2012 - Transformational Year? - Focus to shift from Inflation to Growth

Contributed By: M. Ravvichandran, Vice President - Investment Strategy

The previous year turned out to be a nightmare with multiple domestic issues combined with slowing global environment.  What is worrying is the fact that the growth deceleration could spill over into 2012 and perhaps beyond.  As per reports, global growth is expected to slow from 4.2% in 2010 to 3% in 2011 and to 2.5% in 2012.  Considering the false start of FDI in retail and populist measures like Food Security Bill, the domestic policy prospects for 2012 don’t appear good.  Last year, we were discussing about double dip in US economy and possibility of India’s growth overtaking China.  Ironically, today the U.S. is doing satisfactorily and the hot topics are ‘Fiscal Integration in Europe’ and who will slow down more, between India and China!

Although USA may not recover significantly, the recession talk has vanished. European banks will continue to take a hit on their balance sheet owing to their exposure to sovereign debt.  Whether it is a ‘default’ or a ‘managed default’, credit shortage could become a handicap for growth in EU region.  In India, the government has to battle on many fronts.  The first half of 2012 will see concerns about a slowdown gaining prominence over peaking-off inflation.  Most of the leading economists have already revised down the GDP forecast for India to 6.7% for FY12 and 6.6% FY13, well below the government guidance of 7.25%.  This reflects the impact of higher interest rates resulting in slowing investment demand and global uncertainties affecting export demand.  I expect the growth rates to bottom out in middle 2012 on account of rate cuts and base effect.  I also expect the RBI to cut rates by around 200bps in Q2-Q3CY12. At this juncture, inflation is likely to peak off in early 2012.  However, with five states going in for elections in March ’12, I will not be surprised to see price hike in Kerosene, diesel and LPG post-elections.  Further, possible price increase in coal and power tariff cannot also be ruled out. These measures will once again stoke the inflation up, testing RBI’s policy stance. 

Any adverse global economic developments are obviously not in our control. What’s more deplorable is the fact that Indian government has severely fallen short of expectations on the reforms agenda. The problems are well-documented starting from coal shortage to policy paralysis, fiscal slippages and multiple scams.  The market participants don’t have any big hope on the reforms front as any related impact on the economy comes only with a lag.  However, one can hope that the government would be able to manage the fiscal issues without disturbing the rates as slowing economy will pull down the loan demand. Prudent fiscal management coupled with some determined policy decision-making from the political class could help the economy bounce back with a growth rate of around 8% in  FY2014.

What lies ahead?

Cyclical deceleration in growth and policy inertia are the key drivers for the current slow-down in India.  Unlike 2008, the problems now are home grown.  Trading volumes in equity market is at five year low and still declining.  The current bear market has sustained long enough and we have to look out for reasons that can cause a turnaround.  As explained earlier, consensus is also concerned about macro signs with fiscal, current account and rupee spiraling out of control.  Most of the domestic funds and insurance companies are a tired lot with no fresh inflow of funds. 

Though Indian markets look attractive based on P/E multiple, considering the amount of earnings downgrades the PEs may be higher than our current belief.  While markets could rally on rate cuts, the sustainability would depend on investment spending and policy reforms from capital.  As we go in 2012, though the macro picture looks weak, we will probably see raw material prices moderating on the back of a slow-down in China which in turn would help India Inc to improve their gross margins.  Interest cost will peak in next couple of quarters that would help driving below-the-line profits.  In other words, considering the below-expectation profits for December and March quarter, the base effect will provide some sense of optimism that earnings can surprise on the upside during the later part of 2012. Right now, “it’s so bad, it’s almost good”.

As we are in a transformational phase, it is easy to be bearish on India and equally easy to construct a bullish scenario from here-on. Most of the negatives are now well-documented and debated and hence are already reflecting in the price. Given the macro economic scenario, the beaten down stocks and sectors will continue to under-perform at least for next couple of quarters.  A further correction is likely to be in terms of time rather than value and a good entry point is likely to emerge soon. 

The author is Vice President at Unifi Capital, Chennai.  Views expressed are personal. Email: ravvichandran@unificap.com