Mumbai: With the markets shifting focus to earnings growth, the weakening macro situation could throw a spanner in the works for India’s fiscal health, say analysts.

The markets had so far been ignoring the deteriorating macros, but surging crude oil prices, rising bond yields and a depreciating rupee may lead to fiscal slippages.

Last week, Brent crude was at $80 a barrel for the first time in four years, triggering fears of high inflation. Any slippage on fiscal deficit would also have ripple effects on interest rates and the government’s borrowing programme, which in turn would hurt corporate earnings.

“The market has (so far) pinned its hopes on earnings recovery and has largely ignored the deterioration in the macros, which may weigh on heady multiples," said Kotak Institutional Equities on 13 May.  According to the research firm, India’s macro has weakened considerably over the past few months, and it may have to contend with weaker figures in 2018-19 compared to those in 2017-18, given the likelihood of higher inflation, interest rates and possibly higher current account deficit and a weaker currency. 

“While we are somewhat confident about earnings recovery, given the likely normalisation of operating conditions in sectors such as banking and global tailwinds to commodities and rupee depreciation favouring the IT and pharmaceuticals sectors, we see risks to multiples on the back of worsening macro," the firm said. “Bond yields have risen sharply while earnings yields have stayed flat, suggesting that the market is quite confident about earnings recovery."

The rupee has lost 6.08% against the dollar in 2018, while Brent crude prices have gained 18.6%. In May alone, the currency has slipped 1.98%, while Brent crude has surged 5.49%. The month also saw the benchmark Sensex trading marginally lower, while the MSCI World gained 3.67%.

Though the Sensex has gained nearly 3% in 2018 so far, it has underperformed global peers. In the year so far, MSCI World jumped 7.32% and MSCI Emerging Markets gained 4.89%. Valuation-wise, the Indian market is still the most expensive and an earnings recovery would be critical at this juncture. The Sensex is trading at 17.86 times its expected earnings for the current fiscal year, Bloomberg data showed. 

However, the rise in crude prices may delay earnings recovery. “If crude prices keep rising or fail to reverse soon, the earnings recovery that everyone was anticipating to take place in FY19 will be pushed further by a few quarters," said Deepak Jasani, head of retail research at HDFC Securities Ltd. He added that profit margins of sectors consuming crude oil or its derivatives could get impacted on higher crude prices.

“We do not think that markets could witness sharp declines owing just to crude oil price rise, as excesses in the current markets are not extreme. Instead, markets may face modest declines in a choppy range," Jaswani said. “However, lack of buying interest could impact individual stock valuation severely especially in the small and mid-cap space."  

According to Edelweiss Securities Ltd, India’s macro has probably come back “half circle" after a favourable three-year run. “We expect it to stay in this broad range, with global risks and rising bond yields as the primary risk that could vitiate the macro environment," said Edelweiss. “This will be a headwind for the market and we do see its risks keeping a lid on the market."  

High crude prices and higher inflation may also result in a shift to the Reserve Bank of India’s (RBI) monetary policy stance. According to Goldman Sachs, RBI is likely to keep policy rates on hold at its 4-6 June meeting, and may even adopt a hawkish tone in its policy calls.

Goldman said higher inflation and rising crude oil prices point towards a more hawkish RBI considering a policy rate hike. However, it hopes the RBI will await clarity on minimum support price hikes for summer crops, monsoon and more inflation data before embarking on a rate hiking cycle.

“The probability of a June hike would increase if international oil prices rise further, or the rupee depreciates significantly ahead of the June meeting," Goldman said in a note on 17 May.

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