Expected moderation in sales growth will extend the pressure on PAT growth
While global liquidity and the ‘risk on’ trade continues to drive equities, it is important not to lose sight of fundamentals. Many argue that earnings downgrade cycle has peaked and also argue for sharper cuts in interest rates ahead. Our analysis indicate that the earnings downgrade cycle is not yet over and would continue with a similar velocity over the next four quarters, led primarily by sharply slower sales growth and partly through an elevated cost structure. On interest rates, while we have no doubt they have peaked, we conclude that liquidity deficit is structural and will provide little headroom for rate cuts anytime soon. In this note, we focus on analyzing why sales growth would be sharply slower and argue that the factors look more structural than short term cyclical.
Cross section of leading indicators suggests slowdown in sales growth: Our thesis of moderation in aggregate sales growth is derived from our cyclical and structural assessment. In our view, contraction in PAT growth in Q3FY12 may lead into a prolonged moderation cycle lasting for 4-5 quarters. A still robust sales growth is unlikely to evolve into a virtuous cycle of margin and PAT expansion soon. On the contrary, we see sales growth slowing to 10-15% compared to the robust 20-23% delivered over FY11-12 and continued pressure on PAT growth and margins. Our projection feeding from a cross section of leading indicators, including 1) growth in narrow money (M1), 2) exports of goods and services, 3) nominal GDP and 4) profit growth suggests a decisive slowdown in topline growth.
Lower disposable income growth will blunt the firepower: Consumption boom since FY10 will now weaken due to a combination of cyclical and structural factors. A) Increase in effective tax rates and reduction of subsidies & transfers will have squeezing impact on personal disposable income; B) Attempts to rebuild financial savings will imply lower spending growth; C) Declining corporate profits will imply weak compensation growth, D) Contraction in net cash flows for the agri sector and E) These could imply trend decline in incremental liabilities/saving ratio or de-leveraged household. Overall, on the back of a slower personal disposable income growth of 8.5-9.5% in FY13E (less than nominal GDP growth at 12.5% FY13E) and compensation growth of similar magnitude, we expect private final consumption to grow modestly at 8.5-9% in nominal terms vs 15.8% in FY12AE (17% in FY11).
Declining savings rate a drag on investments and potential growth: Our analysis ties in the linkage between savings, investments, current account deficit and potential GDP growth. Overall saving rate declined in FY11 to 32% from a high of 37% in FY08. We estimate that it declined further to 27.6% in FY12E and will remain low at 26.5% in FY13E. Structural savings rate is far less supportive now given the decline in household savings rate, lower corporate profitability and government revenue deficits. These underscore the limitation on revival of investment cycle. The reciprocal structural widening in current account deficit can expose the economy to funding problem if global financial condition worsens. Hence, we believe that potential growth for India has declined to 5.5-6.5%. We expect FY13E real GDP growth to be around 6.5% compared to CSO’s FY12 advance estimate of 6.9% in FY12 and 8.4% in FY11. While slowing demand should ideally lead to lower inflation but this will be impeded by decline potential growth. Hence, we expect overall inflation to average at 6-6.5% in FY13E.
Structural imbalances akin to 1980s: The co-movement in investment and domestic savings cycle that existed during FY94-FY08 has broken and the widening non-household saving-investment gap (risen to a historically high level of -7.8% of GDP in FY12E after rising to -3.5% in FY11) and current account deficit (goods & services) since FY08 is akin to conditions prevailing in 1980s. While this widening gap could be bridged by external capital inflows, historical evidence suggest that capital inflows are pro cyclical and are stronger when saving and investment rates are rising in tandem (e,g FY04-09 and FY94-97).
The spill over effects
a) RBI will continue to draw down Fx reserves, do CRR cuts and OMOs; Will get little headroom to cut rates soon: The structural imbalances outlined above reflects on the persistent liquidity deficit which has failed to ebb despite recovery in portfolio inflows this year and RBI OMO purchases and CRR cut. Unless these structural imbalances are narrowed significantly, RBI will need to drawdown Fx reserves and will find little head room to bring down policy rates, despite moderation in domestic growth and inflation. We expect RBI to continue with some more CRR cuts and considerably monetize government deficits through OMO purchases.
b) INR could weaken again; revisit of 50 levels will not be surprising: Reduction in potential growth and the structurally high CAD also imply that fundamentals for INR will continue remain under stress. INR has not been able to appreciate back to its earlier highs despite the large easing by US Fed, ECB and BoJ. Contrastingly, while the earlier INR/USD peak of 39 in 2007-08 was achieved with much tighter global liquidity conditions, its recent weakening to 52/53 occurred in the backdrop of enormous liquidity injection by central banks. Clearly, prevalence of global liquidity is no guarantee for appreciating INR if global liquidity feed into high crude oil prices and reinforces the domestic structural imbalances.
c) Inflation: Declining in potential growth will imply inflationary pressures reemerging even with modest domestic demand growth. Decline in potential growth implies higher inflation for a given level of demand growth. Evidently, persistence of high inflation despite growth deceleration is emblematic of the decline in estimated potential growth to 5.5-6.5% (our estimate). As corollary, demand has to decelerate further to achieve the thresh hold inflation level of 4.5-5%. To us it does not look attainable in the near future and we expect overall inflation to average at 6-6.5% in FY13E. Key factors providing the upside impulses will largely be cost led including 1) Global crude prices remaining higher than USD100/bbl (currently at USD124/bbl) has longer than in 2008, 2) Increase in pass-through coming by way of higher prices for petrol, diesel, gas, coal, electricity, railway freights and increase in indirect taxes. Further weakening INR will also have pass through implications on domestic prices.
What can change our thesis?
a) Convergence of imbalances to a stable equilibrium needs active fiscal consolidation and enhancement in financial savings from household before the economy moves into a virtuous confluence of rising savings, investments and growth. Proactive policy measures to enable the above will shorten the adjustment cycle.
b) Fundamental shift in strategy from a transfer based consumption model to investment spending based strategy can provide the critical supply response trigger.
c) Conversely, if the government continue with its consumption driven fiscal expansion, the structural vulnerabilities highlighted by us can get even worse.
d) Sustained and steep fall in global crude oil and other commodity prices due to risk aversion or sharper global slowdown can ease the constraints arising from falling savings and investments.
e) A truncated scenario of constructive external capital inflows along with decline in commodity prices emerging from breakdown of liquidity-commodity price linkages.
f) Global recovery surprises on the positive side; including sustained growth cycle in the US, thereby pulling Europe out of recession.
| 
India Equity Research Reports, IPO and Stock News
No comments:
Post a Comment