The next trigger for the market will be the FY08 first quarter earnings.
The results promise to be interesting, in many ways.
This will be the quarter which will see the full impact of the rupee appreciation and the impact of higher interest rates. Bank results will be scrutinized to see whether bad loans have gone up. The impact of higher wage costs will also be felt and analysts will check whether the backlog in the order books of engineering companies is increasing. Slowing growth may also be an issue.
Also, in the last three years corporates have had the benefit of higher sales without having to do capex and while enjoying the benefits of their earlier cost-cutting measures. That operating leverage is coming to an end.
In fact, an analysis of 2,739 companies by capitalmarket.com finds a substantial drop in net profit growth to 23.1% for the March quarter, compared to the full year’s growth of 42.7%. Lower growth in sales and other income, coupled with higher interest cost, has been responsible. These trends will likely be even stronger in the June quarter.
Why then is the market going up?
Shriram Iyer, head of research at Edelweiss Securities, says that investors are revaluing balance sheet assets. By way of example, he points to ICICI Bank Ltd, where the proposal for a sale of 5% in its holding company led to analysts revising their valuations upward.
Companies such as Bharti Airtel Ltd and Reliance Communications Ltd have gained, with the market putting a value on their towers. Reliance Industries Ltd has also gained from the higher valuation of its gas finds. Companies such as Zee Telefilms Ltd and Indiabulls Ltd have benefited from their de-mergers. Several companies have seen a rise in their valuations because of M&A activity or on account of their land banks.
Earlier this year, Ratnesh Kumar, head of India research at Citigroup had put a number to this “embedded value” that sits on corporate balance sheets and said that it accounted for 1,700 points of the Sensex.
The MSCI Index for India has outperformed the Emerging Markets Index in the past five years, thanks largely to higher earnings growth and a re-rating of the Indian market. But much of the outperformance over the last year has been due to the discovery of embedded value in Indian balance sheets.
The trouble is, as Iyer underlines, this value also depends to a large extent on optimism and liquidity. In case the outlook changes, it won’t take long for the embedded value to be revised downwards. That’s why the June quarter results are so important.
Balance of Payments
A couple of trends stand out from the balance of payments data. First, net external commercial borrowings amounted to $6.7 billion (Rs29,480 crore then) in the January-March quarter, up from $3.9 billion in the preceding quarter. The country’s total commercial borrowings have increased by 59% during the year and were mainly responsible for the 22.6% rise in the country’s total external debt. The increase in debt is not a concern, because of the high level of reserves, but the proportion of short-term debt has increased.
The other interesting trend is the big jump in foreign direct investment (FDI), both inbound as well as outbound. FDI into India increased from $7.9 billion in FY 2006 to $20.4 billion in FY2007. But, part of this inflow was offset by outward FDI of $12 billion last fiscal, up from $3.2 billion in the previous year.
The continuation of massive inflows is likely to continue to put upward pressure on the rupee, with outward FDI proving to be a saving grace for the Reserve Bank of India (RBI).
Gaurav Kapoor, senior economist with ABN Amro India, also points out that valuation changes accounted for 23% of the rise in forex reserves last fiscal. Since the rupee appreciated against the US dollar and against the Euro over the period, the implication is that the RBI has diversified its reserves, rather profitably, away from the US dollar.
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