Friday’s unexpected hike in policy rates by the Reserve Bank of India sent share prices tumbling amid creeping fears that the successive interest rate hikes since October 2004 will not only cool the economy but also slow corporate profits.
Every company in the 30-share Bombay Stock Exchange Sensex fell, with the index posting its second-biggest single-day fall, down 616.73 points, or 4.72%, to close at 12,455.37. The broader 50-share National Stock Exchange Nifty, too, shed 4.92% and closed at 3,633.60. The previous biggest fall for the Sensex was a 826.38-point decline on 18 May 2006.
“We see a definite shift in RBI’s stance, from a balance between growth and inflation control to a definite focus on price stability. As a result, going forward, we see growth decelerating,” said Rajiv Anand, head of investment at Standard Chartered Mutual Fund.
Many market participants said they are expecting another interest rate hike from the central bank. “There could probably be one more round of interest rate hike,” said N. Sethuraman Iyer, chief investment officer, SBI Mutual Fund.
Many brokerages have downgraded their growth expectations on corporate profits already, some by as much as half of the previous year’s growth. “Corporate profits have grown between 35% and 40% in the past four years. We expect this to come down to between 15% and 25%,” said Sandeepa Arora, head, institutional equities at brokerage India Infoline. She feels the impact of the rate hike may not be visible in the last quarter of 2006-07, for which the results are expected by mid-April. But the rate hikes will start biting into corporate profits over the next three-four quarters.
The impact of corporate profit growth will be both direct and indirect, and may vary from sector to sector. “Many companies are now in the process of capacity expansion. These expansion plans will be affected by rising interest rates,” said Hitesh Kuvelkar, associate director of brokerage First Global. According to him, sectors such as cement, construction, automobiles and banks will be hit the most. Others, too, have toned down their exposure to these sectors. “We are negative on cement, bank and automobile in the short-to-medium term,” said Arora of India Infolines.
Banking and automobile stocks took the worst hits. Among the sectoral indices, the BSE auto sector index fell the most (6.15%), followed by BSE Bankex, which fell by 5.95%.
Higher interest rates are expected to reduce car and truck sales. As much as 75% of the car purchases are financed by loans.
“There is a fear that in its quest to control inflation, the central bank might tighten liquidity too much. What the market is trying to guess is how much more there is to go before the markets price in the monetary tightening,” said Standard Chartered’s Anand. He said he is relooking at his current portfolio in the wake of RBI announcement. “We need to take a closer look at the interest rate impact on the stocks in our portfolio.”
He also said some level of re-rating of the price-earning multiple was due. “When the markets were moving up share prices gained by two factors—upward revision of P/E ratios and the profit growth of companies. Some manner of reversal to this will happen now—slowdown of profits and a downward revision in the earnings multiples.”