Mumbai: While it’s difficult to see earnings upgrades at the beginning of the year, investors should take a longer term view and focus on the potential of the Indian economy, said Nilesh Shah, deputy managing director of ICICI Prudential Asset Management Co. Ltd, in an interview. Edited excerpts:
Now that the earnings season has started, how are your expectations developing?
The street is expecting earnings growth of around 20% plus on a year-on-year basis for major companies excluding commodities, especially the oil and gas sector. Based on the IIP (Index of Industrial Production) numbers trend and the expected GDP (gross domestic product) growth rate in the fourth quarter of fiscal 2010, the earnings growth expectation of the market should be met easily. More critically, the market will be watching for guidance for the next fiscal. A robust and confident guidance of at least 20%-plus earnings growth is necessary to keep current valuations supported.
Do you expect the good run to continue, given supply constraints on the economy?
India is focused on spurring domestic consumption. Enhanced government expenditure fiscal 2009 onwards boosted consumption in the wake of a slowing global economy. Even in fiscal 2011, the Budget has provided tax benefits to boost consumption. This, in the short term, is resulting in inflation, especially consumption-related inflation. For years, India has dealt with inflation by raising rates, tightening liquidity and curbing demand. This time there is a subtle change of strategy. India is trying to create supply by keeping liquidity, keeping rates stable or (staying) moderately behind the curve and allowing creation of capacity. This is the right way to tackle inflation. However, it will require speedy execution on the ground. RBI (Reserve Bank of India) has done its part on the monetary side. The ball is in the government’s court to allow accelerated capacity creation.
Graphic: Paras Jain/Mint
Do you think the high inflation and interest rates we have witnessed so early in this uptrend cycle will make it a short cycle?
RBI has managed the inflation and rate cycle quite well till now. One can take comfort from their past track record. However, the market will certainly keep on watching both factors closely in the near future. India, which is dependent upon the rain gods to a great extent for managing food inflation, cannot afford to take inflation lightly as it hurts the poor the most. Interest rates are rising mainly due to the large borrowing programme of the government. While it is difficult to control the expenditure side of the budget in a democracy, the low tax to GDP ratio of India gives comfort on the revenue side. RBI should be able to manage the interest cycle without having too much impact on overall growth.
Is it right to expect another round of earnings upgrades? Will this be one of the factors that will justify the next stage of the market rally given stretched valuations?
The market is trading at 17 times plus one year forward earnings. Certainly it is not cheap any more. Current market levels are supported by robust earnings growth expectations, normal monsoon and global flows. It is difficult to see earnings upgrades at the beginning of the year. Most analysts will start with the standard 15-20% earnings growth prediction to support the current valuation. The earnings upgrade cycle is likely to begin only after the monsoon is seen and felt as normal. The market has delivered great returns in fiscal 2010. While there are many supporting factors in terms of robust earnings growth, normal monsoon expectation and lack of any bad news on the global side, the most important factor is unabated flows from global investors. In fiscal 2011, markets will have to meet enhanced divestment targets, rising rate cycle, elevated inflation and a possible double-dip in the global economy. It is important for investors not to get carried away by last year’s rise nor get worried when markets may correct. It is important for investors to take a longer term view and participate in the transformation of India which is likely to double its size over the next couple of years from its present level. Keep the faith and enjoy the ride.