Rain deficit prompts investors to pull back from Indian equities

Rain deficit prompts investors to pull back from Indian equities

Mumbai: The concern on lack of rainfall hurting growth is prompting investors to pull back from Indian equities, with the country’s benchmark Sensex index returning its first weekly decline in a month.

After rounds of raising earnings per share for firms, brokerages and economists are now cutting farm growth forecasts and questioning prospects of sectors such as consumer goods, automobiles and mobile phones.

The Bombay Stock Exchange’s (BSE) Sensex fell 3.26% to 15,160.24 points in the week ended 7 August. The broader 50-stock Nifty index on the National Stock Exchange fell 3.34% to close at 4,481.40 points.

This is the steepest decline in the Sensex since the 9.45% decline in the week ended 10 July when investors expressed disappointment with the Union Budget.

The India’s Meteorological Department said last week that the rainfall deficit for the 1 June-5 August period had widened to 25% from 19% a week earlier. This has prompted economists such as Tushar Poddar of Goldman Sachs to cut agricultural growth forecasts to -2% from a year ago, compared with an earlier prediction of a 1.4% rise.

“The probability of a full year (rain) deficiency has increased," wrote Dhananjaya Sinha and Komal Taparia of Centrum Broking Pvt. Ltd in a 4 August note. “A decline in food grain production would imply agriculture GDP (gross domestic product) decline of 1.75% in FY10E. This...could offset the positive impact from improving financial conditions, external demand and fiscal spending."

To be sure, the share of agriculture in India’s economic output has halved to 17.5% compared with three decades ago. But monsoons remain important as nearly 55% of the labour force is employed in farming.

For companies such as Hindustan Unilever Ltd, Bharti Airtel Ltd and Hero Honda Motors Ltd, rural customers account for half their revenues.

“We think that rural demand will be negatively impacted, and this is a significant negative shock for the equity market, with sectors catering to rural demand...particularly affected," Poddar wrote in a 7 August note.

Even if the negative effect on economic growth is offset by improvement in industrial activity and focus on infrastructure, some of these sectors will still be affected.

“Regional variations will likely persist even if the hit to overall GDP growth is not meaningful, and sectors such as fast-moving consumer goods (FMCG), tractors, two-wheelers and cellular phones could still be adversely impacted," wrote Rajeev Malik, an analyst with Australia-based Macquarie Bank Ltd in a 5 August note.

Indeed, the fall in some of these sectoral indices has been sharper than that of the Sensex.

For instance, BSE Auto index has declined 4.48% during the week, while the FMCG index fell 6.7%. Auto has been one of the outperformers of the year with a 116% gain since January, while FMCG’s performance has been muted at 28.24%.

Analysts predict a near-term correction in the broader market with rain concerns overlapping those of rich valuations.

“With valuations stretched, and indicators of the global manufacturing cycle at near 20-year highs, the balance of risks to Asian equities is to the downside over the next three months, in our view," wrote Daniel McCormack and Henry Hon of Macquarie in a different 4 August note. “A pullback of 15–20% is our base case."

According to Bloomberg data, the Sensex now trades at 18.25 estimated earnings for fiscal 2010, much higher than historic long-term averages, leading analysts to believe that the market is running ahead of fundamentals.

Still, some believe that despite the worsening monsoon, there are some mitigating factors that will help the rural economy and help offset any decline. For one, the government’s rural job guarantee programme for the poor and its spending on rural infrastructure is likely to protect rural incomes to some extent. There is also enough buffer stock of food grains from the good crop last year. Industrial recovery, too, is likely to help offset the impact on economic output.

“We believe that the industrial recovery will be stronger than expected earlier, offsetting the potential downside from agriculture growth. Indeed, we are now expecting industrial growth to average 5.4% in FY2010 compared with 4.7% earlier." wrote Chetan Ahya and Tanvee Gupta of Morgan Stanley in a 7 August note.

For now, all eyes are looking towards the end of August when the full impact of the sowing season delays will be known.

Bloomberg contributed to this story.