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Why the Indian markets are falling
Jitendra Kumar Gupta
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June 09, 2008

It all started with the US subprime problem and the global credit crunch, which led the BSE Sensex nosediving from its peak of 21,206 on January 10, 2008 to 14,677 on March 18. A part of the fall can also be attributed to the concerns pertaining to the increase in crude oil prices and its impact on India's economic growth.

Some of the early signs were also visible from rising inflation and the slowdown in domestic industrial production numbers. This further led to concerns over high interest rates, slowdown in GDP and thus, corporate earnings as well.

Sensing these developments, foreign institutional investors were the first ones to move out of the market, and they partly became the reason for the markets to fall.

End of the bloodbath?

If the global and domestic problems persist, experts predict the Sensex to fall to 12,000-14,500 levels. Though bold and unbelievable, there are few players who are predicting that the Sensex may touch the 9,000 levels.

While we are not predicting the Sensex levels, we jot down and bring certain factors that may determine the future course of the markets and what investors should do during these uncertain times.

Crude realities

No investor will be willing to invest in an asset headed for reporting lower profits and no asset can be profitable if costs are higher than realisations.

Crude oil is one such commodity, whether it is the economy (macro) or corporate profitability (micro), which is considered to be the source of most of the problems.

While crude oil prices had corrected to $125 levels, after crossing $135 a barrel mark, it again scaled a new peak of $139.12 a barrel last week. There are reports predicting that it will go to $150 to $200 a barrel.

There are several reasons attributed to the recent spike in the crude oil prices including increased financial investments and a marginal rise in costs of oil production.

Whether the crude oil price rises to such high levels or not, experts suggest that the good old days of cheap oil may be gone for a long time to come.

Bloating deficit

According to studies, a $10 increase in the crude oil prices may reduce India's GDP growth by about 0.3 percentage points and an increase in the consumer price index by 1.2 percentage points.

India imports about 70 per cent of its oil requirements, suggesting that at current levels, it will have to pay a significantly higher amount to meet demand. It has already led to a large trade deficit (over 7 per cent of the GDP).

Fiscal deficit, which is currently at about 3 per cent of the GDP, could reach to 10 per cent levels if the fertiliser, food, farm and oil subsidies are added.

Hence, further rise in crude oil prices will only make things worse. Not only this, rising oil will have serious consequences on others things as well.

"If crude oil touches $150 levels and sustains there, it will be a crude awakening for the global as well as for India. India's annual import bill will touch to $140 billion against the $78 billion estimated for the FY08," says Devendra Nevgi, CEO and CIO, Quantum Mutual Fund.

High inflation

High crude oil prices would have a sweeping impact on the Indian economy.

To put forth some of them: Higher inflation rate, rupee depreciation, increasing trade account and fiscal deficit, and firm interest rates. The other side of an oil shock would probably the ensuing political instability and social unrest.

The inflation rate, which is already high at over 8 per cent, could emerge as a key concern. Economists share different views with regards to inflation reaching the double digit figure in the short term, and if not, it could range at about 7-8 per cent, especially after the recent hike in the petrol and diesel prices.

"We are yet to see the cascading effect of recent spike in oil prices, and the recent hike in fuel prices will further translate into higher inflation in the weeks to come. We think the inflation rate is heading towards 9 per cent levels, however it will ease out in the later part of the year," says, Anand Krishnamurthy, Co-Head Global Markets, HSBC.

Experts observe that the high oil prices will further increase the cost of goods and not to mention, the logistic costs itself, which is expected to go up by another 10-15 per cent as most of the truck operators have increased rentals.

And to join the league, we have already seen airlines companies increasing the fuel surcharge by 15-20 per cent on the ticket price.

So, either the companies will have to increase the prices of goods sold or services rendered or they will have to take a hit on margins. This will certainly lead to overall cost push on other sectors and may discourage the consumer spending further. In both the cases, either the sales volumes will come down or margins thus, lower earnings for companies.

Interest rate worries

One of the objectives of the monetary policy in India has been achieving price stability, which the RBI may try to achieve even at the cost of giving up growth. If inflation spirals, the RBI may also raise either the CRR (cash reserve ratio) or the repo rate, depending on the prevailing situation.

The RBI's comfort level for inflation rate is 5.50 per cent, whereas the current level is 8.24 per cent. As there are worries over the rising interest rates, the economist also predict higher interest rates, which along with other factors would shave off around 50-75 basis point from the GDP growth rate.

"It seems that the economy will slow down, closer to its long term average of around 6-7 per cent for the next decade. Higher inflation and rising crude oil prices remain a risk to the Indian growth story," says Devendra Nevgi.

Earnings slowdown

The high interest rates along with the factors like inflation and higher commodity prices will hit India Inc negatively. The domestic cost of capital has already increased, with the prime lending rates having gone up by 175 basis points since the second half of 2006 to 12.5 per cent currently.

Also, the housing loans have become more expensive, while in many of the cases the banks are charging about 18-22 per cent for the two wheeler and personal loans. As a result of this, the bank credit growth has come down to about 24 per cent as against the recent high of over 30 per cent in January 2007.

This will not only hit the banks' income growth, but also hit the companies immediately, due to higher interest outgo and slow down in the consumer demand. The early sign of this is seen in the slow down in industrial production to 5.8 per cent during the quarter ended March 2008 compared to over 10 per cent a few months ago.

The lag effect is also felt by the companies. According to estimates, sales growth of a cluster of 1,524 companies, excluding oil and gas and finance companies, was 14 per cent year-on-year during the quarter ended March 2008 as against the recent peak of 28.9 per cent YoY growth during the quarter ended September 2006.

Analysts expect this trend to continue going forward if the various issues, as mentioned above, remain.

"We think the Sensex earnings growth will slow down in FY09 mainly on account of margin pressure across the sectors led by input costs of power, coal and other raw materials. Also, higher interest rates and slower credit growth should pressure the banking sector," says Harendra Kumar, head research, Centrum Broking.

"Yes, moderation in earnings is quite visible. With increase in input costs (of materials, human resources and capital) margins are also under pressure. We have seen decline in margins of companies from the IT, automobiles, engineering, capital goods and logistics sectors" Says Bhavesh Shah, VP Research, Asit C Mehta Investment Intermediates.

Though not all sectors will witness a slowdown, certain sectors will be more vulnerable, such as financials and banking services, real estate, industrials, capital goods and auto, among a few others.

Analysts are also predicting a slowdown in the BSE Sensex earnings in the FY09 in the range of about 5-10 per cent.

"We expect Sensex EPS to be Rs 1,001 for FY09. We have revised this slightly lower (by one per cent) over the past couple of months from Rs 1,012, but do believe that the risk for further downward revisions does exist," says Ajay Loganadan, Head Investment Advisory Group, HSBC Private Banking.

Foreign capital

Considering these issues coupled with the slowdown in the earnings, market participants say that the Indian equity markets are relatively expensive as compared to other emerging markets. Also, this is cited as one of the reasons for the FIIs selling witnessed lately.

The depreciation of the rupee has lowered net returns (in dollar terms) for FIIs.

While sharing his view on the FII investments, Ajay Loganadan say, "FIIs have been net sellers of Indian equities to the tune of about $4.2 billion with about $1.2 billion of this selling coming in May.

Given the high levels of risk aversion and P/E contraction, we could expect flows to remain muted over the near term. Fund flow for the rest of the year will depend on global news flow and the perception of risk amongst foreign investors. Also, rising trade and fiscal deficits are not viewed very favourably by FIIs."

Global markets

Besides the FII flows the direction of the market will be determined by the global developments, which are not considered to be very favourable. "In our view, global markets are going to remain weak over the next 12 months.

US Housing data continues to get worse, record number of small businesses in the US are filing for bankruptcy (5,000 in April 2008 alone), debt of 174 large US companies is trading at distressed levels.

In these circumstances, it is tough to make a case for stability in the US financial space," says Madhusudan Rajagopalan, Director, Aranca India Operations. Besides the instability and slow down in the US, analysts also see more risk due to the sub prime crisis.

So far, major banks and other financial institutions across the world have reported losses of approximately $380 billion. In a recent development, Lehman Brothers Holding, a top investment bank in the US is expected to raise approximately $4 billion to shore up its balance sheet after incurring losses due to the subprime crisis (S&Powngraded its ratings).

The rating agency also downgraded credit ratings of Merrill Lynch and Morgan Stanley, saying they may have to book more write-downs on devalued assets.


For many, it is a bearish market due to the negative micro and macro factors that are affecting the markets, while for others it is the right time to invest and use the lower levels as an opportunity to invest for the long term. Considering that these issues remain, it also indicates that there are concerns for the market to rise from here in the near term.

A good monsoon, lower inflation rate along with the better global cues could be the positive triggers, which though seem some time away.

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