With oil prices showing fewer signs of easing, inflation and interest rates would only move up, hurting consumer demand, corporate profitability and the growth of the broader economy.
Most analysts see the Indian economy expanding between 7 per cent and 7.5 per cent through 2008-09, compared with 9 per cent last year, while growth in corporate profits slows to 15 per cent.
"We have a problem virtually on all three sides of the trade. Current account deficit resulting in rupee depreciation, inflation leading to margin squeeze and fiscal deficit impacting overall macroeconomic stability," said Nilesh Shah, deputy-managing director, ICICI Prudential AMC.
Inflation is already hovering over 8 per cent and is likely to go up further with the government’s decision last week to bring a steep hike in retail prices of petrol, diesel and LPG.
"Inflation will remain at elevated levels of around 9.5 per cent till November after which the base effect and fiscal measures will start playing their role leading to a possible reversal," said Abheek Barua, chief economist at HDFC Bank.
High inflation could force the Reserve Bank of India to raise the cash reserve ratio or increase its key lending rates that, in turn, could prompt commercial banks to go another round of interest rate hike. "Interest rates will move up by 25-50 basis points by December," Barua said.
Most analysts and experts have already scaled down their expectations about GDP and corporate profitability in anticipation of a hardening of interest rates.
"Initially we projected the GDP for the year at 8 per cent, but now with the recent developments we expect it at 7.3 per cent, " said Sonal Varma at Lehman Brothers. Companies will face pressure on their sales from the fall in consumption and on profits on account of higher interest costs, said Sandesh Kirkire, chief executive officer, Kotak Mahindra AMC. "We expected a growth of around 20 per cent ( in corporate profits) for the FY 2008-09 but now we have revised it to around 15 per cent," said, Nirmal Jain, Chief Executive Officer of India Infoline. Some businesses will be hit harder than others.
"Interest rate sensitive sectors like real estate and capital goods will face more hardship along with the import sensitive sectors feeling the pinch of depreciating rupee," said Jain.
Takeaway for investors: they must scale down their expectations on returns on equity for this year.