The crystal balls are getting cloudier. Till the beginning of this month, many equity strategists were firm in their belief that the second half of this fiscal would be better as growth and investments pick up, and that the markets would bounce back.

Also See | Attractive Valuation (PDF)

The Sensex is trading at 18.5 times earnings for the fiscal that ended in March. That is the lowest in about 23 months and seems to suggest that the market has priced in the macro risks. But that doesn’t take into account external factors such as the resurfacing of the Greek debt crisis and now the weather bureau’s forecast that the monsoon will be less than the 50-year average.

If one considers the forward price-earnings multiple, the Indian benchmark is trading at 14.2 times estimated earnings for fiscal 2012 (FY12). That’s a tad below the long-term average, but in itself a big change from the 17 times it was trading at six months ago. But while that implies more reasonable valuations, there are other concerns. Consensus earnings forecasts for this fiscal have been clipped as much as 8% since the beginning of this year.

Most of the earnings growth estimates seem to be predicated on volume growth as seen in the March quarter. But demand is increasingly at the risk of a slowdown. The most obvious reason is, of course, higher interest rates. Yes, the bond market does indicate that the Reserve Bank of India may be nearing the end of the rate hike cycle, but the consensus is for another 50 basis points increase. That much can be deduced from the one-year overnight indexed swap, which is trading at 7.94%. One basis point is one-hundredth of a percentage point.

However, despite a 2.75 percentage points increase in policy rates, inflation remains at stubbornly high levels. While it may be too early to draw firm conclusions from the Indian Meteorological Department’s monsoon forecast, below normal rain can not only fuel inflation, but also dampen growth.

The recent surge in exports is also not sustainable. As BNP Paribas Securities (Asia) Ltd points out: “The palpable weakness in a range of leading indicators such as US New Orders PMI (Purchasing Managers’ Index), G3 (Group of Three—the US, the European Union and Japan) and Chinese economic growth suggests that the current strength (in exports) will likely dissipate."

Thirdly, with New Delhi grappling with governance issues, it has virtually stopped functioning on economic policy. The number of cabinet approvals fell 39% from a year ago to 33 in the first six months of 2011, according to Bloomberg. That, in turn, affects both private and public spending, even as project execution lags targets.

Risks have only increased for economic growth and company earnings. In other words, the decline in earnings is unlikely to stop. Brokerages are sharpening their knives to shave off another 3-4% from their FY12 forecasts.

Graphic by Yogesh Kumar/Mint

We welcome your comments at