After posting its biggest monthly jump in two years, the Indian market is likely to face resistance if oil prices rise further and the rupee’s slide continues. Political uncertainty, possibility of disappointment in earnings of banks and a surge in stock valuations — following a 7% jump in the benchmark S&P BSE Sensex last month — could exert downward pressure on the equity markets.
“Macro headwind is rising for Indian equities in the form of increased commodity price, especially oil, depreciating rupee, fiscal challenges, election-related uncertainty and upside risks to inflation,” says Vinod Karki, vice-president (strategy), ICICI Securities.
Brent crude oil is hovering around $74 a barrel, up 20% from its 2018 lows of $62 a barrel in February. Not to mention, oil prices have jumped close to 70% from June 2017 levels, while prices of other commodities such as base metals have also been on an uptrend. These have significant implications for corporate earnings, the economy and government finances.
According to Nomura, every $10 per barrel rise in oil price widens India’s current account balance by 0.4% of gross domestic product (GDP), increases inflation by up to 40 basis points (bps), hurts growth by about 15 bps and worsens the fiscal balance by 10 bps of GDP.
JP Morgan, in a note, said, while Indian equities have so far shown resilience to the rise in crude oil prices, any continuation of the surge would pose a “greater risk” to the stocks as it would accentuate India’s twin deficit problems — fiscal and current accounts.
“India’s fiscal situation still remains challenged. High oil prices will put pressure on the government’s fiscal position, especially if it is forced to cut excise duty on diesel and gasoline to mitigate the impact of high retail fuel prices on consumers. Politics may preclude the most rational economic approach to fuel pricing,” says Sanjeev Prasad, co-head, Kotak Institutional Equities.
The government has so far stayed away from announcing populist measures, such as delinking of retail fuel prices to global oil prices. But, many people say that it is only a matter of time given the tight election calendar. Besides Karnataka elections later this month, there are another four state elections in 2018 and the General Elections in May 2019.
Experts say political uncertainty is a significant headwind for the market, fuelling further decline in sales and investments ahead.
Raj Bhatt, CEO, Elara Capital, says the markets have not priced in the possibility of a Bharatiya Janata Party (BJP) defeat in 2019. Any trend signalling weakening of the BJP and strengthening of the regional parties is likely to weigh on the market, he says.
The weakness in the rupee and rising US bond yields is also likely to play spoilsport for equities as it has direct bearing on capital flows from foreign shores. The rupee has weakened by more than 5% against the dollar from the 2018 highs of 63.4 to 66.66. It is likely to weaken further as the dollar has been strengthening against major global currencies ahead of the US Federal Reserve meeting later this week. The US central bank is expected to maintain status quo at its latest meeting. The market is expecting the US Fed to increase rates three more times during the year, which could hurt fund flows and put pressure on currencies, including the rupee. Also, the yield on the 10-year US Treasury, which is hovering around the three % level, has kept global investors’ risk appetite in check. Since February, foreign institutional investor (FII) flows into India have remained subdued, with the market up-move being driven by mutual fund (MF) buying. Flush with liquidity, domestic MFs have pumped in Rs 426 billion into equities so far in 2018. The buying has provided strong counter-balance to dwindling FII flows.
While headwinds are many, analysts also see some tailwinds which could help recent gains to sustain. Karki of ICICI Securities says improved GDP growth outlook for India, sanguine beginning to fourth quarter earnings, normal monsoon forecast for the year and easing of global geopolitical tensions are the key tailwinds.
While higher crude oil and commodity prices coupled with a weak rupee could boost earnings of oil and commodity players, it could have a negative impact for most other companies, with their margins getting squeezed. A weak rupee could, however, help export sectors such as information technology and pharmaceuticals.
Prasad says the recent rupee depreciation and continued strength in commodity prices may support 2018-19 net profit of some Indian companies.
Source: Business Standard