Companies & Sectors
High inflation, interest rates slow demand will impact Q1 performance, say brokerages

Domestic slowdown and global uncertainty has resulted in lower FII inflows in the April-June quarter 

High inflation and high interest rates continues to be a drag on overall economic growth and will likely hurt the performance of companies in the first quarter of 2011-12, according to various brokerages. But some are optimistic that the stiff economic conditions could ease in the second half of the year, making it possible to yet achieve GDP growth of 7.5%-8% this year.

Angel Broking says that high inflation and high interest are the top twin concerns for the economy and the equity market. But the indications are that inflation and interest rates may be close to their peak levels and that there might be some respite in the second half, it said in a report published this week.

With the Reserve Bank of India (RBI) hiking rates ten times in 16 months and demand-supply pushing up broader interest rates by 200 basis points, the demand momentum in the economy has slowed down, Angel Broking said. Further, external negative factors like the Greek crisis could contribute to near-term uncertainty and volatility.

The uncertainty in advanced economies, rising interest rates and wage inflation impacting corporate earnings are responsible for the muted FII inflows of Rs5,171 crore in the April-June quarter, which consequently affected the performance of the equity market.

KR Choksey Institutional Research says that as companies report their first quarter results this month, the factors to watch will be increasing commodity prices that would lead to a squeeze on margins, the hike in interest rates that is dampening demand, and a slowdown in momentum in select sectors like automobiles.

Besides automobiles, the other sector that has been particularly adversely affected by high interest rates is real estate (and infrastructure), says Pinc Research. However, while automobile sales are going through rough weather, two-wheelers have not been affected much due to low dependence on finance and lower operational cost.

This is reflected in the record quarterly volumes by Hero Honda, Bajaj Auto and TVS Motor. Maruti Suzuki, however, suffered due to a labour strike at its Manesar facility which hurt volumes, after nine successive quarters of double-digit growth.

While credit off-take has slowed down, the banking, financial services and insurance sector continues to show strong performance, highlighting the under-penetration of financial services in India that will drive credit growth in the years ahead. The slowdown in economic activity would also likely moderate direct and indirect tax collections.

KR Choksey said inflation has remained at an elevated level due to high non-food manufacturing inflation and fuel prices. Concerns over possible deficit rainfall in major parts of the country, expressed by the Indian Meteorological Department, would increase the pressure on food prices and will be the key upside risk to inflation going forward.

In the export-oriented IT services sector, Standard Chartered Equity Research says, the focus is on pricing gains. The annual wage revision cycle and rupee appreciation will apply a squeeze on margins for all companies in the sector.

Telecom companies are expected to report a decline in profits, despite substantial top-line growth. Top line growth is estimated at a healthy 29.1% year-on-year, partially because of the inclusion of Zain's numbers in Bharti Airtel's account. But profits are expected to decline by 2.5% year-on-year due to increased competition and higher interest and other costs on account of the 3G network rollout.

Finally, the oil burden is closer to the peak of historical averages and other commodities are also expected to soften on moderating global demand. The government recently decided to hike prices of several regulated fuels due to rising under-recoveries of oil marketing companies.

The recent decline in crude prices is expected to contain inflationary pressures within comfortable levels, going forward. The US Fed has said it expects pressures from global commodity and energy prices to dissipate as it modulates its accommodative monetary policy.

Angel Broking suggests that cooling of inflation and interest rates from the second half of the year could improve credit growth and asset quality outlook for the banking sector. It believes that the RBI's tightening measures to contain demand-side inflationary pressures are bearing fruit.


CPI a better indicator of inflation than WPI: RBI governor

"Conceptually, the CPI is a better indicator of demand side pressures than the WPI-and there is no denying that consumer prices better reflect demand side pressures than wholesale prices," RBI governor D Subbarao stated

Mumbai: Reserve Bank of India (RBI) governor D Subbarao on Tuesday said consumer price index (CPI) works better than wholesale price index (WPI) in capturing market dynamics and arriving at a more realistic inflation forecast, reports PTI.

"Conceptually, the CPI is a better indicator of demand side pressures than the WPI-and there is no denying that consumer prices better reflect demand side pressures than wholesale prices," Mr Subbarao said at the RBI's 5th Statistical day celebrations at the Mint Road office.

Elaborating it, the governor said a sustained rise in wholesale prices either results in an eventual increase in prices by retailers or a squeeze in their margins.

But if the demand is strong, retailers may exercise pricing power and pass on the increase in wholesale prices to consumers. In case demand is weak, retailers will be forced to partly absorb the increase in wholesale prices in their margins, he said.

However, defending the WPI usage in the apex bank's inflation forecast, Mr Subbarao said, "Given the limited efficacy of monetary policy to deal with food and fuel inflation, and the limits on using core CPI inflation measures, we have focussed our attention on non-food manufactured products inflation as an indicator of demand-side pressures in the economy."

He admitted that there was some merit in the criticism of RBI's inflation forecasts, which has been going off the mark, but pointed out that the bank has "opted for WPI over CPI as a second best choice for a number of reasons, first and most importantly, we do not have a single CPI that is representative of the whole country.

"Until recently we had four, and currently we have three CPIs representing different segments of the population," he said, pointing out that while WPI is computed on an all-India basis, while CPIs are constructed for specific centres and then aggregated to an all-India index.

"Secondly, WPI is available with a shorter lag than the CPIs. Third, WPI has a broader coverage than the CPIs in terms of the number of commodities, quotations, inclusion of non -agricultural products and tradeable items," he said.
Noting that the WPI has been revised upwards, sometimes sharply, in recent months, he said accordingly, the RBI was forced to revise upwards many a time its own inflation forecast during the past fiscal.

Noting that generally, core inflation is a derived inflation measure from the headline, he said, "The transitory component of the headline, food and fuel, is excluded in this process. This is the standard practice though there are many statistical methods of exclusion."

While it is true that commodity prices influence the non-food manufactured products component of WPI, it is also true that the pass-through from higher commodity prices to WPI depends critically upon the underlying demand conditions in the economy, he argued.

"For inflation assessment, RBI looks at all the measures of inflation, both overall and disaggregated components, in conjunction with other economic and financial indicators. In the context of monetary policy formulation, it is important to have a robust primary measure of inflation at the national level," he said.

In this direction, the compilation and dissemination of CPI (urban), CPI (rural) and CPI for the country by CSO is an important step forward, but the long time series data, especially for the back period are not available for these new indices making them unsuitable for policy analysis, he said.

Stating the RBI has been left to double-guess on inflation numbers, he said sharp variance in the data supply had led to a systematic under-prediction of inflation numbers by RBI last year and called for the need to make efforts to ensure the quantum and frequency of revisions reduced.

Blaming the sharp rise in oil and commodity prices, lower-than-expected decline in food prices despite a normal monsoon, erroneous signals from the Index of Industrial Production (IIP) data, and the more than expected upward revisions to the past inflation data, as the factors that led to the inflation miscalculation, Mr Subbarao admitted that generally, private inflation forecasts came much closer to what was ultimately reported for last fiscal year.

Noting that the revision of the basket for CPI series lags that of the WPI series, he said though last year when the WPI series was revised to the base of 2004-05, the existing CPIs continue with the old base-for CPI-RL (rural labourers) (1986-87), CPI-AL (agri labourers )(1986-87) and CPI-IW (industrial workers) (2001), making them ill-equipped to capture the price behaviour caused by the rapid structural changes in the economy.

Pointing out that the changes in the weights for manufactured products are not substantial even in the revised WPI base year, he said there is a tilt in the weights towards non-food manufactured products reflecting changes in the production pattern over the decade.

Some key economic data widely used elsewhere, such as regular retail sales data, as well as those on employment and housing sales, are not regularly compiled in the country, leading the inflation numbers half-baked or non-representative of the actual demand and price movements in the economy.

Pointing out that the more critical data on WPI inflation also have been subject to large revisions, he said, "The initial estimates of WPI inflation were 8.2% for January 2011 and 8.3% for February 2011. (But) both these numbers were substantially revised upwards by 120 basis points (bps) each.

"Often, it is not clear if the revisions are occasioned by one-off factors or systemic factors. Nevertheless, each time we have to make an assessment of the inflation situation, we are left to double-guessing how the provisional number might be revised," Mr Subbarao said

"But if the provisional data that we feed into the econometric model is off-track and does not exhibit any systematic pattern, our projections of inflation too gets off-track," he concluded.


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