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India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
■ Consensus expects the rupee to appreciate. Will it? If debt flows
disappoint, we believe the rupee may depreciate further. That would hurt
equity performance, and prolong and intensify high inflation, thus delaying
rate cuts. The pain in rate sensitive sectors such as banks, real estate,
infrastructure and four-wheeler automobiles can thus be prolonged, while IT
and pharma may gain. A potential positive would be a push for reforms—
regulatory change is almost always driven by external stresses.
■ Growing dependence on debt inflows. The long-held Indian policy of
sustained current account deficits to neutralise capital inflows has worked
well so far. Progressively, though, against the wide-held expectation of a
surfeit of global capital naturally flowing into India, we see challenges. With
equity inflows peaking, the RBI has been steadily increasing foreign debt
limits to maintain total capital inflows, a sign of desperation, given India’s
dismal scores on most essential measures for capital account convertibility.
■ Do not expect the RBI to intervene. With forex reserves down 6% and
currency market turnover up 64% in the last three years, the RBI’s ability to
intervene is much depleted. Moreover, foreign currency loans being due in a
year being a high 48% of forex reserves may be another reason for it to
refrain from intervening.
■ Winners and losers. If the rupee falls, companies with un-hedged forex
debt such as Aban and Bharti could see book value erosion. We like Infosys,
TCS, Sun Pharma, Lupin and Hindustan Zinc, for their rupee costs and
dollar revenues, and still do not prefer ICICI, SBI and Maruti
INR—when low borrowing could be
bad
If foreign debt inflows were to disappoint, we fear rupee may depreciate further, versus
consensus expectations of its appreciation. A weaker rupee would hurt equity
performance—given its pro-cyclical nature, in most years, the delta from the rupee itself is
more than 5% every year. It would also intensify inflation pressures for India, given that
32% of the WPI is linked to global commodity prices. A 5% fall can increase inflation by
1.6 pp. The rupee’s recent fall has already had an impact. While oil is down 14% from its
peak, in rupee terms, it is down only 4%. Sustained high inflation could mean rate cuts get
pushed out, which would be negative for rate-sensitive sectors such as banks, real-estate,
construction, infrastructure and four-wheeler automobile companies.
Policy assumptions under stress
Indian policymakers target sustained current account deficits so that capital inflows can be
absorbed without strengthening the currency. This has worked well so far, with India
receiving Rs20 tn of capital inflows since 1994 without much currency impact. While equity
flows dominated in early years, debt inflows have picked up sharply. The RBI, perhaps
anticipating a peak in equity inflows, has been aggressively raising limits on debt flows.
The consensus view currently is that India is likely to see growing capital inflows, driven by
(1) excess of capital globally with sustained low interest rates; (2) India’s growth being
steadily higher than elsewhere; and (3) high interest rate differentials. We disagree: there
are headwinds for all four major forms of capital flows: FII equity, FDI, FII debt, as well as
External Commercial Borrowings (ECB).
(1) FII equity flows have been near zero this year, and may stay that way with growth
forecasts and earnings estimates still seeing cuts. (2) One-offs aside, the declining trend
of net FDI may continue, with many high FDI sectors slowing, few new sectors coming up
to stem the fall, and FDI outflows sustaining; (3) FII debt flows, the closest to hot money,
have reversed recently on fears of worsening domestic credit quality and global risk
aversion. (4) Risk appetite may constrain un-hedged ECBs, and given hedging costs, they
only make sense for short time horizons. Further, Indian banks, which provide a large part
of ECBs, may struggle to grow their overseas book, given rising CDS spreads, and their
reliance on wholesale funding.
RBI can only devalue, not protect
Consensus believes regulators can and will intervene to stem the damage. With forex
reserves down 6% from the May 2008 peak, and currency market turnover up 64% in the
same period, RBI’s ability to intervene is much depleted. Moreover, with foreign currency
loans due in a year being a high 48% of the country’s forex reserves, the central bank may
be selective about using its ammunition. Further opening up of the capital account is also
unlikely. The economy’s score on most critical measures required for capital account
convertibility is quite dismal – fiscal deficit and inflation remain high, and months of imports
reserves can support are at their decade’s low. Despite this, foreign debt limits are being
steadily increased. In such an environment, given ‘the impossible trinity’, if it goes for a
fixed exchange rate, it would lose its independence in setting up the monetary policy.
Sector and stock-specific impact
Companies such as Aban, Bharti, JSW Steel and Reliance Communications, which have
un-hedged foreign currency debt, could see book value erosion. On the other hand, a
weaker rupee would benefit IT (TCS, Infosys), pharmaceuticals (Sun Pharma, Lupin) and
metal companies (Hindustan Zinc) that have US dollar revenues but rupee-based costs. If
debt flows do occur, they would constrain profit growth for India’s banks.
Un-hedged loans could create an overhang
(1) Aban offshore has US$1.9 bn of USD-denominated debt and additional US$247 mn of
debt denominated in NOK. A depreciation of 5% in the rupee could reduce its book
value by 18.8%.
(2) Bharti’s debt in USD (~$US10 bn) is mostly unhedged and is largely related to its
Africa acquisition. Under Bharti’s IFRS accounting, the resulting translation losses
due to INR movements do not impact the P&L, but are adjusted to reserves.
(3) JSW steel has US$3 bn of dollar-denominated loans.
(4) Reliance Communication has ~US$6 bn of foreign currency loans, FCCBs and
options, which would impact its book value by 3.2%.
(5) Adani Power has outstanding ECBs of ~US$700 mn. Though it also has US$2.9 bn
worth of bills to be converted into term loans, they have been used to buy assets from
China, which would be revalued accordingly. Hence, the impact on book value would
only be due to the outstanding ECB, i.e. 2.3% of the book value for a 5% move in INR.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
■ Consensus expects the rupee to appreciate. Will it? If debt flows
disappoint, we believe the rupee may depreciate further. That would hurt
equity performance, and prolong and intensify high inflation, thus delaying
rate cuts. The pain in rate sensitive sectors such as banks, real estate,
infrastructure and four-wheeler automobiles can thus be prolonged, while IT
and pharma may gain. A potential positive would be a push for reforms—
regulatory change is almost always driven by external stresses.
■ Growing dependence on debt inflows. The long-held Indian policy of
sustained current account deficits to neutralise capital inflows has worked
well so far. Progressively, though, against the wide-held expectation of a
surfeit of global capital naturally flowing into India, we see challenges. With
equity inflows peaking, the RBI has been steadily increasing foreign debt
limits to maintain total capital inflows, a sign of desperation, given India’s
dismal scores on most essential measures for capital account convertibility.
■ Do not expect the RBI to intervene. With forex reserves down 6% and
currency market turnover up 64% in the last three years, the RBI’s ability to
intervene is much depleted. Moreover, foreign currency loans being due in a
year being a high 48% of forex reserves may be another reason for it to
refrain from intervening.
■ Winners and losers. If the rupee falls, companies with un-hedged forex
debt such as Aban and Bharti could see book value erosion. We like Infosys,
TCS, Sun Pharma, Lupin and Hindustan Zinc, for their rupee costs and
dollar revenues, and still do not prefer ICICI, SBI and Maruti
INR—when low borrowing could be
bad
If foreign debt inflows were to disappoint, we fear rupee may depreciate further, versus
consensus expectations of its appreciation. A weaker rupee would hurt equity
performance—given its pro-cyclical nature, in most years, the delta from the rupee itself is
more than 5% every year. It would also intensify inflation pressures for India, given that
32% of the WPI is linked to global commodity prices. A 5% fall can increase inflation by
1.6 pp. The rupee’s recent fall has already had an impact. While oil is down 14% from its
peak, in rupee terms, it is down only 4%. Sustained high inflation could mean rate cuts get
pushed out, which would be negative for rate-sensitive sectors such as banks, real-estate,
construction, infrastructure and four-wheeler automobile companies.
Policy assumptions under stress
Indian policymakers target sustained current account deficits so that capital inflows can be
absorbed without strengthening the currency. This has worked well so far, with India
receiving Rs20 tn of capital inflows since 1994 without much currency impact. While equity
flows dominated in early years, debt inflows have picked up sharply. The RBI, perhaps
anticipating a peak in equity inflows, has been aggressively raising limits on debt flows.
The consensus view currently is that India is likely to see growing capital inflows, driven by
(1) excess of capital globally with sustained low interest rates; (2) India’s growth being
steadily higher than elsewhere; and (3) high interest rate differentials. We disagree: there
are headwinds for all four major forms of capital flows: FII equity, FDI, FII debt, as well as
External Commercial Borrowings (ECB).
(1) FII equity flows have been near zero this year, and may stay that way with growth
forecasts and earnings estimates still seeing cuts. (2) One-offs aside, the declining trend
of net FDI may continue, with many high FDI sectors slowing, few new sectors coming up
to stem the fall, and FDI outflows sustaining; (3) FII debt flows, the closest to hot money,
have reversed recently on fears of worsening domestic credit quality and global risk
aversion. (4) Risk appetite may constrain un-hedged ECBs, and given hedging costs, they
only make sense for short time horizons. Further, Indian banks, which provide a large part
of ECBs, may struggle to grow their overseas book, given rising CDS spreads, and their
reliance on wholesale funding.
RBI can only devalue, not protect
Consensus believes regulators can and will intervene to stem the damage. With forex
reserves down 6% from the May 2008 peak, and currency market turnover up 64% in the
same period, RBI’s ability to intervene is much depleted. Moreover, with foreign currency
loans due in a year being a high 48% of the country’s forex reserves, the central bank may
be selective about using its ammunition. Further opening up of the capital account is also
unlikely. The economy’s score on most critical measures required for capital account
convertibility is quite dismal – fiscal deficit and inflation remain high, and months of imports
reserves can support are at their decade’s low. Despite this, foreign debt limits are being
steadily increased. In such an environment, given ‘the impossible trinity’, if it goes for a
fixed exchange rate, it would lose its independence in setting up the monetary policy.
Sector and stock-specific impact
Companies such as Aban, Bharti, JSW Steel and Reliance Communications, which have
un-hedged foreign currency debt, could see book value erosion. On the other hand, a
weaker rupee would benefit IT (TCS, Infosys), pharmaceuticals (Sun Pharma, Lupin) and
metal companies (Hindustan Zinc) that have US dollar revenues but rupee-based costs. If
debt flows do occur, they would constrain profit growth for India’s banks.
Un-hedged loans could create an overhang
(1) Aban offshore has US$1.9 bn of USD-denominated debt and additional US$247 mn of
debt denominated in NOK. A depreciation of 5% in the rupee could reduce its book
value by 18.8%.
(2) Bharti’s debt in USD (~$US10 bn) is mostly unhedged and is largely related to its
Africa acquisition. Under Bharti’s IFRS accounting, the resulting translation losses
due to INR movements do not impact the P&L, but are adjusted to reserves.
(3) JSW steel has US$3 bn of dollar-denominated loans.
(4) Reliance Communication has ~US$6 bn of foreign currency loans, FCCBs and
options, which would impact its book value by 3.2%.
(5) Adani Power has outstanding ECBs of ~US$700 mn. Though it also has US$2.9 bn
worth of bills to be converted into term loans, they have been used to buy assets from
China, which would be revalued accordingly. Hence, the impact on book value would
only be due to the outstanding ECB, i.e. 2.3% of the book value for a 5% move in INR.
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