Ever since the election results came in, the market had been swept up on euphoric expectations from the new government. These have now been largely belied.
It’s clear the government’s main objective is to protect the poor from the slowdown—morally laudable, but not particularly favourable for the market. The other market driver, a rise in global risk appetite, also shows signs of a pause. With the Budget out of the way and quarterly earnings season coming up ahead, it’s time to focus on the fundamentals.
But first, since the government is now the biggest supporter of demand, take a look at what the Budget does for the economy. Nomura Securities Co. Ltd economist Sonal Varma says: “The direct impact of higher government spending on GDP (gross domestic product), which is determined by revenue expenditure, is budgeted to increase by 11.7% year-on-year (y-o-y) in FY10 versus 35.2% in FY09. Therefore, the contribution of government consumption in real GDP growth will be much lower in FY10.”
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At the same time, government capital expenditure is budgeted to be significantly higher. What will be its impact? The medium-term fiscal policy statement clearly states: “Due to the prevailing uncertainty in the world economy, the real GDP growth has been estimated at 6.51% in 2009-10.” That’s lower than the 6.7% growth notched up last fiscal.
Since nominal GDP growth for FY10 has been estimated at 10%, the implication is that average inflation will be 3.5%. Last fiscal, nominal GDP growth was 12.7% and average inflation 6%. Will interest rates go up because of the government’s huge borrowing programme? The government has indicated that open market operations will be equal to around half of net borrowing, so that will infuse plenty of liquidity to finance the borrowing. Varma says that the government has already borrowed 36% of the full-year target, which suggests it may have intentionally front-loaded a part of its borrowing programme to avoid crowding out private investment later in the second half of the year, when credit growth picks up.
But won’t the higher liquidity lead to higher inflation? Inflation is in any case going to go higher later in the year due to the effect of a lower base. But Gaurav Kapur, senior economist with ABN Amro Bank NV, says: “With economies having output gaps all over the world, the finance minister is betting that demand-pull inflation is not going to kick in anytime soon.”
In other words, there’s too much spare capacity for inflation to take hold soon. Growth is the key; if it picks up too much, inflation will be the result and interest rates will rise. But that is in the future. Will the June quarter earnings provide direction to the market? That’s unlikely. Nobody expects the quarterly results to be good. Angel Broking Ltd estimates net sales of firms on the Sensex index on the Bombay Stock Exchange to decline by 4% y-o-y and net profit to fall by 12% y-o-y. Motilal Oswal Securities Ltd expects Sensex earnings to decline by 17% y-o-y. Religare Hichens Harrison Plc. expects profits after tax of the Sensex companies to fall by 9.7%.
In short, it’s not a pretty picture, but then the dismal results have already been discounted by the market. As Religare’s Amitabh Chakraborty pointed out in a pre-Budget research note: “Q1 FY10 may end up being a non-event as the market has already factored in flat FY10 earnings and is now floating on high Budget expectations.”
In fact, there have been few earnings upgrades for FY10, with most analysts preferring to look to FY11 for a jump in corporate profits. The Motilal Oswal quarterly earnings preview points out that while their FY10 earnings per share estimate for the Sensex has remains unchanged at Rs883, their FY11 Sensex earnings per share estimate has been upped by 5% in the last three months and is now at Rs1,028.
Growth in Sensex earnings was 4% in FY09 and is expected to be 1% in FY10, but shoots up to 16% in FY11. Yet, with the global economy being so volatile, there is bound to be plenty of uncertainty around forecasts for FY11.
The mover of the markets in the near term will, therefore, be global factors. What do they tell us? Barclays Capital has been a great supporter of the green shoots theory, but even they are calling for a pause in the emerging markets rally. In their recent Emerging Markets Outlook, analysts Piero Ghezzi and Eduardo Levi-Yeyati say: “We think markets in the next quarter will continue to move to the rhythm of data releases in core economies, but the easier trades are gone, and the more limited cyclical upside may make country idiosyncrasies increasingly important.”
The country idiosyncrasy that investors were looking for in India was a government with an agenda for reform. The market had hoped that this would be the factor that made India especially attractive to investors.
Unfortunately, with the uncertainties surrounding the huge deficit, the Indian market could very well have a negative idiosyncrasy. No wonder the market reacted so violently to the Budget.
Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at firstname.lastname@example.org