Wobbling to new lows?

Rajiv Bhuva        Print Edition: Jan 22, 2012

The year 2012 is the Chinese year of the dragon, a creature whose symbol in Chinese astrology is said to bring good luck and charm. Both are badly needed, globally as well as in India, including in the Indian stock markets.

The year gone by saw the Bombay Stock Exchange's, or BSE's, Sensitive Index, or Sensex, begin trading at 20,621.6 on January 3, recording the same day what turned out to be the annual peak of 20,664.8. By December 20, it had fallen to its lowest in the year: 15,136.9. Though it recovered a little subsequently, the year saw the Sensex declining by 23.26 per cent.

"The economic concerns of 2011 started in the US and followed in Europe, while domestic issues became challenges in India," says Motilal Oswal, Chairman and Managing Director of Motilal Oswal Financial Services. Globally, the tsunami in Japan, unrest in oil-rich West Asia, the rating downgrade of the United States and the sovereign crisis in the euro zone ensured a tumultuous year, while in India, rising interest rates, higher input costs and the weak rupee wreaked havoc.

Investor sentiment has weakened, with 2011 - up to end-November - seeing just 39 initial public offerings, or IPOs, which raised a total of Rs 14,021 crore ($3.1 billion). In comparison, there had been 72 IPOs in 2010, raising Rs 69,112 crore ($15.3 billion). The net investment of foreign institutional investors, or FIIs, in India during 2011 was $8.4 billion, a mere one-fifth of the $39.5 billion they brought in the previous year. Moreover, most of it was in debt, not equities: indeed, equities saw a net outflow of $242 million of FII funds; $8.65 billion was invested in debt. Last year FIIs had invested $10.1 billion in equities and $29.4 billion in debt. "Investors have lost confidence," says Oswal.

The sentiment among India focused investors has been negative for some time now. "The economy is decelerating quite sharply," says Neelkanth Mishra, Director, Equity Research, Credit Suisse Securities (India). He feels there are currently downside risks to both price to earnings, or P/E, multiples and earnings of stocks. Since most analysts expect the gross domestic product, or GDP, growth to be below seven per cent for the next few quarters, and P/E multiples are closely linked to GDP growth, these multiples could contract to 11 to 12 times from 13 to 14 today. "We are not on the eight to 8.5 per cent growth trajectory anymore," Mishra adds.

No doubt the current FII outflow is insignificant compared to the exodus during the last economic crisis of 2008, when $11.8 billion was pulled out of India. What has worked so far in India's favour, feels Mishra, is the resilience it showed during the 2008 downturn, creating a perception that it could be a hedge during slowdowns. "But this optimism is misplaced and the view will be challenged now," Mishra adds.

Earnings are being hit, too. The growth estimate in earnings per share, or EPS, has been repeatedly cut through 2011/12, and is now pegged at marginally below 10 per cent, against 21 per cent at the beginning of the year.

Leverage is a still bigger concern. Indian companies have borrowed heavily overseas. External commercial borrowings , or ECBs, in the first 10 months of 2011 amounted to $30.5 billion, over 58 per cent more than the $19.3 billion raised in the corresponding period in 2010. With ECBs worth $20 billion maturing in next 12 months, companies could face stresses during repayment or rollover of the debt.

This will also continue to keep up the pressure on the rupee, which, like any debt-supported currency, will remain fundamentally weak. "Over the next six months we do not see any mechanism for the rupee to stabilise," says Mishra of Credit Suisse. From 44.67 a dollar on January 3, the rupee weakened by over 19.5 per cent to 53.36 on December 29.

The older issue of foreign currency convertible bonds, or FCCBs, also remains. "There is lot of caution and lots of question marks about whether people will meet their obligations," says Nick Paulson-Ellis, Country Head (India), Espirito Santo Securities. Twenty eight BSE 500 companies have their FCCBs maturing in the fiscal year ending March 2013. A report by Edelweiss Securities says the combined outflow of 25 of them will be around Rs 33,000 crore. The steep rupee depreciation has led to huge 'mark to market' losses, which coupled with the redemption premium will lead to higher effective cost of borrowing through FCCBs. "While refinancing through domestic debt will trim profit before tax, companies resorting to restructuring of FCCB will face higher dilution," the report adds.

The quantum of shares some company promoters have pledged is another worrying factor. There are 169 companies in the BT500 list which have reported pledging promoters' shares. When the markets were on the upswing, from mid-2009 to end-2010, no eyebrows were raised. But with a falling Sensex, pledged shares are a concern, due to the erosion of market capitalisation of companies and hence the collateral value of the shares. "The quantum of pledge reporting shows that we are getting in the pressure zone," says Dipen Shah, Head of Fundamental Research at Kotak Securities.

Beyond the market challenges, the big blow of 2011 came from policy inaction. "Policy inaction and inability to fast-track reforms is troubling investment confidence," says Ramanathan K., Chief Investment Of ficer at ING Investment Management India. Nor is there much hope for change until after the five assembly elections scheduled for the first three months of 2012.

Alongside, there is the pressure of RBI having raised key rates 13 times since March 2010 in its effort to control inflation, substantially hiking financing costs for companies. Still, in a major shift from the past, the latest RBI monetary review does discuss the issue of growth, too.

Finally, the bigger issue is the fate of the dozen plus European economies that are in deep trouble.Will they take enough corrective action to cheer the markets? For Indian markets in 2012, the dragon is likely to sleep until inflation shows a downward trend and in turn gives comfort to the RBI to loosen its grip on interest rates.

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