The stock market’s reaction to the better-than-expected July numbers for the Index of Industrial Production (IIP) was strange, to say the least.
Attempts at rallies were made after the data came in, but they were swiftly sold into. It was also odd that the Indian market was one of the worst performing in Asia on Friday and it didn’t get any solace from the higher opening in the European markets. The market action pointed to distress selling and rumours abounded about foreign institutional investors (FIIs) selling and unwinding of positions by the beleaguered US investment bank Lehman Brothers Holdings Inc.
There’s no reason, though, why distress selling by FIIs should be limited to India. The fall in the shares of information technology companies, on concerns that their hedging strategies may have misfired, and the drop in the Reliance Industries Ltd shares, on worries about lower oil prices and refining margins, also helped push the Sensex down.
Growth in capital goods production rose by a huge 21.9% in July, but that’s largely on account of a base effect—the index for capital goods fell sharply from 358.3 to 317.4 in July last year. But there has been no such base effect in consumer goods, where growth has been 7.3% year-on-year in July.
Consumer durables production rose by 11.2%, which is surprising given the interest rate hikes, but then the increase has been on the back of negative growth in consumer durables in the year-ago period. Moreover, two-wheeler sales have started to pick up lately.
The bottom line: while growth has been slowing, it still remains well-supported.
For the market, that should imply a bottom is in place, unless distress selling by foreign investors continues. With the financial system in the West in a shambles, that could well happen.
Click here to read Could this be the first time Infy misses its annual guidance?
A look at the sector indices shows that the worst hit on Friday were IT, realty and banking stocks, the last two rate-sensitive sectors being dumped perhaps on fears that better-than-expected industrial production may be a mixed blessing. It’s true that demand pressures continue to be strong and they will get stronger with the money from the pay hike for government employees and as a result of a good monsoon. The latest Reserve Bank of India (RBI) data show that money supply (M3) growth is 21% year-on-year, far above the central bank’s target. Another hike in the cash reserve ratio could be called for.
But with oil and commodity prices coming down, with inflation near to topping out and now with industrial growth better than in the first quarter, RBI’s attempt at a soft-landing for the economy seems to be on track.
Cross-currency movements or slowdown worries?
Till recently, Indian shareholders of IT stocks were content with the knowledge that an appreciation in the dollar versus the rupee was good news for their companies and vice-versa.
CLSA Research’s client note released on Thursday night has now caused them to look closely at the movement of the dollar vis-a-vis other currencies such as the euro and the pound. The note says that Infosys Technologies Ltd is likely to miss the guidance it had given in dollar-terms, because of the sharp appreciation in the dollar against the euro and the pound.
Rupee Woes (Graphic)
The Infosys stock was the second biggest loser among the National Stock Exchange’s Nifty stocks, losing 6.1% in value on Friday.
But should Indian shareholders be so bothered about reported dollar numbers. After all, four-fifths of the company’s shares are issued in India and its main reporting currency is the rupee. In local currency terms, things look bright because of the sharp appreciation of the dollar. True, currencies in the faster growing European region have depreciated against the rupee, but the proportion of revenues collected in these currencies is still only 30%. The pre-dominance of dollar revenues will ensure Infosys will be a net gainer when numbers are reported in rupee terms.
The company’s chief financial officer, V. Balakrishnan, says when the dollar depreciated sharply in the previous financial year, the markets were focused on rupee-based numbers. This year, when the opposite is happening, the focus has shifted to dollar-based growth. Are analysts being too finicky? That would be true if the only thing that’s impacting Infosys’s dollar-based numbers is the cross-currency movement.
But as CLSA has pointed out, the more important question is: “What is the margin of safety with which Indian IT vendors are operating this year?” Infosys is known to be conservative with its guidance, which in other words means that it keeps a buffer or a margin of safety. If Infosys says it will grow revenues by 20%, the markets assume growth to be 22-23%. The margin of safety is this difference of 2-3%.
As one veteran IT analyst puts it, cross currency movements and the like should be taken care of by this buffer. If, as CLSA estimates, the company cuts its guidance by two percentage points, it actually means that growth would fall by 4-5 percentage points. The company may cut its guidance because of cross-currency movements, but there’s no denying the fact that business fundamentals have deteriorated since it gave its guidance in April.
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