel and Unitech impacted the most. However, given the correction in markets,
valuations, both on an absolute as well as relative basis, have begun to look attractive.
On absolute basis, the Sensex trades at 13x NTM PE, which, except the weeks
succeeding the Lehman crisis, is the lowest in almost six years.
Economy
Global economic conditions deteriorate sharply
Last month saw sharp deterioration in the incoming economic data from both US and Europe,
which weighed heavily on the financial market sentiments; MSCI G7 fell ~7%, while MSCI EM
declined ~9% in August. Q2 GDP data in the US showed that the economy grew at 1.3% QoQ
annualised lower than required to bring the unemployment rate down on a sustainable basis.
The business confidence (as depicted by PMI) and household confidence (as captured by
consumer confidence index) have been on a declining trend even as housing market remains
in a slump. Further, the sharp decline in equity markets is only aggravating the erosion in
wealth effect. This, along with ongoing fiscal retrenchment (by states and soon by federal
government), could keep private consumption weak in the coming quarters.
Across the Atlantic, the situation was no less pessimistic. Flat growth in France and Germany
in Q2 suggests that economic weakness is now spreading to core of Europe. Forward looking
business and consumer confidence indicators, adverse conditions prevailing in the financial
markets and ongoing fiscal retrenchment across the board suggest that growth will remain
anemic in the foreseeable future. Notably, it is the deterioration in the economic activity in
the peripheral economies which remains the biggest threat to fiscal consolidation targets of
these economies.
EM economies have been resilient so far as they remain largely free of any structural
constraints such as overleveraged balance sheets and deficient demand. Nonetheless,
persistently high inflation and aggressive monetary tightening, along with weakening
external demand environment, do not augur well for EM growth prospects either. While no
EM economy is completely isolated from developments in western economies, exports
oriented Asian EMs including China are particularly vulnerable. Accordingly, we believe that
as we proceed through the year, growth concerns will start dominating inflation concerns,
thereby bringing a halt to the monetary tightening cycle. Indeed, Brazil has already reversed
the monetary cycle by cutting policy rates 50bps recently.
Policy response in western economies reaching its limits
Monetary and fiscal support at an unprecedented scale played a major role in supporting the
global economy in the post‐recession recovery period. However, the recovery has not proved
durable particularly in western economies where we are seeing renewed economic weakness.
What’s notable is the fact that now both monetary and fiscal policies in the western
economies are reaching their limits and, to that extent, these economies remain quite
vulnerable to any negative shock.
On fiscal side, support to the financial sector, increased fiscal spending and fall in revenues is
now apparent in the severe strains in the sovereign balance sheets. In the US, already elevated
fiscal deficit and debt levels, recent debt deal and political stalemate mean that it is quite
difficult for the government to provide any further support to the flagging economy. In this
regard, forthcoming speech of Obama will be closely watched. In Europe, the Union is facing a
crisis of its existence as the debt contagion is spreading to larger economies and even Greece
continues to slip on its fiscal and debt targets despite repeated bailouts. In some sense, the
problem is now becoming political. The main lender country, Germany, is losing appetite for
further bail‐outs in the face of rising opposition from domestic tax payers and some others such
as Finland are putting extra conditions to support the bail‐out package. On the troubled
countries side, Greece in the recent past has seen rising wave of protests against the austerity
measures. From this perspective, there is no room for any fiscal support in Europe.
On the monetary side, advanced countries’ central banks have been quite accommodative
using conventional and non‐conventional measures to support growth. Now, with the policy
rates close to zero levels and unconventional measures (like QE2) not having the desired
effect, monetary policy is also close to its limit. Therefore, with limited firepower available
with the monetary policy, it can be said that it won’t be able to support growth in a
significant way. Admittedly, in light of the present growth slowdown central banks may
decide to carry out another round of quantitative easing but that, in our view, should not
have any meaningful impact on growth. Across the Atlantic, the situation is somewhat
different in this regard. The ECB has been largely dormant since debt crisis aggravated in mid‐
2010. Despite worsening debt conditions and spreading contagion, the ECB remains very
reluctant in pursuing bond purchase program as it remains overly worried about inflation and
moral hazard problems. If ECB remains reluctant, it can cost Europe dearly.
India’s growth moderates but does not falter
GDP grew ~7.7% Y‐o‐Y in Q1FY12 (against 7.8% in Q4FY11), in line with our expectation. The
present data clearly shows that while growth is slowing, it has not weakened sharply. On the
sectoral side, services led the momentum, growing at a robust 10% Y‐o‐Y, possibly reflecting
pick‐up in investment. However, the negative impact of persistent monetary tightening and
government policy paralysis since late last year was clearly visible in construction and mining
sectors where growth slumped. On the expenditure side, investment staged some rebound
after a period of weakness while consumption eased. Meanwhile, contribution from net
trade was significantly negative.
Manufacturing stable; mining, construction slump
Industrial growth slowed to 5.1% against 6.1% in the last quarter, Y‐o‐Y, primarily due to a
sharp slump in mining and construction sectors, largely attributable to delays in government
approvals and high interest rates. Meanwhile, manufacturing continues to expand at a
moderate rate and electricity is growing at above the trend level. Though manufacturing
growth stays below trend at ~7%, it does suggest that the economic activity is not falling off
sharply. Meanwhile, a strong growth in electricity was the result of many power plants
coming on stream last year. Going forward, as the government machinery swings back into
action, growth in mining and construction sectors should improve.
Service sector growth accelerates
Services grew strongly at ~10.0% versus ~8.7%, Y‐o‐Y, in the previous quarter. This, we
believe, is a result of strong investment growth; consumption in the economy declined this
quarter and, hence, strong momentum in services must have resulted from a pick‐up in
services‐related investments which may not be so interest rate sensitive. Going forward, as
shown by leading indicators including PMI, the services sector is expected to grow at a
healthy pace. Meanwhile, agriculture grew at ~3.9% Y‐o‐Y, reflecting a good crop.
Consumption slips, investment rebounds
On the demand side, private consumption growth slowed to ~6.3% Y‐o‐Y this quarter against
~8.0% in the last quarter. On a seasonally adjusted sequential basis also, consumption seems to
have topped out owing to continued monetary tightening by RBI that has now started to hit
interest rate sensitive spending (e.g. auto sales etc). Besides, government spending also weakened
during the quarter; government consumption growth slowed sharply to ~2.1% Y‐o‐Y this quarter
from ~5%. Broadly, given the fact that interest rates will remain elevated in the coming quarters
and government will gradually pursue fiscal consolidation, below‐trend growth in consumption is
likely to persist. Fall in consumption demand would start translating into reduced demand
inflation in the coming months.
While the present quarter’s investment growth of ~9.5% Y‐o‐Y is much higher than ~2.2% seen in
the last quarter, it is still below its trend growth. The sub‐par investment growth is the result of
high interest rates and policy uncertainty. Presently, the investment data is quite mixed with
projects under implementation and credit growth showing weakness on one hand while strong
non‐oil imports and IIP – capital goods showing strength on the other. We think, going forward,
investments will continue to grow at current levels (below the trend but not very weak). Though
high interest rates will continue to exert pressure, some support is likely to come from noninterest
rate sensitive investment, base effect and government machinery swinging back to action.
RBI may hike policy rates by 25bps; to take pause thereafter
Current GDP data clearly shows that the central bank’s monetary policy has started to hit
consumption growth in the economy. This would be comforting for RBI, which has been trying to
quell inflation – especially demand – last year onwards. In addition to weakening demand
pressure, external economy is quite weak and inflation is expected to be on downward trajectory
in H2FY12. Considering these factors, we believe RBI policy rates are quite close to peaking.
Although RBI might raise rates by 25bps in the next policy meeting on September 16 (as inflation is
likely to remain elevated for the next 2‐3 months), we expect the central bank to pause thereafter.
Equities
Risk assets in a free fall driven by macro headwinds
Globally, risk assets were in a free fall in August as risk aversion driven by US debt downgrade,
poor economic data from the developed world and the continued impasse in the European
debt crisis engulfed markets. Equity markets bore the brunt, with global equities (MSCI AC
World Index) down ~8% M‐o‐M (a level last seen in May 2010). Some of the major European
markets such as Germany and Italy were down ~15‐20%. In an otherwise highly volatile
month, gold emerged as the best performing asset class, up almost 12%, despite a 4% scaledown
from its all time peak of USD 1,900/oz. The VIX almost touched 50, its highest in more
than three years, while in a signal of evolving risks to the European banks EURIBOR threemonth
swap rates jumped sharply to 65bps (last seen in July 2009).
M‐o‐M, August was torrid for Indian equities with the MSCI India index declining ~12%, once
again underperforming EMs which were down 9% (in USD terms). This year so far, Indian
markets continue to underperform (down ~22.0%) vis‐à‐vis EMs (down ~10.3%), opening up
a relative underperformance gap which is the highest in the past 10 years.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
August was witness to sharp sell offs in global as well as domestic equity
markets. While this undoubtedly makes domestic markets inexpensive on
several parameters, headwinds (mostly global) such as growth scare in
advanced economies, the European crisis spreading to core European
countries, and recognition of the fact that policy actions (both fiscal and
monetary) are reaching their limits, continue to linger. Domestically, the
Q1FY12 GDP data indicated that growth is weakening, but not falling off
sharply. Inflation, meanwhile, remains elevated although prices pressures
are receding. In September policy meeting, the RBI may hike rates by 25
bps but expect a pause thereafter.
Global economic conditions deteriorate sharply
The incoming macroeconomic data from the western economies point towards
significant weakness in economic activity. Q2 GDP data, both in the US and Europe,
have been lower than expected, with momentum stalling even in core European
countries such as Germany. More worryingly, leading indicators are hinting at further
deterioration in the coming months. In such a backdrop, recognition that policy support
may be reaching its limits is rattling markets. Notably, in Europe, lack of political will on
the part of creditor governments to extend meaningful support to weak countries and
ECB’s reluctance with regards to any aggressive policy support are adding to the
jitteriness in the financial markets.
India’s growth moderates but does not falter
Real GDP grew ~7.7% Y‐o‐Y in Q1FY12, broadly in line with expectations. On the sector
front, mining was weak and construction slumped, reflecting the ongoing monetary
tightening and government policy paralysis. On the expenditure side, consumption
eased and investments rebounded after a prolonged soft patch, although the
momentum was well below trend. Meanwhile, exports grew strongly, but firmer
imports led to a sharp widening in trade deficit. In a nutshell, though growth has turned
softer, it is not falling off sharply. Going ahead, the weakness is expected to persist
through Q2FY12 with some improvement thereafter. We, therefore, maintain our FY12
GDP growth forecast at ~7.7%. On the rate front, the RBI may hike the repo rate by
25bps in September, but we anticipate a pause thereafter.
Earnings trajectory continues to soften; valuations become cheaper
FY12 and FY13 earnings expectations continue to be scaled down with downgrades
more pervasive than upgrades ‐ two thirds stocks in the Sensex universe being
downgraded during the recently concluded Q1FY12 earnings season. Within the larger
BSE‐100 universe, downgrades were most sharp within cyclical sectors with IVRCL, JSW
Steel and Unitech impacted the most. However, given the correction in markets,
valuations, both on an absolute as well as relative basis, have begun to look attractive.
On absolute basis, the Sensex trades at 13x NTM PE, which, except the weeks
succeeding the Lehman crisis, is the lowest in almost six years.
Economy
Global economic conditions deteriorate sharply
Last month saw sharp deterioration in the incoming economic data from both US and Europe,
which weighed heavily on the financial market sentiments; MSCI G7 fell ~7%, while MSCI EM
declined ~9% in August. Q2 GDP data in the US showed that the economy grew at 1.3% QoQ
annualised lower than required to bring the unemployment rate down on a sustainable basis.
The business confidence (as depicted by PMI) and household confidence (as captured by
consumer confidence index) have been on a declining trend even as housing market remains
in a slump. Further, the sharp decline in equity markets is only aggravating the erosion in
wealth effect. This, along with ongoing fiscal retrenchment (by states and soon by federal
government), could keep private consumption weak in the coming quarters.
Across the Atlantic, the situation was no less pessimistic. Flat growth in France and Germany
in Q2 suggests that economic weakness is now spreading to core of Europe. Forward looking
business and consumer confidence indicators, adverse conditions prevailing in the financial
markets and ongoing fiscal retrenchment across the board suggest that growth will remain
anemic in the foreseeable future. Notably, it is the deterioration in the economic activity in
the peripheral economies which remains the biggest threat to fiscal consolidation targets of
these economies.
EM economies have been resilient so far as they remain largely free of any structural
constraints such as overleveraged balance sheets and deficient demand. Nonetheless,
persistently high inflation and aggressive monetary tightening, along with weakening
external demand environment, do not augur well for EM growth prospects either. While no
EM economy is completely isolated from developments in western economies, exports
oriented Asian EMs including China are particularly vulnerable. Accordingly, we believe that
as we proceed through the year, growth concerns will start dominating inflation concerns,
thereby bringing a halt to the monetary tightening cycle. Indeed, Brazil has already reversed
the monetary cycle by cutting policy rates 50bps recently.
Policy response in western economies reaching its limits
Monetary and fiscal support at an unprecedented scale played a major role in supporting the
global economy in the post‐recession recovery period. However, the recovery has not proved
durable particularly in western economies where we are seeing renewed economic weakness.
What’s notable is the fact that now both monetary and fiscal policies in the western
economies are reaching their limits and, to that extent, these economies remain quite
vulnerable to any negative shock.
On fiscal side, support to the financial sector, increased fiscal spending and fall in revenues is
now apparent in the severe strains in the sovereign balance sheets. In the US, already elevated
fiscal deficit and debt levels, recent debt deal and political stalemate mean that it is quite
difficult for the government to provide any further support to the flagging economy. In this
regard, forthcoming speech of Obama will be closely watched. In Europe, the Union is facing a
crisis of its existence as the debt contagion is spreading to larger economies and even Greece
continues to slip on its fiscal and debt targets despite repeated bailouts. In some sense, the
problem is now becoming political. The main lender country, Germany, is losing appetite for
further bail‐outs in the face of rising opposition from domestic tax payers and some others such
as Finland are putting extra conditions to support the bail‐out package. On the troubled
countries side, Greece in the recent past has seen rising wave of protests against the austerity
measures. From this perspective, there is no room for any fiscal support in Europe.
On the monetary side, advanced countries’ central banks have been quite accommodative
using conventional and non‐conventional measures to support growth. Now, with the policy
rates close to zero levels and unconventional measures (like QE2) not having the desired
effect, monetary policy is also close to its limit. Therefore, with limited firepower available
with the monetary policy, it can be said that it won’t be able to support growth in a
significant way. Admittedly, in light of the present growth slowdown central banks may
decide to carry out another round of quantitative easing but that, in our view, should not
have any meaningful impact on growth. Across the Atlantic, the situation is somewhat
different in this regard. The ECB has been largely dormant since debt crisis aggravated in mid‐
2010. Despite worsening debt conditions and spreading contagion, the ECB remains very
reluctant in pursuing bond purchase program as it remains overly worried about inflation and
moral hazard problems. If ECB remains reluctant, it can cost Europe dearly.
India’s growth moderates but does not falter
GDP grew ~7.7% Y‐o‐Y in Q1FY12 (against 7.8% in Q4FY11), in line with our expectation. The
present data clearly shows that while growth is slowing, it has not weakened sharply. On the
sectoral side, services led the momentum, growing at a robust 10% Y‐o‐Y, possibly reflecting
pick‐up in investment. However, the negative impact of persistent monetary tightening and
government policy paralysis since late last year was clearly visible in construction and mining
sectors where growth slumped. On the expenditure side, investment staged some rebound
after a period of weakness while consumption eased. Meanwhile, contribution from net
trade was significantly negative.
Manufacturing stable; mining, construction slump
Industrial growth slowed to 5.1% against 6.1% in the last quarter, Y‐o‐Y, primarily due to a
sharp slump in mining and construction sectors, largely attributable to delays in government
approvals and high interest rates. Meanwhile, manufacturing continues to expand at a
moderate rate and electricity is growing at above the trend level. Though manufacturing
growth stays below trend at ~7%, it does suggest that the economic activity is not falling off
sharply. Meanwhile, a strong growth in electricity was the result of many power plants
coming on stream last year. Going forward, as the government machinery swings back into
action, growth in mining and construction sectors should improve.
Service sector growth accelerates
Services grew strongly at ~10.0% versus ~8.7%, Y‐o‐Y, in the previous quarter. This, we
believe, is a result of strong investment growth; consumption in the economy declined this
quarter and, hence, strong momentum in services must have resulted from a pick‐up in
services‐related investments which may not be so interest rate sensitive. Going forward, as
shown by leading indicators including PMI, the services sector is expected to grow at a
healthy pace. Meanwhile, agriculture grew at ~3.9% Y‐o‐Y, reflecting a good crop.
Consumption slips, investment rebounds
On the demand side, private consumption growth slowed to ~6.3% Y‐o‐Y this quarter against
~8.0% in the last quarter. On a seasonally adjusted sequential basis also, consumption seems to
have topped out owing to continued monetary tightening by RBI that has now started to hit
interest rate sensitive spending (e.g. auto sales etc). Besides, government spending also weakened
during the quarter; government consumption growth slowed sharply to ~2.1% Y‐o‐Y this quarter
from ~5%. Broadly, given the fact that interest rates will remain elevated in the coming quarters
and government will gradually pursue fiscal consolidation, below‐trend growth in consumption is
likely to persist. Fall in consumption demand would start translating into reduced demand
inflation in the coming months.
While the present quarter’s investment growth of ~9.5% Y‐o‐Y is much higher than ~2.2% seen in
the last quarter, it is still below its trend growth. The sub‐par investment growth is the result of
high interest rates and policy uncertainty. Presently, the investment data is quite mixed with
projects under implementation and credit growth showing weakness on one hand while strong
non‐oil imports and IIP – capital goods showing strength on the other. We think, going forward,
investments will continue to grow at current levels (below the trend but not very weak). Though
high interest rates will continue to exert pressure, some support is likely to come from noninterest
rate sensitive investment, base effect and government machinery swinging back to action.
RBI may hike policy rates by 25bps; to take pause thereafter
Current GDP data clearly shows that the central bank’s monetary policy has started to hit
consumption growth in the economy. This would be comforting for RBI, which has been trying to
quell inflation – especially demand – last year onwards. In addition to weakening demand
pressure, external economy is quite weak and inflation is expected to be on downward trajectory
in H2FY12. Considering these factors, we believe RBI policy rates are quite close to peaking.
Although RBI might raise rates by 25bps in the next policy meeting on September 16 (as inflation is
likely to remain elevated for the next 2‐3 months), we expect the central bank to pause thereafter.
Equities
Risk assets in a free fall driven by macro headwinds
Globally, risk assets were in a free fall in August as risk aversion driven by US debt downgrade,
poor economic data from the developed world and the continued impasse in the European
debt crisis engulfed markets. Equity markets bore the brunt, with global equities (MSCI AC
World Index) down ~8% M‐o‐M (a level last seen in May 2010). Some of the major European
markets such as Germany and Italy were down ~15‐20%. In an otherwise highly volatile
month, gold emerged as the best performing asset class, up almost 12%, despite a 4% scaledown
from its all time peak of USD 1,900/oz. The VIX almost touched 50, its highest in more
than three years, while in a signal of evolving risks to the European banks EURIBOR threemonth
swap rates jumped sharply to 65bps (last seen in July 2009).
M‐o‐M, August was torrid for Indian equities with the MSCI India index declining ~12%, once
again underperforming EMs which were down 9% (in USD terms). This year so far, Indian
markets continue to underperform (down ~22.0%) vis‐à‐vis EMs (down ~10.3%), opening up
a relative underperformance gap which is the highest in the past 10 years.
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