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Macro risks near term but
largely discounted, see much
improved second half
We expect growth in India to stay slow, inflation to slowly ease, the
rupee to be weak near term and rate cuts to happen with a lag.
In this environment, we prefer banks and exporters such as IT and
pharma to capital goods and autos. We are also underweight the
consumer sector. We would play the investment cycle through
cement rather than infrastructure.
Our top picks are SBI and Axis Bank on a more benign rate
environment, and exporters like Infosys and Lupin on the weak
rupee. We like Power Grid’s regulated return profile.
Key analysis in this anchor report includes:
• Outlook for economic growth and the investment cycle
• Why we expect the rate-cutting cycle to be back-ended in 2012 if
further rupee pressure disrupts the fall in inflation momentum
• A look at the near-term currency headwinds due to concerns about
capital flows and Europe
• How valuations stack up historically. We see 15-20% market upside
through the year
India outlook 2012
Rolling back the clouds
Macro risks near term but
largely discounted, see much
improved second half
Macro risks near term, but largely discounted; we see a much
improved 2H
Taking stock of India’s macroeconomic variables today makes for
depressing reading. Policy inaction, rising rates and an adverse global
environment have taken a toll on growth. A fragile external account has
caused the rupee much distress, particularly against a backdrop of
volatile global risk sentiment. Politics and policy continue to disappoint
and populism has elevated the fiscal deficit.
We start 2012 against this backdrop. The bad news is that not much
is likely to change in the 1H of this year. The sharp depreciation of
the rupee on global cues has hijacked inflation. India has to fund its high
current account deficit; there are also large debt repayments to contend
with. This is likely to create growth and currency headwinds as capital
inflows are constrained by the ongoing European crisis.
The good news is that these headwinds are temporary and are
likely to dissipate in 2H12. Capital constraints should ease as slower
growth and a weaker rupee rein-in the current account and debt
repayments run their course. Cooler growth and range-bound global
commodity prices are likely to accelerate the downtrend of inflation. The
rupee could well appreciate on these cues. Growth may well remain
subpar as the impact of rate cuts lifts the economy with a lag. However,
we believe India will continue to enjoy high growth differentials.
With the market earnings multiple at a 23% discount to its 5-year
average, market valuations are fairly pricing in the negative
scenario, in our view. Growth plays and domestic cyclicals have been
punished, while strong cash flows and consumer-facing companies have
been rewarded. There could be some risk to earnings, but no more than
5%, we think.
We acknowledge that the positive dynamics could well take about
six months to kick in. However, we could well move towards a more
benign rate environment in this period. The backdrop for equities in the
1H12 is likely to be slowing growth, gradually falling inflation, weak
rupee and a peaking rates cycle. We prefer banks and exporters (IT
and pharma). We are underweight capital goods, infra &
construction, autos and global cyclicals.
India today finds itself smack in the middle of a whirlpool of pessimism. Taking stock of
India’s macroeconomic variables makes for depressing reading. Policy inaction, rising
rates and a difficult global environment have taken a toll on growth. Meanwhile, a fragile
external account has caused the rupee much distress in the backdrop of volatile global
risk sentiment. Politics and policy continue to disappoint and populism has elevated
fiscal deficit concerns.
It’s against this backdrop that we enter into 2012. The bad news is that not much is likely
to change in the first half of this year. The good news is that these headwinds are
temporary and would dissipate in the second half of the year.
The incremental deterioration in India’s macro fundamentals was triggered by the
sudden global risk flare-up late last year following the sovereign downgrade of the US
and rising deleveraging fears for eurozone banks. The resulting sharp depreciation of the
rupee has hijacked inflation and arrested its otherwise declining momentum. This has
pushed back the rate-cutting cycle, which we think would be back-loaded in 2012. The
RBI would find it difficult to justify a rate cut unless inflation is reined in to more
comfortable levels, probably closer to 7%.
However, inflation should be less of a concern for markets this year, in our view. As the
economy slows down, pressure on labour markets should recede and wage increases
should slow. A strong US dollar and a slow-moving global economy are likely to keep
global commodity prices in check. This should aid the decline of inflation further.
Gradually declining inflation and continuing growth concerns would likely keep bond
yields in benign territory in the first-half of the year.
India has to fund its high current account deficit, which has been made worse by a switch
in allocation of household savings into valuables. Unlike the last crisis in 2008, there are
also large debt repayments to contend with on account of private borrowings raised in
2006-07. This is likely to create growth and currency headwinds as capital inflows are
constrained by the ongoing European crisis. After its sharp underperformance, we
reckon the rupee is probably undervalued at current levels. This should gradually
improve India's current account with a lag while concerns on debt repayments diminish
through the year. We see this happening in 2H12.
Growth would continue to face headwinds. The lagged effects of past tightening and tight
liquidity are likely to continue to play out in 1H12. Private consumption is starting to slow,
government spending power is muted and investment cycle is adjusting to slower growth
amidst uncertainties on external demand. Market sentiment is likely to take its cue from
weakness in industrial production growth in 1HCY11F. However, India should continue to
enjoy its high growth differentials vs. developed economies in a weak global growth
scenario expected this year.
However, market valuations are no longer expensive at current levels and are pricing in
a significant cut in earnings and further downside to economic growth. The market
earnings multiple would start to look more attractive as inflation eases and bond yields
fall.
We expect FY13F Sensex earnings growth of c.10-12%. We believe the trajectory for
earnings through the year would likely slow. Earnings could see some more risk as the
economy feels the lagged impact of the rate tightening cycle. Margin pressures could
persist in first-half from lagged effects of rate tightening and high commodity prices.
However, a weak outlook for global commodity prices would subsequently be a tailwind
for corporate margins provided the rupee does not depreciate further from here. As well,
base effect tailwinds will come into play in the second half of the year.
So how do we play this? The backdrop for equities in the first-half of the year would be
slowing growth, gradually falling inflation, weak rupee and peaking rates cycle. We prefer
banks and exporters (IT and pharma). Given concerns on the capex cycle, are
underweight domestic cyclicals — capital goods and infra & construction. We would play
India’s investment cycle through the cement sector rather than capital goods. Slowing
growth would lead to weak government finances which would mean that its ability to
spend incrementally would be compromised. In our opinion, the consumer cannot expect
too many freebies from the government from here on in.
We see little hope for big-bang reforms during the tenure of the present government.
However, the outcome of the upcoming state elections in the first-half could shape policy
expectations and could very well lead to a positive surprise.
We expect the market to rise 15-20% from here and take cues from the likely
improvement in the macroeconomic environment in the second half of the year. Further
deterioration in Europe poses a key risk. Exaggerated declines in the market could
provide a good buying opportunity.
Fig. 2: Key themes
Source: Nomura Research
Key theme Comments
Growth We expect continuing headwinds to growth. Tight systemic liquidity and adverse base effects are likely to lead to weak industrial growth
numbers in 1H12. Private consumption is starting to slow, government spending power is muted and investment cycle is adjusting to slower
growth and uncertainties on external demand. Market sentiment is likely to take its cue from weakness in IIP growth in 1HCY11F. However,
India should continue to enjoy its high growth differentials vs. developed economies in a weak global growth scenario expected this year.
Inflation While inflation momentum has come off its highs, the rupee's depreciation would mean that the fall of inflation momentum would be slower.
As the economy slows down pressure on labour markets should recede and wage increases should slow. We expect more tapering off in
2HCY12F on base effects. Inflation should become less of risk to markets this year. As well, a strong US dollar and a slow-moving global
economy are likely to keep global commodity prices in check this year. A prospective improvement in the current account would be a tailwind
for the rupee.
Earnings We expect FY13F Sensex earnings growth of c.10-12%. We believe the trajectory for earnings in 2012 would likely be slow. Earnings could
see some more risk as the economy feels the lagged impact of the rate tightening cycle. We see margin pressures in 1H12 from lagged
effects of rate tightening and high commodity prices. Weak outlook for global commodity prices in 2012 would subsequently be a tailwind for
corporate margins, provided the rupee does not depreciate further from here. In addition, base effect tailwinds are likely to come into play in
2H12.
Investment cycle/capex We expect some disappointment in the short- to medium term. We see several obstacles to the capex cycle, despite strength in demand.
With a few large sectors driving organised manufacturing capex, the investment outlook for these key capex-driving sectors remains muted
next year. Meanwhile, the unorganised manufacturing sectors suffers the most in an environment of very tight liquidity and high rates. We
believe that new order inflows would remain poor as the economy adjusts to a lower growth path and government spending power remains
limited due to poor finances.
Policy We expect monetary policy to start easing, albeit slowly. The downward trajectory of inflation momentum has been pushed back by rupee
depreciation. The external environment remains a key determinant of the RBI's ability to respond to slower growth. We expect rate cuts to be
back-loaded this year. Key risks are further rupee weakness arising from eurozone deleveraging concerns; a cost-push shock (higher oil
prices on geopolitical risks); and fiscal profligacy. We do not expect positive developments on reforms to be a catalyst for the market next
year. However, the outcome in the upcoming state elections could prove important in shaping policy.
Liquidity We expect liquidity to remain tight in the near term, particulary due to external account pressures. Funding costs for corporates are likely to
remain high in the next six months before starting to come off. Bank NIMs may continue to do fine due to lack of overseas funding and
sigificant forex debt repayments which would likely be funded by India banks.
Rates Rate cuts are likely to be back-loaded this year: While inflation should be on the decline, its fall has been tempered by the weakness in rupee.
Hence, it would take much longer for the RBI to be comfortable enough with inflation numbers before going in for a rate cut even as growth
slows down further. We reckon that a fall in inflation below 7% or so could trigger policy action—unlikely to be reached in 1H12, we
reckon—unless the RBI deems growth headwinds to have intensified enough to warrant a cut with inflation at 6-7%. Significant rate cuts are
also unlikely in 1H12 because external sector pressures and concerns on capital flows would be elevated. A cut would reduce India’s rate
differentials at a time when the RBI is taking several measures to attract capital inflows.
Rupee The rupee is likely to remain under some pressure over six months on account of large debt repayments on capital account and lack of
external funding on account of the European situation. The rupee is probably undervalued at current levels and this should gradually improve
India's current account while concerns on debt repayments diminish through the year. Falling inflation should also help support India's high
rate differentials. This should lead to a rally in the currency later in the year. Key risks to this view are from oil prices and disorderly defaults in
the European economy.
Valuation Valuations are no longer expensive and are pricing in a significant cut in earnings, further downside to economic growth and an elevated rate
cycle. The market earnings multiple would start to look more attractive as inflation eases and bond yields fall. We see limited downside to the
markets. However, there is also limited visibility the in near-term; the 2H of the year looks better. We do note that the market would continue
to lack short-term triggers
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Macro risks near term but
largely discounted, see much
improved second half
We expect growth in India to stay slow, inflation to slowly ease, the
rupee to be weak near term and rate cuts to happen with a lag.
In this environment, we prefer banks and exporters such as IT and
pharma to capital goods and autos. We are also underweight the
consumer sector. We would play the investment cycle through
cement rather than infrastructure.
Our top picks are SBI and Axis Bank on a more benign rate
environment, and exporters like Infosys and Lupin on the weak
rupee. We like Power Grid’s regulated return profile.
Key analysis in this anchor report includes:
• Outlook for economic growth and the investment cycle
• Why we expect the rate-cutting cycle to be back-ended in 2012 if
further rupee pressure disrupts the fall in inflation momentum
• A look at the near-term currency headwinds due to concerns about
capital flows and Europe
• How valuations stack up historically. We see 15-20% market upside
through the year
India outlook 2012
Rolling back the clouds
Macro risks near term but
largely discounted, see much
improved second half
Macro risks near term, but largely discounted; we see a much
improved 2H
Taking stock of India’s macroeconomic variables today makes for
depressing reading. Policy inaction, rising rates and an adverse global
environment have taken a toll on growth. A fragile external account has
caused the rupee much distress, particularly against a backdrop of
volatile global risk sentiment. Politics and policy continue to disappoint
and populism has elevated the fiscal deficit.
We start 2012 against this backdrop. The bad news is that not much
is likely to change in the 1H of this year. The sharp depreciation of
the rupee on global cues has hijacked inflation. India has to fund its high
current account deficit; there are also large debt repayments to contend
with. This is likely to create growth and currency headwinds as capital
inflows are constrained by the ongoing European crisis.
The good news is that these headwinds are temporary and are
likely to dissipate in 2H12. Capital constraints should ease as slower
growth and a weaker rupee rein-in the current account and debt
repayments run their course. Cooler growth and range-bound global
commodity prices are likely to accelerate the downtrend of inflation. The
rupee could well appreciate on these cues. Growth may well remain
subpar as the impact of rate cuts lifts the economy with a lag. However,
we believe India will continue to enjoy high growth differentials.
With the market earnings multiple at a 23% discount to its 5-year
average, market valuations are fairly pricing in the negative
scenario, in our view. Growth plays and domestic cyclicals have been
punished, while strong cash flows and consumer-facing companies have
been rewarded. There could be some risk to earnings, but no more than
5%, we think.
We acknowledge that the positive dynamics could well take about
six months to kick in. However, we could well move towards a more
benign rate environment in this period. The backdrop for equities in the
1H12 is likely to be slowing growth, gradually falling inflation, weak
rupee and a peaking rates cycle. We prefer banks and exporters (IT
and pharma). We are underweight capital goods, infra &
construction, autos and global cyclicals.
India today finds itself smack in the middle of a whirlpool of pessimism. Taking stock of
India’s macroeconomic variables makes for depressing reading. Policy inaction, rising
rates and a difficult global environment have taken a toll on growth. Meanwhile, a fragile
external account has caused the rupee much distress in the backdrop of volatile global
risk sentiment. Politics and policy continue to disappoint and populism has elevated
fiscal deficit concerns.
It’s against this backdrop that we enter into 2012. The bad news is that not much is likely
to change in the first half of this year. The good news is that these headwinds are
temporary and would dissipate in the second half of the year.
The incremental deterioration in India’s macro fundamentals was triggered by the
sudden global risk flare-up late last year following the sovereign downgrade of the US
and rising deleveraging fears for eurozone banks. The resulting sharp depreciation of the
rupee has hijacked inflation and arrested its otherwise declining momentum. This has
pushed back the rate-cutting cycle, which we think would be back-loaded in 2012. The
RBI would find it difficult to justify a rate cut unless inflation is reined in to more
comfortable levels, probably closer to 7%.
However, inflation should be less of a concern for markets this year, in our view. As the
economy slows down, pressure on labour markets should recede and wage increases
should slow. A strong US dollar and a slow-moving global economy are likely to keep
global commodity prices in check. This should aid the decline of inflation further.
Gradually declining inflation and continuing growth concerns would likely keep bond
yields in benign territory in the first-half of the year.
India has to fund its high current account deficit, which has been made worse by a switch
in allocation of household savings into valuables. Unlike the last crisis in 2008, there are
also large debt repayments to contend with on account of private borrowings raised in
2006-07. This is likely to create growth and currency headwinds as capital inflows are
constrained by the ongoing European crisis. After its sharp underperformance, we
reckon the rupee is probably undervalued at current levels. This should gradually
improve India's current account with a lag while concerns on debt repayments diminish
through the year. We see this happening in 2H12.
Growth would continue to face headwinds. The lagged effects of past tightening and tight
liquidity are likely to continue to play out in 1H12. Private consumption is starting to slow,
government spending power is muted and investment cycle is adjusting to slower growth
amidst uncertainties on external demand. Market sentiment is likely to take its cue from
weakness in industrial production growth in 1HCY11F. However, India should continue to
enjoy its high growth differentials vs. developed economies in a weak global growth
scenario expected this year.
However, market valuations are no longer expensive at current levels and are pricing in
a significant cut in earnings and further downside to economic growth. The market
earnings multiple would start to look more attractive as inflation eases and bond yields
fall.
We expect FY13F Sensex earnings growth of c.10-12%. We believe the trajectory for
earnings through the year would likely slow. Earnings could see some more risk as the
economy feels the lagged impact of the rate tightening cycle. Margin pressures could
persist in first-half from lagged effects of rate tightening and high commodity prices.
However, a weak outlook for global commodity prices would subsequently be a tailwind
for corporate margins provided the rupee does not depreciate further from here. As well,
base effect tailwinds will come into play in the second half of the year.
So how do we play this? The backdrop for equities in the first-half of the year would be
slowing growth, gradually falling inflation, weak rupee and peaking rates cycle. We prefer
banks and exporters (IT and pharma). Given concerns on the capex cycle, are
underweight domestic cyclicals — capital goods and infra & construction. We would play
India’s investment cycle through the cement sector rather than capital goods. Slowing
growth would lead to weak government finances which would mean that its ability to
spend incrementally would be compromised. In our opinion, the consumer cannot expect
too many freebies from the government from here on in.
We see little hope for big-bang reforms during the tenure of the present government.
However, the outcome of the upcoming state elections in the first-half could shape policy
expectations and could very well lead to a positive surprise.
We expect the market to rise 15-20% from here and take cues from the likely
improvement in the macroeconomic environment in the second half of the year. Further
deterioration in Europe poses a key risk. Exaggerated declines in the market could
provide a good buying opportunity.
Fig. 2: Key themes
Source: Nomura Research
Key theme Comments
Growth We expect continuing headwinds to growth. Tight systemic liquidity and adverse base effects are likely to lead to weak industrial growth
numbers in 1H12. Private consumption is starting to slow, government spending power is muted and investment cycle is adjusting to slower
growth and uncertainties on external demand. Market sentiment is likely to take its cue from weakness in IIP growth in 1HCY11F. However,
India should continue to enjoy its high growth differentials vs. developed economies in a weak global growth scenario expected this year.
Inflation While inflation momentum has come off its highs, the rupee's depreciation would mean that the fall of inflation momentum would be slower.
As the economy slows down pressure on labour markets should recede and wage increases should slow. We expect more tapering off in
2HCY12F on base effects. Inflation should become less of risk to markets this year. As well, a strong US dollar and a slow-moving global
economy are likely to keep global commodity prices in check this year. A prospective improvement in the current account would be a tailwind
for the rupee.
Earnings We expect FY13F Sensex earnings growth of c.10-12%. We believe the trajectory for earnings in 2012 would likely be slow. Earnings could
see some more risk as the economy feels the lagged impact of the rate tightening cycle. We see margin pressures in 1H12 from lagged
effects of rate tightening and high commodity prices. Weak outlook for global commodity prices in 2012 would subsequently be a tailwind for
corporate margins, provided the rupee does not depreciate further from here. In addition, base effect tailwinds are likely to come into play in
2H12.
Investment cycle/capex We expect some disappointment in the short- to medium term. We see several obstacles to the capex cycle, despite strength in demand.
With a few large sectors driving organised manufacturing capex, the investment outlook for these key capex-driving sectors remains muted
next year. Meanwhile, the unorganised manufacturing sectors suffers the most in an environment of very tight liquidity and high rates. We
believe that new order inflows would remain poor as the economy adjusts to a lower growth path and government spending power remains
limited due to poor finances.
Policy We expect monetary policy to start easing, albeit slowly. The downward trajectory of inflation momentum has been pushed back by rupee
depreciation. The external environment remains a key determinant of the RBI's ability to respond to slower growth. We expect rate cuts to be
back-loaded this year. Key risks are further rupee weakness arising from eurozone deleveraging concerns; a cost-push shock (higher oil
prices on geopolitical risks); and fiscal profligacy. We do not expect positive developments on reforms to be a catalyst for the market next
year. However, the outcome in the upcoming state elections could prove important in shaping policy.
Liquidity We expect liquidity to remain tight in the near term, particulary due to external account pressures. Funding costs for corporates are likely to
remain high in the next six months before starting to come off. Bank NIMs may continue to do fine due to lack of overseas funding and
sigificant forex debt repayments which would likely be funded by India banks.
Rates Rate cuts are likely to be back-loaded this year: While inflation should be on the decline, its fall has been tempered by the weakness in rupee.
Hence, it would take much longer for the RBI to be comfortable enough with inflation numbers before going in for a rate cut even as growth
slows down further. We reckon that a fall in inflation below 7% or so could trigger policy action—unlikely to be reached in 1H12, we
reckon—unless the RBI deems growth headwinds to have intensified enough to warrant a cut with inflation at 6-7%. Significant rate cuts are
also unlikely in 1H12 because external sector pressures and concerns on capital flows would be elevated. A cut would reduce India’s rate
differentials at a time when the RBI is taking several measures to attract capital inflows.
Rupee The rupee is likely to remain under some pressure over six months on account of large debt repayments on capital account and lack of
external funding on account of the European situation. The rupee is probably undervalued at current levels and this should gradually improve
India's current account while concerns on debt repayments diminish through the year. Falling inflation should also help support India's high
rate differentials. This should lead to a rally in the currency later in the year. Key risks to this view are from oil prices and disorderly defaults in
the European economy.
Valuation Valuations are no longer expensive and are pricing in a significant cut in earnings, further downside to economic growth and an elevated rate
cycle. The market earnings multiple would start to look more attractive as inflation eases and bond yields fall. We see limited downside to the
markets. However, there is also limited visibility the in near-term; the 2H of the year looks better. We do note that the market would continue
to lack short-term triggers
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