Indian investors braced for sharply lower earnings

Indian shares will face strong headwinds this week as investors brace for sharply lower quarterly earnings, which will start flowing in January and an uncertain global environment for capital flows.

The outlook for corporate earnings took a knock on Friday when the government said advance tax collections from companies for the December quarter fell 22 per cent from the same period last year. It was the latest in a series of data that pointed towards a deepening economic gloom.

"This should redouble efforts to tackle the problem more vigorously, but the government's responses have been painstakingly slow and too little," said equity analyst Mehul Patel.

"Neither are companies willing to go the extra mile to lure buyers back."

For more than two weeks it has become evident the government would have to further slash interest rates, cut taxes and increase spending to halt a rapidly slowing economy and revive growth.

The central bank has lowered its main short-term lending rate by 250 basis points since mid-October to 6.5 per cent, but this is still relatively high compared to US rates at 0-0.25 per cent, or Japanese at 0.1 per cent.

"An aggressive monetary policy may be necessary if the global economic dep-ression continues to adversely affect manufacturing," the finance ministry said in a mid-year review report released last week.

"Having run a tight monetary policy during first half 2008-09, there is considerable scope for monetary policy easing over the next six to 12 months to offset the global increase in demand for money that is being transmitted to India," it said.

Foolhardy

The report intensified expectations the central bank would reduce rates by at least 100 basis points, but the Reserve Bank of India (RBI) has given no hint when it would do it.

The RBI is scheduled to review policy only on January 27, but it can intervene early.

"It is desirable to cut the repo and the reverse repo rate, I think, by 100 basis points in my judgement," said Suresh Tendulkar, chairman of the prime minister's Economic Advisory Council.

Patel said falling inflation should give the RBI more reason to cut rates.

Annual inflation dropped to a nine-month low of 6.61 per cent in mid-December, well off a high of 12.9 per cent in early August and analysts are forecasting it will decline to less than three per cent by March.

The top-30 Sensex fell 7.6 per cent last week, its biggest weekly drop in two months, to 9,328.92 as foreign funds turned net sellers of more than $150 million (Dh550.98 million) after buying $365 million earlier in the month.

The fall picked up steam after the government said advance corporate taxes for the December quarter fell to Rs426 billion (Dh32.30 billion) from Rs549 billion in the same period last year.

The Sensex is on course to post a fall of more than 50 per cent in 2008, largely on foreign portfolio outflows of $13.3 billion. In comparison, the index had gained 47 per cent on the back of record foreign investment of $17.4 billion.

Patel said the outlook for 2009 was dismal. "There will be more pain for company earnings," he said.

Part of the problem was because companies such as developers were reluctant to cut prices.

"It's foolhardy to expect falling borrowing costs alone to bring buyers back," Patel said. "Apartment prices had more than quadrupled during the boom over the past three to four years; they will have to come down."

The finance ministry said GDP growth in 2008-09 would slow to about seven per cent from nine per cent in 2007-08, and its adviser Arvind Virmani said the RBI should put more emphasis on growth.

The expectation matches private forecasts but many economists believe expansion will fall to about six per cent in 2009 to 10. The government has announced plans for extra spending of $9 billion to prevent a sharper slowdown, but it knows this will not suffice to undo the damage and another economic stimulus package is needed.

However, Tendulkar said the government needed to see the impact of its first stimulus package announced early in December, before it could consider more.

"We are seeing some teething problems in the implementation of the first package," he said. "The second stimulus package will depend on the response to the first one."

Securities firm Macquarie said in a report last month that unlike China, India had little scope for significantly boosting fiscal spending and so policy reliance would be on aggressive monetary easing.

"India's investment spending will be a serious casualty of the current global crisis, despite the economy's relatively low export-to-GDP ratio."

Cautious optimism in the long-term

The Sensex fell 7% further by 695 points to close at 9,093 on November 28th, 2008 as compared to 9,788 on October 2008 end. The focussed measures taken by the RBI to calm the credit markets along with complementary steps taken by SEBI has finally started showing positive signals in the market. However, the FIIs continued their redemption induced sales putting pressure on the market.

GDP growth has slowed to 7.8% in the first half (April-September) of this fiscal year, which in itself is the highest in the world today after China. However, the recession in several major economies could lead to difficult times for India even though India is in a relatively better position to weather it.

Global rating agency Standard & Poor’s stated that the terrorist attacks in Mumbai were an isolated case and that it does not expect any negative implications on India’s macro economic activities or government’s fiscal position from the attacks. The act will have limited impact on markets. Mainly hospitality, travel and tourism and aviation segments could be affected. The terrorist attack is unlikely to increase India’s geopolitical risk perception such that it can adversely impact India as a growing outsourcing base of goods and services.

Although prospects for corporate results for the quarter ending December 2008 appear grim, things could begin to look up from the January-March 2009 quarter and thereafter, once the liquidity situation improves significantly. Valuations have now come down to appealing levels with Indian markets no longer expensive on an absolute basis. The country’s long-term strength continues to lie in the quality of its entrepreneurs.

While economic news might remain stable to negative in the early part of 2009, markets typically bottom ahead of the economy and earnings bottoming out due to the lead lag nature of the stock market and economy. Easing liquidity, interest rates and lower inflation could be drivers for better market performance in the second half of 2009. A downturn is a precursor to an upturn. A great majority of people across the world are still employed and eventually, with proper proactive fiscal and monetary measures being taken by all the nations in a co-ordinated manner, economic structures will become more stable and strong.

In the downward fall of the market, some scrips have been battered by urgent sellers and these now discount their underlying fair value. For such scrips, the downward risk is limited, while the upside potential is quite phenomenal. No one enjoys a sharp market downturn as at present with economic dislocation, growing panic, mark-to-market losses and other such adversities. Successful investing always requires a long-term perspective and this has never been truer than at this moment in time.

Once the market stabilizes, investors will start rationalizing between good and bad companies. Good quality businesses managed by quality management will be the theme in the coming days. Hence, we are reasonably optimistic about the long-term prospects of such companies.