Mumbai: Prime Minister Manmohan Singh’s remark that inflation poses a serious threat to the growth trajectory of the Indian economy pulled down the Sensex, the bellwether equity index, by 441 points or 2.3% on Friday. The Sensex closed at 18,008.15, its lowest since August 2010.
The 30-stock index fell by at least 150 points after the Prime Minister’s statement was reported on Bloomberg half an hour before markets closed.
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The broader 50-stock Nifty index fell below the 5,400 level for the first time in six months to close at 5,395.75, losing 2.37%.
The central bank had raised policy rates to fight inflation at its last policy review on 25 January, the seventh such hike in the past one year, and is expected to continue raising rates for the next few quarters, impacting valuations of corporations and earnings growth.
The Prime Minister’s statement on inflation has highlighted the growth-inflation trade-off and signalled that fiscal tightening to complement monetary policy could become a distinct reality, analysts said.
This would mean a moderation in economic growth as well as in domestic demand.
“The PM’s statement created fresh concerns in the market, which was trying to form a bottom around 5,400, leading to a sell-off in the second half of the session,” said Manish Shah, associate director, equities and derivatives, at Motilal Oswal Financial Services Ltd.
The Sensex, the world’s worst performer this year after Egypt, has slumped 14% from a 5 November closing high of 21,005, as foreign institutional investors (FIIs) turned net sellers for the first time since May 2010.
India was the best performer with 17% returns among the top 10 markets of the world in 2010.
However, persistently high food inflation, which has been hovering at 15% in the past few weeks, as well as concerns on political uncertainties have seen Indian equities lose sheen over the past three months.
While faster global recovery has led to a rally in developed market equities and commodities, this has ironically weakened the outlook on Indian markets. A rise in commodity prices adds to domestic inflationary pressures and raises the risk to earnings growth of corporations in the coming quarters.
Many brokerages such as Credit Suisse, Goldman Sachs, Citigroup and Nomura have been underweight India for quite sometime, saying strong global recovery and better valuations make export-oriented markets look more attractive.
So far, investors seem to be heeding their advice. After pumping in a record $28 billion of net investments in Indian markets in 2010, FIIs have sold $1.35 billion (Rs6,156 crore) worth of equities net of buying since January.
“With a double whammy in the form of poor governance and macro issues, unless Indian markets get cheap, I do not see foreign investors buying,” said Saurabh Mukherjea, head of equities at Ambit Capital Pvt. Ltd.
Indian markets, which were trading at more than 20 times their forward year earnings three months ago, now trade at 14.5 times their consensus earnings estimate for fiscal 2012. Yet, they are at a 20% premium to emerging markets.
Mohan K.R. Swamy, head of Indian equities at the broking arm of Royal Bank of Scotland Plc, said the negatives have largely been priced in but the markets could fall further if investors sell because of the negative momentum.
“Valuations are now at a much more sensible level,” Swamy said.
Yet, most analysts do not see a major rally taking place unless there are definite signs of inflation cooling off and greater clarity emerges on the political front.
“Inflation is a concern for emerging markets,” said Taina Erajuuri, who helps manage $1.2 billion of emerging-market stocks, including Indian shares, at Helsinki-based FIM Asset Management Ltd. “Rising food and oil prices have made the situation worse. Central banks have to increase rates to control inflation.”
Erajuuri holds fewer auto, consumer staples and real estate shares than the benchmark suggests as “their margins are likely to get hit due to rising inflation and interest rates,” she said.
Interest-rate sensitive sectors such as real estate, banking and automobiles have been the hardest hit in the market slump over the past three months. Mahindra and Mahindra Ltd, the country’s largest maker of sport-utility vehicles and tractors, sank the most in eight months to close at Rs669 on Friday.
Interestingly, defensive sectors such as fast moving consumer goods and information technology were among the biggest losers on Friday, even as 67% of stocks saw a decline.
Bloomberg and Ashwin Ramarathinam of Mint contributed to this story.
Graphic by Paras Jain/Mint