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Corporate profits walk the wedge

Indian companies have once again proven why investors worldwide are chasing them, posting robust fourth quarter results for the period ended March 31. Vyas Mohan tells more.
Hindustan Times | By Vyas Mohan
UPDATED ON MAY 12, 2008 09:03 PM IST

Largely unscathed by a global economic slowdown, Indian companies have once again proven why investors worldwide are chasing them, posting robust fourth quarter results for the period ended March 31.

However, with crude prices on the boil and the rate of inflation in the country hovering a tad below its three-year high level and the Reserve Bank of India (RBI) increasing the cash reserve ratio for banks by a quarter percentage point to 8.25 per cent last month, the financial year 2008-09 may witness India Inc facing a considerable slowdown in profit growth, feel analysts.

As if on clue industrial growth data for March released on Monday showed year-on-year growth at only 3 per cent in March, compared with 14.8 per cent in the same month a year earlier. Overall for 2007/08, industrial growth was 8.1 per cent, down from 11.6 per cent in 2006/07. All that seemed to confirm a mood of slowdown.

"The fourth quarter results for 2007-08 have been better than expected. No negative surprises have come out yet. However, we have downgraded the earnings per share (EPS) estimate on the 30-share Sensex for the financial year 2008-09 from Rs 1,050 to 1,002. Most factors have been factored into in this downgrade. However, crude prices continue to be a cause of concern," said Manish Sonthalia, Vice President, Equity Strategy, at Motilal Oswal Securities.

Following RBI, the US Federal Reserve cut its key benchmark interest rate by a quarter point to 2 per cent in a move to buoy up an ailing US economy. The RBI, in a surprise move, had in mid-April hiked the cash reserve ratio (CRR) for banks by 0.5 percentage point to 8 per cent to squeeze out cash that could fuel demand and push up inflation.

Reacting to the RBI move, Sandesh Kirkire, CEO of Kotak Mutual Fund said, "The RBI move to keep the repo rate unchanged in the face of severe inflationary pressure reaffirms the fact that the inflation is mainly supply-induced and can be best handled through the fiscal measures. The CRR hike however ensures no liquidity overhang in the system and achieves the policy objective of lower inflation."

Repo rate or repurchase rate is the rate at which the central bank borrows from banks.

So, how will high inflation, a tight monetary regime and boiling crude prices affect India Inc's profitability for financial year 2008-09?

While spiraling commodity prices and higher crude prices have already pushed up the cost of production for companies across the board, especially for those in the manufacturing sector, a stringent interest rate regime is likely to eat into corporate profits in terms of interest payments besides stifling consumer demand for products due to a liquidity suck-out.

While most of these factors have more or less been factored into share prices of companies that have dropped substantially from their January highs, what has largely gone unnoticed is its corollary – a depletion in investor wealth that followed the equity market fall.

"The wealth effect on consumption seems to be by far ignored. With equity markets easing off their highs and real estate market expected to follow suit, the dent it causes on the spending power of people, it seems, has not been factored in yet.

There may be further slowdown in demand and a certain pressure on margins because of higher costs," said Sandeep Bagla, chief investment officer for fixed income assets at AIG Investments.

The Sensex is down about 19 per cent from its all-time high recorded last January and other stocks are down even more. This reduction in investor wealth is likely to bring down the spending power of people causing demand shrinkage and a consequent reduction in corporate sales. In such a scenario, how far an impact will it have on companies? Which all sectors would steer clear?

Telecom and banking sectors are expected to do well, but banks are sitting on top of losses triggered by derivatives trading in foreign exchange products.

"A clear trend will emerge only by the second half of the current financial year. However, we think the big three of telecommunication companies may defy the slowdown owing to a big jump in usage minutes, while the banking sector should also do well. Looking at the recent quarterly numbers of Axis bank, ICICI bank and so on, the derivative losses have not been as high as expected. And these stocks had corrected sharply on highly negative outlooks. Thus, they should do well," says Sonthalia.

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