Recall the days when stocks of all companies in a sector went up because of a private placement at a higher-than-market price, which established a new benchmark for valuing the company?
Well, that process is now operating in reverse—if Bear Stearns Cos Inc. is valued at just $2 (Rs82) a share (it had told analysts last Friday that its book value was at least $80 a share), what should the other financial institutions that have similar assets be valued at? That’s what spooked the Dow Jones futures and sent stocks tumbling across the world.
While the Indian economy may be relatively insulated from the credit crisis in the West, its markets clearly are not. Foreign institutional investors hit by problems in the credit markets and facing margin calls have been selling assets across the board to raise money; and Indian stocks, on which investors were sitting on profits, have been sold heavily.
But it’s not only the stock markets that have been hit— more and more economists are revising their growth forecasts downward. An Indian GDP growth rate of 7% for fiscal 2009 is increasingly becoming the consensus estimate. With capital flows being reversed and the markets being in the shape they are in, many IPOs are being put off. The companies that were planning capital expenditure may either defer it or access local funding. The first option would mean fewer orders for capital goods companies and a slowdown in investment demand. The second option would mean higher funding costs. Analysts point out that for airline companies, for example, the rise in funding costs will occur at a time when they are planning to expand their global operations and growth will slow as global travel budgets get slashed.
Sectors such as real estate and construction, where companies operate on negative cash flow and have to regularly raise funds, will be particularly hit. Earnings estimates have already been slashed for blue chips such as Larsen and Toubro Ltd, Suzlon Energy Ltd and Indian Oil Corp. Ltd, to name a few. In short, even the fundamentals will be hit.
Part of that slowdown could be offset by a rise in consumption demand, thanks to the giveaways in the 2008 Budget and the Sixth Pay Commission. On the other hand, there’s also the concern that hiring will decrease in export-related sectors, in particular information technology (IT), financial services and in other sectors affected by the slowdown—that could impact consumer demand.
“So, on all fronts—exports, investment demand and consumer demand—you’re likely to see a deceleration,” says A. Prasanna, economist with ICICI Securities Ltd. He says he’s lowering his GDP forecast to 7% for fiscal 2009.
So, are we in the same situation as in 2000, at the time of the last US recession?
GDP growth had fallen to 4.4% in 2000-01 from 6.4% in the previous year. Ajit Ranade, chief economist with the Aditya Birla Group, points to the much higher current savings rate and says that Asia is much stronger than it was in 2000-01. On the flip side, Lehman Brothers Holdings Inc. has pointed out that “India’s growth shave-off could be much larger than in past US recessions, as the trade and financial linkages have strengthened.”
But, as the chart shows, our markets still haven’t fallen as much as they did in 2000.
Indian IT industry: sitting closest to the bomb
The Bombay Stock Exchange’s IT and FMCG indices were the best performers on Monday, each falling by just 3.2%. While the affinity for companies with steady cash flows is understandable, the markets seem to be calmly ignoring the risk involved with the IT sector. As one fund manager likes to put it, “The IT industry is sitting closest to the bomb,” referring to the likely recession in the US.
For some time now, IT companies have got away with the argument that even if the US were to go into recession, they are likely to benefit as more work would be routed to offshore locations in order to cut costs. But if the outcome at broker Bear Stearns Cos Inc. is anything to go by, some clients in the financial services sector may soon cease to exist.
Already, Tata Consultancy Services Ltd (TCS) has said that two of its clients have delayed projects. This could soon become a trend given the rate at which the credit crisis is claiming victims. And, coming to the parallels with 2000 when the US last went into recession, Indian IT vendors also had to take significant price cuts.
Top companies such as TCS and Cognizant Technology Solutions Corp. get well over 40% of their total business from financial services clients. At Wipro Ltd, it’s lower at 25%, while Infosys Technologies Ltd has a 37% exposure. On the whole, it’s foolhardy to expect that Indian IT companies won’t get hurt as a result of the credit crisis. Meanwhile, current prices imply that markets expect earnings growth of about 15-17% for top-tier companies in the near term. This seems ambitious considering that the industry may soon face a double whammy: a drop in volumes and a decline in prices.
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