Expect Volatility To Continue

Murali Krishnan
Head - Institutional Equities
Karvy Stock Broking

• What's In Store?
  We expect the volatility to continue, given the expanding multiples in conjunction with sticky inflation, high interest rates, poor fiscal discipline and a higher governmental borrowing programme.

• A Safety Net
  What is needed is the containment of existing sources of global and local risks and a fall in volatilities, to catalyse investors into becoming less uncertain and fearful.

Currently, MSCI India’s PE ratiois at a 34 per cent premium to the MSCI EMs Index, compared to its peak premium of 90.4 per cent as on March 26, 2010. The current premium of MSCI India’s P/BV to the MSCI EMs has come off from its high of 153 per cent to 51 per cent, lower than the last five years’ average premium of 70 per cent. The Sensex is trading at a P/BV of 2.4x FY13E, a 9.4 per cent discount to its 10-year average P/BV of 2.6x, implying at least a 10.4 per cent upside and an Index level of 19093. Notwithstanding the mild market rally post the repo rate cut in April 2012, we expect the volatility to continue, given the expanding multiples in conjunction with sticky inflation, high interest rates, poor fiscal discipline and a higher governmental borrowing programme.

In Q4FY12, we saw the initial impact of interest costs on profitability. This was exacerbated over this quarter. We foresee that over the next two quarters, the interest rates will remain where they are and profitability will get impacted. Despite the central banker cutting the interest rates by 50 basis points, most banks did not pass on the full benefits to the borrowers, as the previous 25 basis points rate hikes were absorbed by the banks in a scenario of visibly slowing credit offtake. Profitability will get impacted on account of longer working capital cycles that are not easing, a strong currency that has led to a 25 per cent raise in input costs, while the end product pricing has not been to that extent, given the state of consumption. Moreover, asset sweating has been very high and there has been very less scope to spread the cost overheads.

FY12 saw multiple squalls of stubborn inflation, consistent policy rate upshots and the economy losing steam, with a slew of activity indicators reflecting a much sharper slowdown than what was envisaged by the policymakers. This came in conjunction with a worsening trade balance, high fiscal slippages, the Sensex being the worst performer in Asia and the INR languishing at an all-time low. The year ended on pervasive fears of the economy soon falling into a ‘stagflationary’ state – primarily as a consequence of the self-inflicted policy paralysis.

However, there is hope at the end of the tunnel, with the new fiscal year starting with a slew of mixed activity data, both domestic and global. While the calendar year 2012 started on a relatively healthier note for India, with the lead indicators showing some respite, this sluggish uptick seems to be an aberration or the start of a trend. More importantly, policy traction has been poor, with the government’s latest mishandling of the taxation issues. This is making investors’ confidence even more feeble. The latest dovish move by the RBI with cautious guidance seems more confused than a move with conviction – especially on the back of unhinged inflationary expectations.

Our soft bullishness for risk assets does not really require very strong economic or earnings growth. Instead, it demands a lack of major policy accidents and some upfront commitments following the state elections as a containment of existing sources of risk. This should be topped simply by the containment of existing sources of global and local risks and a fall in volatilities, to catalyse investors into becoming less uncertain and fearful.

The surprise 50 basis points cut by the RBI in April 2012 appears to stand against its image of being an ‘inflation hawk’. However, prime facie, the faltering growth, muted IIP numbers and slowing core inflation all pushed for a rate cut in April. Somewhere from the mixed tone lurches a hint of limited easing scope. Upside risks to inflation persist, inherently limiting the space for any further reduction in policy rates.

Specifically, the evolution of core and headline inflation won’t be too pleasant once the statistical anomaly of the base effect wears off. One needs to watch out for the sustained slowdown in sequential momentum. We are far from being out of the woods yet!