fuel to the fire

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  • 7/31/2019 Fuel to the Fire

    1/2

    A FALSE DAWN

    The gap up opening of the markets on Friday the 14th

    looks like a kind of a relief rally to me. With so

    much negativism around, this move by the government to hike diesel prices looks good. However,

    the flip side is where the negativism in the move lies. This move is not a move to reduce subsidies

    but a move to bring additional income in to government coffers. Given the extortionist levies on

    petrol and diesel, surely the subsidy is an accounting illusion. People may not agree with me, but if

    you take a look at the selective subsidies that industry get where the benefit reaches only a few

    pockets, the fuel subsidy is a more equitable one.

    A diesel price hike of over ten percent is inflationary and is going to impact everything. Inflation in

    food prices is already running high and this move is (borrowed quote from a reader who commented

    on the QE 3 on a website) like throwingwood in to a fire to douse the fire.

    The announcement of permitting FDI in retail and aviation has made people happy, but what it

    means is yet to filter in. The retail FDI policy is a misnomer. One would have expected a

    government in power to not create a division between states. By saying that the centre will approve

    and then each state to approve is mindless. This will set a dangerous precedent for all future moves

    where economic liberalisation is needed. Borders between states are being thickened by such a

    thoughtless policy. In hard number terms, we will not see more than ten billion dollars flowing in

    over the next three years. As regards aviation, again it may provide relief and/or an opportunity to a

    couple of airline company promoters but it does nothing to change the

    The moves by the ECB and the US Federal Reserve give a reprieve to global markets. Perhaps itwould mean additional cash to spare for emerging markets. Already, our markets have witnessed

    good inflows and the stock markets are on a decent run. The US markets crossed their 2007 highs.

    Presuming that there is no roll back of a significant nature by the time you read this, we will have a

    spike in inflation. Freight rates are surely set to go up. Captive power (most SMEs operate on diesel

    gen sets) costs would also go up. A spiral that would make the RBI even more reluctant to lower

    interest rates (unless pressurized by the government of India).

    The other negative impact of the global moves on easing liquidity would be to fuel up commodity

    prices. Easy availability of money at ridiculously low costs will see more speculative action in

    commodities. This and the high interest costs would tend to put pressure on corporate profits. The

    big worry for us would be whether this spike in commodity prices would extend to oil. Logic says

    that a feeling of wellness across the globe would push up oil prices further.

    However, the markets may actually go higher for some time. If the government sticks on to its

    announced price hike in diesel, the presumption would be that our government is serious about

    reining in fiscal deficit and bring in higher flows to the markets. There would be enough valuation

    arguments created to encourage this flow. The move by the government to hike diesel prices means

    an annualised additional recovery of around Rs.20000 crores. Surely, consumer price impact across

    the board would be far higher than this number.

  • 7/31/2019 Fuel to the Fire

    2/2

    The BSE Sensex at around 18000 is trading at around 17 times FY 2011-12 earnings. For those who

    like to look at calendar year data, the return is close to 19% YTD for 2012. If earnings grow this year

    at around 12% (close to long term averages), we are talking about markets valued at nearly 15 times

    expected earnings for this financial year. Is it cheap? We have fixed income instruments available at

    eight times earnings. The difference in valuation represents our expectation of future earnings

    momentum in the stocks as well as a possible fall in interest rates.

    Should all this happen the rupee could strengthen. Whether it would be significant enough to make

    a dent on the trade deficit is not clear to me. Perhaps the rising commodity prices would offset the

    rupee gains.

    Inflation will be the biggest fight investors and consumers will face. Easing liquidity without doing

    anything to improve supply side is futile. Increased liquidity will simply chase the same volume of

    goods. You do not have to be an Einstein to figure out the outcome.

    So if markets are going to remain strong in the near term, I would reduce my exposure to equities byselling off some of my stocks/mutual funds. Maybe there would be some momentum in sectors that

    have fallen off heavily over the past six months to a year, but these moves would be without any

    strong backing on the earnings. The Indian market at 15 times plus forward earnings is expensive

    and leaves very little room for long term capital appreciation. Clearly, liquidity is driving markets and

    not corporate earnings.

    I know and hear that everyone is talking about markets having strength and poised for further highs.

    In fact there is talk of the BSE Sensex breaking old highs and forming a new high. I am happy to have

    people like that around so that they provide the exit to cowardly persons like me.

    R. Balakrishnan

    ([email protected])

    September 16th

    , 2012