Performance of the Indian equity market has been good so far. Rally was primarily fuelled by result of the general election which gave hope that macroeconomic scenario will improve considerably in coming time. However, performance of the corporates was not very encouraging this year so far. Many would believe that corporate performance in general is driven to an extent by macroeconomic factors. Some key economic factors, which are likely to impact corporate performance in FY14-15, are:
- INR rate (foreign exchange)
- Investment capex
- Interest rate (both global and local) and Inflation
- Global commodity prices
- Government infrastructure spending
The evolution of each factors individually and interaction between each factor will drive the overall impact on the corporate. For example, take a case of a company with high leverage, which is also a net exporter. A reduction in interest rate may reduce interest expense of the company. But INR appreciation may adversely affect its performance in terms of revenue and margin.
Share trader should know about factors & performance
Now, let us briefly discuss some of the above-mentioned macro-economic factors.
INR rate: Foreign exchange continues to be one of the most decisive factors. The INR has been exhibiting considerable strength against the USD after reaching record lows during August-September 2013. However, from November 2013 to May 2014, the INR has strengthened the most against the USD as compared to other prominent emerging market currencies. This was driven by improvement in the CAD as well as measures taken by the RBI to strengthen the rupee. However continuous reduction in global cost of funds and higher foreign currency investment in the Indian equity market has also helped the cause of a strengthening INR. Given the situation, high forex volatility and sharp currency depreciation could have an adverse effect on chances of recovery of Indian corporates.
Investment Capex: With political uncertainty resolved given the election outcome, the market expects corporates to focus on their capex investment plans. Many companies in capital-intensive sectors are highly leveraged. This may cause delay in some companies’ capex plan for the reason that their ability to access incremental debt would be limited. While market expects faster clearance and removal of various regulatory bans, even in the most optimistic scenario, this will take at least six months to a year. As such, after these positive developments, assuming they come through, implementation of meaningful scale can only be anticipated in 4QFY15 and thereafter.
Interest rate (both global and local) and Inflation: The benign global interest rate environment in spite of the gradual unwinding of the unconventional monetary policy (quantitative easing) in the US, could also have contributed to making Indian investments attractive. The investment flowing into India has further strengthened the rupee. One needs to remain cautious of a scenario in which global interest rates start rising.
In local context, market is expecting RBI to at least consider reducing interest rate. However, one must be cautious of the fact that the post-election phase usually exhibits a spike in inflation. In the event that inflation rises this time around as well, the current expected improvement in the real interest rate may be reversed. While I am writing this, news flashed on the screen that India’s wholesale price inflation hit a five-month high in May (In May, wholesale prices rose a faster-than-expected 6.01% as a 19% increase in potato prices during the month pushed up food inflation to 9.50% from 8.64% in April). Food inflation would be critical to watch in view of expectation of below normal monsoon and El Nino effect. Hope of interest rate cut certainly takes a hit when this kind of news hits the market.
If interest rates are increased further by 25bps-50bps in the next three to six months, the number of stressed corporates will certainly increase.
Global commodity prices: With respect to commodity prices, India is possibly most optimally placed in FY14-15 than at any point in time in the recent past. In 2012 and 2013, even though global commodity prices were under pressure, Indian corporates were unable to extract any meaningful benefit due to INR depreciation. In a lot of instances the landed INR cost of the commodity actually increased during this period.
Corporates with primary exposure are more capable of contractually passing on price increases. Thus, their margins are relatively less affected by commodity price volatility. On the contrary, corporates with secondary exposure experience higher margin volatility attributable to commodity price volatility.
Crude oil price are very critical for Indian economy as a whole. Some days back, light crude oil futures touched $106 a barrel, up nearly 2% and the highest price since September 2013 as escalating violence in Iraq sparked worries about crude exports. Combined effect of a crude price rise (in USD terms) and INR depreciation could be fatal to the Indian corporates with secondary exposure to crude oil.
Government infrastructure spending: According to a Morgan Stanley estimate, infrastructure development peaked at 8.4% of GDP in fiscal 2011 and fell to about 6.0% in fiscal 2014. High infrastructure spending would be required to remove supply side bottlenecks in the economy and sustain a high growth path. With new government at center, market is expecting jump in infrastructure spending.