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India Year Ahead 2012
Will get worse before it gets
better
�� Sell year-end rally; tough markets over next six months;
expect index to correct to 14,500
India has been the worst-performing market this year, falling a third in US$ terms.
Peaking inflation and a consequent pause in RBI rates are a positive which will
likely help the traditional December rally. However, we continue to expect a tough
market over the next six months and expect a correction of the Sensex to 14,500
as growth concerns take center-stage:
1. GDP growth to slow; downgrades likely: We expect FY13 GDP to slow to
6.8% and consensus to cut GDP forecasts over the next few months. GDP
growth in the next few quarters is likely to come even lower at around 6.5%.
A slower GDP will be led by: (a) a slowing global economy, (b) impact of high
rates and (c) slowing investment spend.
2. Earnings downgrades to continue: We continue to expect earnings
downgrades, led by slowing sales and sustained margin pressure from rising
labor and interest costs. We expect the bottom-up Sensex EPS of Rs1,275 to
be downgraded to Rs1,200 (growth of under 10% vs. expectations of nearly
15%).
3. Valuations will see slight de-rating: Based on analysts’ forecasts, markets at
13x one-year forward PE are at a slight discount to long-term averages. Slow
down in GDP and earnings growth as well as falling RoEs will likely lead markets
to trade lower. Secondly, on a relative basis, India trades at a 27% PE premium
to GEM markets, higher than a 10-year average of 17%.
Markets stop panicking when policymakers start panicking;
year-end index 19,000
The good news is that we could get some positive returns in 2012 if policymakers
take steps to reverse the economic slowdown.like a) aggressive rate cuts by RBI:
we expect rate cuts from April 2012 (though slow given stick inflation); markets
typically rally 3-6 months after the rate-cut cycle starts, and (b) policy reform by
the Government.
Sector Overweights: Pharma, autos and banks
We play a mix of defensives (through pharma rather than staples) and consumerrelated
rate sensitives through autos and private sector banks.
Top Buys: Sun Pharma, Lupin, Maruti, HDFC Bank, ICICI Bank
Top Underperforms: Bajaj Auto, Tata Steel, Ambuja Cement
Top Mid Cap Buys: Apollo Tyres, Havells, Exide, Dish Tv, Manappuram
Reforms required for sustainable rally
While markets rally on rate cuts, we believe a sustainable rally is unlikely till we get
investment spend accelerating. While a cut in interest rates helps since the cost of
capital comes down (though raising equity and the cost of equity is as important), the
Government needs to reverse some of the other factors responsible for the capex
slowdown:
1. Regulatory issues: These include stricter environment-related clearance norms,
difficulties in procuring land, mine clearances etc.
2. Slowdown by bureaucracy: Bureaucrats are under pressure given the recent
spate of corruption scandals. Hence, we are seeing a more careful assessment by
bureaucrats before granting project clearances.
3. Low business confidence: A slowing domestic economy, regulatory issues as
well as the developments internationally have led to poor business confidence in
India. We believe a strong policy action by the government is required to get
investments moving again.
Lower commodity prices would be an icing on the cake
Lower commodity prices would help ease inflation concerns, enabling the RBI to cut
rates faster. Second, it would ease concerns on fiscal and current account deficits. While
a fall in the oil price is clearly positive for the economy, the trend for the market is mixed.
However, a significant oil-price fall has been positive for the market most of the time.
Sector strategy
A mix of defensives and rate sensitives
Given our view that the economy will continue to be sluggish, we still do not find
value in underperforming stocks yet. However, we are playing some rate sensitives
and believe that will be a key theme for the market in 2012. We expect to gradually
increase weighting to the rate sensitives and cut weighting to the defensive sectors in
2012.
Pharma is our top defensive play
Defensive sectors have done very well, led by consumer staple companies. Given
our view of a slow domestic growth, we believe defensives will continue to do well
over the next few months. However, the consumer staple companies are extremely
expensive. We, therefore, play the defensives through the pharma sector, which is
relatively cheaper. Secondly, the pharma sector should benefit from the rupee’s
depreciation over the past few months.
Prefer consumer rate-sensitive plays: overweight autos
We prefer consumer-oriented rate sensitives rather than investment plays currently.
Autos are our current way to play the pause and subsequent cut in the rate cycle.
The auto sector also benefits from a possible fall in commodity prices.
Banks is the other rate-sensitive overweight
We are also marginally overweight the banking sector. However, our preference
currently is for the defensive names like HDFC Bank and ICICI Bank rather than the
Government banks. We expect to get more aggressive on the PSU banks later in
2012 after the NPA cycle has played out.
Underweight utilities and industrials: Prefer capital goods players
We are underweight the investment space as the capex cycle is likely to slow down.
However, within this space we prefer the capital goods players to the infra/utility
companies where we have a zero weight.
Model portfolio: Adding Sun Pharma
Given the changes in the MSCI index, we have correspondingly tweaked our model
portfolio to reflect those changes. There is no change to our overweight and
underweight sectors. We have added weight to telecom and reduced weight from
banks in line with index changes, while keeping our overweight and underweight
points largely unchanged. Similarly, we have made small tweaks to our pharma,
industrials and software weights.
The one change we have made is to add Sun Pharma to our model portfolio by reallocating
some weight from Lupin. We now have two pharma stocks (Lupin and Sun
Pharma) in our model portfolio.
Pharma (overweight)
Following the estimated 23% profit growth this year, we expect sector earnings to grow
21% in FY13, on the back of sustained strength in the Indian market and US businesses’
benefit from patent expirations. Demand in US generics market (about 28% of industry
sales) will be driven by: (1) new launches in niche segments, (2) patent expirations worth
US$45bn over the next two years. Domestic formulations’ growth will be dictated by
increased penetration in Tier 2/3 cities and improved field-force productivity.
Autos (overweight)
We expect auto volume to bounce back in CY12/FY13 on pent-up demand and
reversal of the interest-rate/inflation cycle. Despite the current slowdown, structural
uptrend in the industry is intact, driven by the improving demographic profile, rising
disposable income and new launches.
Financials (overweight)
We expect loan growth to moderate to 15% by FY13. There is minimal fresh capex
activity, which could see its impact on FY13 growth. Moreover, infrastructure lending
was mostly impacted due to issues in the power sector. But retail is still likely to be
‘OK’. Among the banks, we believe private banks may trade closer to their average
multiples of the past 5-7 year cycles as their overall risk profile is better, and earnings
growth too could be better hedged in the emerging environment.
Software (equalweight)
Given an uncertain macro climate and likely quarterly review of IT budgets in 2012,
discretionary spends (e.g., application development & package implementation) may
see slower growth. However, unlike 2008, discretionary IT demand has not dried up
and is being driven by spends on regulation, business optimization including adoption
of technologies like cloud and analytics and business transformation to address an
increasingly digital consumer and employee, globalization and growing ‘mobility’.
Telecom (underweight)
The RoE of Indian telecom companies is much below the GEM average, and 3G data
uptake will be the key to RoE improvement. We expect strong YoY growth in data
uptake but worry that data contribution to revenue and profit will remain small unless
data prices drop sharply and spur usage elasticity. LTE launches may add to competitive
pressures by end-CY12. Varying exposure to rural growth and the imminent launch of
LTE services by new and existing players may aggravate competition.
Real Estate (underweight)
We expect volume recovery in the residential segment from 2HCY12 as developers
correct prices over the next six months to clear off rising unsold inventory. We believe
stock-price performance is closely linked to recovery in volume as it will improve cash
flow and earnings visibility. Leverage across our real estate coverage universe
remains a key concern as volume shrinks while interest costs are at its peak.
Energy (underweight)
Global oil demand has weakened since 2Q 2011. We believe weakness in the
developed world to be the key risk to 2012 demand growth. We expect a strong
refining capacity addition in 2012. Coupled with the expected weak growth or decline
in oil demand, GRM can decline steeply from high levels in FY12. Also, if the rupee
remains weak throughout most of FY13, it would hurt oil PSUs as it increases the
subsidy burden.
Metals & Mining (underweight)
We remain cautious on base metals as global growth is expected to slow due to
structural (sovereign debt issues) and cyclical headwinds (low confidence). Also, we
expect China’s metal demand growth to moderate from the peak levels over the past
few years. For steel companies, pricing power for steel firms globally should remain
tough in CY12 due to slowing global demand and rising supply.
Consumer staples (underweight)
Volume growth for organized players is expected to remain robust despite price hikes
led by rural demand as well as growth in modern trade. Raw material costs are
expected to stabilize. A strong correction in raw material costs can provide an upside
to margins. Also, while competitive intensity will remain high, margin destructive
competition will likely be limited as per channel checks. We are however worried on
valuations in the sector.
Infrastructure (underweight)
We are overall underweight on the infrastructure space but prefer capital goods to
utilities where we have zero weight. Implementation delays will likely lead to
disappointments.
(a) We see an extended cycle in which the Government of India has planned total
infrastructure spends of Rs41tn (US$890bn) over FY13-17E – an about 2x rise
compared with the FY08-12E spend at 14% CAGR. This is likely help the capital
goods companies more. In the near term, we expect the soft material prices as the
key driver of margins and to cushion weak-demand led pricing pressure
(b) We expect weakness in utility stocks on account of (a) lack of fuel and business
case certainty, (b) the relatively expensive valuations of large IPPs such as NTPC,
(c) increase in competition (regulated utilities) post the closure of MoU window (in
Jan 2011) for winning projects as India moves to a competitive bidding regime and
(d) limited near-term growth catalysts. Competition for new generation capacity could
make returns volatile and we believe that merchant power is a new ‘hype’ and
potentially a ‘fad’.
Economy – Battle of Nerves
We see FY13 as a battle of nerves. In our base case of the world muddling through,
India will likely clock 6.8% growth. We believe growth should fall to 6% if the US
double dips or the European crisis blows up. Inflation will likely peak off early 2012
but cross 7.5% again in 2H12 after Delhi raises oil prices after the summer UP polls.
In response, we expect the RBI to cut policy rates in two tranches of 100bp each – in
April-July 2012 and again in the March 2013 quarter – with a tense pause in
between. Slackening loan demand will likely pull down lending rates by 150bp. In our
view, twin deficit risks will prove overdone. Softer loan demand should prevent the
fiscal deficit, at a high 8.6% of GDP, from putting undue pressure on interest rates.
The 10y should thus trade around 8.5% levels. The current account deficit, at 3% of
GDP, will likely be funded by capital flows. In case of 2008-type capital outflows, the
RBI should be able to sell about US$20bn to protect the INR. The INR will likely
gradually appreciate to Rs49/USD by December 2012 as the US Dollar settles at
1.35/Euro.
Battle of nerves
2012 will be a constant battle of nerves. 1H12 will see concerns about a slowdown in
growth shadow the relief over the peak off in inflation. On our part, we expect the RBI
to cut policy rates by 100bp beginning April to protect rates. This will enable growth to
bottom out in mid-2012, given base effects of the mid-2012 industrial slowdown.
2H12 will likely see resurgence in inflation that will overshadow the relief about the
bottoming out of growth. After all, Delhi will likely hike oil prices by 10% after the
summer UP polls. This will likely force the RBI back on hold amidst concerns over
"stagflation".
Inflation will likely peak off in 1Q13 as the second round impact of the summer oil
price hike works itself off. This should allow the RBI to resume cutting policy rates by
another 100bp to support domestic growth.
6.8% FY13 growth, 6% if US double dips
We continue to expect FY13 growth to slow to 6.8% – well below the 7.5-8% potential
– in our base case of the US growing 2% in 2012 (Table 11). This reflects the impact
of higher rates as well as global uncertainties that will contract export demand as well
as undermine business confidence, pushing back the capex cycle. In our view,
growth will likely bottom out in mid-2012 on rates coming off and base effects (Figure
1). Growth will likely fall to 6% if the US double dips or the European crisis blows up.
What’s on the reform agenda?
The good news from the Government point of view is that reform expectations have
now turned low and they can surprise the market. Of course, given how low business
confidence is, they will need to do much more to kick-start investments. We believe
the reform window is likely only post the UP elections.
1. Disinvestment of Public Sector Units
While the Finance Minister had set an aggressive disinvestment target of Rs400bn
for Public Sector Units (PSUs), poor secondary market conditions have led to the
target not being achieved. The Government is now looking at cross-holdings and
buy-back as means to meet the target and cut the fiscal deficit. In our view, the
Government will again need to set a US$8-10bn disinvestment target and try to meet
it whenever secondary market conditions improve.
2. Goods and Services Tax
India has been trying to move to a common Goods and Services Tax (GST) regime
for the past three years. We do not expect this to be implemented from April 2012.
But, hopefully, the Congress-led Central Government and all the State Governments
can achieve a compromise and kick off GST in CY2012. Some estimates are that
introduction of GST can add 1-1.5% to GDP growth. The two broad features of the
GST Act are: (a) common tax rates across all states in India and (b) set off at each
stage for tax paid earlier.
3. Direct Tax Code
The implementation of a Direct Tax Code (DTC) was deferred early this year to April
2012, but we expect it may be delayed again. The DTC was aimed at simplifying
India’s tax structure and reducing tax rates while also reducing a lot of tax
exemptions. The Bill has been diluted considerably since the first draft, but still does
not seem to have a consensus on its implementation.
4. Decontrol of industries to reduce subsidies
The Government has made many attempts to decontrol the oil and fertilizer industry,
in an effort to cut subsidies and improve its fiscal deficit. While the Government had
earlier announced free pricing of petrol and diesel, high oil prices led to a freeze on
increase in diesel prices. With the UP state elections in a few months and inflation
remaining high currently, we do not expect an increase in oil prices till May 2012.
Hopefully, lower oil prices globally will enable the Government to at least de-control
diesel and cut subsidies thereafter.
5. Increase in Foreign Direct Investment (FDI)
The Foreign Direct Investment (FDI) in retail has been a welcome move by the
Government. We expect it will gradually increase FDI limits in other sectors like:
(a) 24% in aviation.
(b) 49% in insurance.
(c) 24% in pension sector.
6. Kick starting infrastructure projects
The most critical part is to ensure that investments in the country start moving. The
Government needs to kick-start infra projects and provide fast-track approvals to
some big-ticket projects.
7. Land Acquisition Bill
The Land Acquisition Bill has been approved by the Cabinet and introduced in the
Lok Sabha by the Minister of Rural Development. Currently it is being reviewed by
the standing committee and would be put for debate in the Parliament at a later date
The Bill proposes a single unified legislation for acquisition of land and adequate
rehabilitation and compensation mechanisms for all affected persons. Among other
things, the Bill proposes that private companies shall provide for rehabilitation and
resettlement if they purchase or acquire land, through private negotiations, equal to
or more than 100 acres in rural areas and 50 acres in urban areas. In addition, if such
companies request the appropriate government to acquire part of an area for public
purpose, they shall be liable for rehabilitation and resettlement of the affected
persons, for the area acquired by the government, as well as the land purchased
previously through private negotiations
8. Mines and Minerals (Development and Regulation) Bill
Draft Mines & Minerals Development and Regulation (MMDR) Bill has been approved
by the Cabinet. It is expected to be tabled in the Parliament during the winter session.
The draft Bill proposes to levy a mining tax equal to: a) 26% of previous year profit
from mining operations (after deduction of tax paid) in case of coal mining companies
or b) 100% of royalty in case of non coal major minerals. The Bill also introduces
central and a state cess to be levied on mining companies, which will be used to set
up a fund that will focus on research and introduction of scientific mining methods.
The central levy will be up to 2.5% of customs/excise duty, while the states can
charge up to 10% of royalty. The new cess will be in addition to any cess or duty
leviable on those items under any other law for the time being in force
9. Companies Bill
Companies Bill has been cleared by the Cabinet and is expected to be tabled (for
consideration and passage) in the ongoing Winter Session of Parliament. It is aimed
at overhauling corporate governance norms and to grant shareholders greater
powers to defend their rights. The Bill has introduced ideas like Corporate Social
Responsibility (2% of the average profit of the preceding three years for CSR
activities), class action suits and a fixed term for independent directors. Among other
things, it also proposes to tighten laws for raising money from the public. The Bill also
seeks to prohibit any insider trading by company directors or key managerial
personnel by treating such activities as a criminal offence.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
India Year Ahead 2012
Will get worse before it gets
better
�� Sell year-end rally; tough markets over next six months;
expect index to correct to 14,500
India has been the worst-performing market this year, falling a third in US$ terms.
Peaking inflation and a consequent pause in RBI rates are a positive which will
likely help the traditional December rally. However, we continue to expect a tough
market over the next six months and expect a correction of the Sensex to 14,500
as growth concerns take center-stage:
1. GDP growth to slow; downgrades likely: We expect FY13 GDP to slow to
6.8% and consensus to cut GDP forecasts over the next few months. GDP
growth in the next few quarters is likely to come even lower at around 6.5%.
A slower GDP will be led by: (a) a slowing global economy, (b) impact of high
rates and (c) slowing investment spend.
2. Earnings downgrades to continue: We continue to expect earnings
downgrades, led by slowing sales and sustained margin pressure from rising
labor and interest costs. We expect the bottom-up Sensex EPS of Rs1,275 to
be downgraded to Rs1,200 (growth of under 10% vs. expectations of nearly
15%).
3. Valuations will see slight de-rating: Based on analysts’ forecasts, markets at
13x one-year forward PE are at a slight discount to long-term averages. Slow
down in GDP and earnings growth as well as falling RoEs will likely lead markets
to trade lower. Secondly, on a relative basis, India trades at a 27% PE premium
to GEM markets, higher than a 10-year average of 17%.
Markets stop panicking when policymakers start panicking;
year-end index 19,000
The good news is that we could get some positive returns in 2012 if policymakers
take steps to reverse the economic slowdown.like a) aggressive rate cuts by RBI:
we expect rate cuts from April 2012 (though slow given stick inflation); markets
typically rally 3-6 months after the rate-cut cycle starts, and (b) policy reform by
the Government.
Sector Overweights: Pharma, autos and banks
We play a mix of defensives (through pharma rather than staples) and consumerrelated
rate sensitives through autos and private sector banks.
Top Buys: Sun Pharma, Lupin, Maruti, HDFC Bank, ICICI Bank
Top Underperforms: Bajaj Auto, Tata Steel, Ambuja Cement
Top Mid Cap Buys: Apollo Tyres, Havells, Exide, Dish Tv, Manappuram
Reforms required for sustainable rally
While markets rally on rate cuts, we believe a sustainable rally is unlikely till we get
investment spend accelerating. While a cut in interest rates helps since the cost of
capital comes down (though raising equity and the cost of equity is as important), the
Government needs to reverse some of the other factors responsible for the capex
slowdown:
1. Regulatory issues: These include stricter environment-related clearance norms,
difficulties in procuring land, mine clearances etc.
2. Slowdown by bureaucracy: Bureaucrats are under pressure given the recent
spate of corruption scandals. Hence, we are seeing a more careful assessment by
bureaucrats before granting project clearances.
3. Low business confidence: A slowing domestic economy, regulatory issues as
well as the developments internationally have led to poor business confidence in
India. We believe a strong policy action by the government is required to get
investments moving again.
Lower commodity prices would be an icing on the cake
Lower commodity prices would help ease inflation concerns, enabling the RBI to cut
rates faster. Second, it would ease concerns on fiscal and current account deficits. While
a fall in the oil price is clearly positive for the economy, the trend for the market is mixed.
However, a significant oil-price fall has been positive for the market most of the time.
Sector strategy
A mix of defensives and rate sensitives
Given our view that the economy will continue to be sluggish, we still do not find
value in underperforming stocks yet. However, we are playing some rate sensitives
and believe that will be a key theme for the market in 2012. We expect to gradually
increase weighting to the rate sensitives and cut weighting to the defensive sectors in
2012.
Pharma is our top defensive play
Defensive sectors have done very well, led by consumer staple companies. Given
our view of a slow domestic growth, we believe defensives will continue to do well
over the next few months. However, the consumer staple companies are extremely
expensive. We, therefore, play the defensives through the pharma sector, which is
relatively cheaper. Secondly, the pharma sector should benefit from the rupee’s
depreciation over the past few months.
Prefer consumer rate-sensitive plays: overweight autos
We prefer consumer-oriented rate sensitives rather than investment plays currently.
Autos are our current way to play the pause and subsequent cut in the rate cycle.
The auto sector also benefits from a possible fall in commodity prices.
Banks is the other rate-sensitive overweight
We are also marginally overweight the banking sector. However, our preference
currently is for the defensive names like HDFC Bank and ICICI Bank rather than the
Government banks. We expect to get more aggressive on the PSU banks later in
2012 after the NPA cycle has played out.
Underweight utilities and industrials: Prefer capital goods players
We are underweight the investment space as the capex cycle is likely to slow down.
However, within this space we prefer the capital goods players to the infra/utility
companies where we have a zero weight.
Model portfolio: Adding Sun Pharma
Given the changes in the MSCI index, we have correspondingly tweaked our model
portfolio to reflect those changes. There is no change to our overweight and
underweight sectors. We have added weight to telecom and reduced weight from
banks in line with index changes, while keeping our overweight and underweight
points largely unchanged. Similarly, we have made small tweaks to our pharma,
industrials and software weights.
The one change we have made is to add Sun Pharma to our model portfolio by reallocating
some weight from Lupin. We now have two pharma stocks (Lupin and Sun
Pharma) in our model portfolio.
Pharma (overweight)
Following the estimated 23% profit growth this year, we expect sector earnings to grow
21% in FY13, on the back of sustained strength in the Indian market and US businesses’
benefit from patent expirations. Demand in US generics market (about 28% of industry
sales) will be driven by: (1) new launches in niche segments, (2) patent expirations worth
US$45bn over the next two years. Domestic formulations’ growth will be dictated by
increased penetration in Tier 2/3 cities and improved field-force productivity.
Autos (overweight)
We expect auto volume to bounce back in CY12/FY13 on pent-up demand and
reversal of the interest-rate/inflation cycle. Despite the current slowdown, structural
uptrend in the industry is intact, driven by the improving demographic profile, rising
disposable income and new launches.
Financials (overweight)
We expect loan growth to moderate to 15% by FY13. There is minimal fresh capex
activity, which could see its impact on FY13 growth. Moreover, infrastructure lending
was mostly impacted due to issues in the power sector. But retail is still likely to be
‘OK’. Among the banks, we believe private banks may trade closer to their average
multiples of the past 5-7 year cycles as their overall risk profile is better, and earnings
growth too could be better hedged in the emerging environment.
Software (equalweight)
Given an uncertain macro climate and likely quarterly review of IT budgets in 2012,
discretionary spends (e.g., application development & package implementation) may
see slower growth. However, unlike 2008, discretionary IT demand has not dried up
and is being driven by spends on regulation, business optimization including adoption
of technologies like cloud and analytics and business transformation to address an
increasingly digital consumer and employee, globalization and growing ‘mobility’.
Telecom (underweight)
The RoE of Indian telecom companies is much below the GEM average, and 3G data
uptake will be the key to RoE improvement. We expect strong YoY growth in data
uptake but worry that data contribution to revenue and profit will remain small unless
data prices drop sharply and spur usage elasticity. LTE launches may add to competitive
pressures by end-CY12. Varying exposure to rural growth and the imminent launch of
LTE services by new and existing players may aggravate competition.
Real Estate (underweight)
We expect volume recovery in the residential segment from 2HCY12 as developers
correct prices over the next six months to clear off rising unsold inventory. We believe
stock-price performance is closely linked to recovery in volume as it will improve cash
flow and earnings visibility. Leverage across our real estate coverage universe
remains a key concern as volume shrinks while interest costs are at its peak.
Energy (underweight)
Global oil demand has weakened since 2Q 2011. We believe weakness in the
developed world to be the key risk to 2012 demand growth. We expect a strong
refining capacity addition in 2012. Coupled with the expected weak growth or decline
in oil demand, GRM can decline steeply from high levels in FY12. Also, if the rupee
remains weak throughout most of FY13, it would hurt oil PSUs as it increases the
subsidy burden.
Metals & Mining (underweight)
We remain cautious on base metals as global growth is expected to slow due to
structural (sovereign debt issues) and cyclical headwinds (low confidence). Also, we
expect China’s metal demand growth to moderate from the peak levels over the past
few years. For steel companies, pricing power for steel firms globally should remain
tough in CY12 due to slowing global demand and rising supply.
Consumer staples (underweight)
Volume growth for organized players is expected to remain robust despite price hikes
led by rural demand as well as growth in modern trade. Raw material costs are
expected to stabilize. A strong correction in raw material costs can provide an upside
to margins. Also, while competitive intensity will remain high, margin destructive
competition will likely be limited as per channel checks. We are however worried on
valuations in the sector.
Infrastructure (underweight)
We are overall underweight on the infrastructure space but prefer capital goods to
utilities where we have zero weight. Implementation delays will likely lead to
disappointments.
(a) We see an extended cycle in which the Government of India has planned total
infrastructure spends of Rs41tn (US$890bn) over FY13-17E – an about 2x rise
compared with the FY08-12E spend at 14% CAGR. This is likely help the capital
goods companies more. In the near term, we expect the soft material prices as the
key driver of margins and to cushion weak-demand led pricing pressure
(b) We expect weakness in utility stocks on account of (a) lack of fuel and business
case certainty, (b) the relatively expensive valuations of large IPPs such as NTPC,
(c) increase in competition (regulated utilities) post the closure of MoU window (in
Jan 2011) for winning projects as India moves to a competitive bidding regime and
(d) limited near-term growth catalysts. Competition for new generation capacity could
make returns volatile and we believe that merchant power is a new ‘hype’ and
potentially a ‘fad’.
Economy – Battle of Nerves
We see FY13 as a battle of nerves. In our base case of the world muddling through,
India will likely clock 6.8% growth. We believe growth should fall to 6% if the US
double dips or the European crisis blows up. Inflation will likely peak off early 2012
but cross 7.5% again in 2H12 after Delhi raises oil prices after the summer UP polls.
In response, we expect the RBI to cut policy rates in two tranches of 100bp each – in
April-July 2012 and again in the March 2013 quarter – with a tense pause in
between. Slackening loan demand will likely pull down lending rates by 150bp. In our
view, twin deficit risks will prove overdone. Softer loan demand should prevent the
fiscal deficit, at a high 8.6% of GDP, from putting undue pressure on interest rates.
The 10y should thus trade around 8.5% levels. The current account deficit, at 3% of
GDP, will likely be funded by capital flows. In case of 2008-type capital outflows, the
RBI should be able to sell about US$20bn to protect the INR. The INR will likely
gradually appreciate to Rs49/USD by December 2012 as the US Dollar settles at
1.35/Euro.
Battle of nerves
2012 will be a constant battle of nerves. 1H12 will see concerns about a slowdown in
growth shadow the relief over the peak off in inflation. On our part, we expect the RBI
to cut policy rates by 100bp beginning April to protect rates. This will enable growth to
bottom out in mid-2012, given base effects of the mid-2012 industrial slowdown.
2H12 will likely see resurgence in inflation that will overshadow the relief about the
bottoming out of growth. After all, Delhi will likely hike oil prices by 10% after the
summer UP polls. This will likely force the RBI back on hold amidst concerns over
"stagflation".
Inflation will likely peak off in 1Q13 as the second round impact of the summer oil
price hike works itself off. This should allow the RBI to resume cutting policy rates by
another 100bp to support domestic growth.
6.8% FY13 growth, 6% if US double dips
We continue to expect FY13 growth to slow to 6.8% – well below the 7.5-8% potential
– in our base case of the US growing 2% in 2012 (Table 11). This reflects the impact
of higher rates as well as global uncertainties that will contract export demand as well
as undermine business confidence, pushing back the capex cycle. In our view,
growth will likely bottom out in mid-2012 on rates coming off and base effects (Figure
1). Growth will likely fall to 6% if the US double dips or the European crisis blows up.
What’s on the reform agenda?
The good news from the Government point of view is that reform expectations have
now turned low and they can surprise the market. Of course, given how low business
confidence is, they will need to do much more to kick-start investments. We believe
the reform window is likely only post the UP elections.
1. Disinvestment of Public Sector Units
While the Finance Minister had set an aggressive disinvestment target of Rs400bn
for Public Sector Units (PSUs), poor secondary market conditions have led to the
target not being achieved. The Government is now looking at cross-holdings and
buy-back as means to meet the target and cut the fiscal deficit. In our view, the
Government will again need to set a US$8-10bn disinvestment target and try to meet
it whenever secondary market conditions improve.
2. Goods and Services Tax
India has been trying to move to a common Goods and Services Tax (GST) regime
for the past three years. We do not expect this to be implemented from April 2012.
But, hopefully, the Congress-led Central Government and all the State Governments
can achieve a compromise and kick off GST in CY2012. Some estimates are that
introduction of GST can add 1-1.5% to GDP growth. The two broad features of the
GST Act are: (a) common tax rates across all states in India and (b) set off at each
stage for tax paid earlier.
3. Direct Tax Code
The implementation of a Direct Tax Code (DTC) was deferred early this year to April
2012, but we expect it may be delayed again. The DTC was aimed at simplifying
India’s tax structure and reducing tax rates while also reducing a lot of tax
exemptions. The Bill has been diluted considerably since the first draft, but still does
not seem to have a consensus on its implementation.
4. Decontrol of industries to reduce subsidies
The Government has made many attempts to decontrol the oil and fertilizer industry,
in an effort to cut subsidies and improve its fiscal deficit. While the Government had
earlier announced free pricing of petrol and diesel, high oil prices led to a freeze on
increase in diesel prices. With the UP state elections in a few months and inflation
remaining high currently, we do not expect an increase in oil prices till May 2012.
Hopefully, lower oil prices globally will enable the Government to at least de-control
diesel and cut subsidies thereafter.
5. Increase in Foreign Direct Investment (FDI)
The Foreign Direct Investment (FDI) in retail has been a welcome move by the
Government. We expect it will gradually increase FDI limits in other sectors like:
(a) 24% in aviation.
(b) 49% in insurance.
(c) 24% in pension sector.
6. Kick starting infrastructure projects
The most critical part is to ensure that investments in the country start moving. The
Government needs to kick-start infra projects and provide fast-track approvals to
some big-ticket projects.
7. Land Acquisition Bill
The Land Acquisition Bill has been approved by the Cabinet and introduced in the
Lok Sabha by the Minister of Rural Development. Currently it is being reviewed by
the standing committee and would be put for debate in the Parliament at a later date
The Bill proposes a single unified legislation for acquisition of land and adequate
rehabilitation and compensation mechanisms for all affected persons. Among other
things, the Bill proposes that private companies shall provide for rehabilitation and
resettlement if they purchase or acquire land, through private negotiations, equal to
or more than 100 acres in rural areas and 50 acres in urban areas. In addition, if such
companies request the appropriate government to acquire part of an area for public
purpose, they shall be liable for rehabilitation and resettlement of the affected
persons, for the area acquired by the government, as well as the land purchased
previously through private negotiations
8. Mines and Minerals (Development and Regulation) Bill
Draft Mines & Minerals Development and Regulation (MMDR) Bill has been approved
by the Cabinet. It is expected to be tabled in the Parliament during the winter session.
The draft Bill proposes to levy a mining tax equal to: a) 26% of previous year profit
from mining operations (after deduction of tax paid) in case of coal mining companies
or b) 100% of royalty in case of non coal major minerals. The Bill also introduces
central and a state cess to be levied on mining companies, which will be used to set
up a fund that will focus on research and introduction of scientific mining methods.
The central levy will be up to 2.5% of customs/excise duty, while the states can
charge up to 10% of royalty. The new cess will be in addition to any cess or duty
leviable on those items under any other law for the time being in force
9. Companies Bill
Companies Bill has been cleared by the Cabinet and is expected to be tabled (for
consideration and passage) in the ongoing Winter Session of Parliament. It is aimed
at overhauling corporate governance norms and to grant shareholders greater
powers to defend their rights. The Bill has introduced ideas like Corporate Social
Responsibility (2% of the average profit of the preceding three years for CSR
activities), class action suits and a fixed term for independent directors. Among other
things, it also proposes to tighten laws for raising money from the public. The Bill also
seeks to prohibit any insider trading by company directors or key managerial
personnel by treating such activities as a criminal offence.
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