Kotak flags Indian market hurdles: Oil, rates, and government woes
Despite a record surge in Indian equity indices, Kotak Institutional Equities has highlighted several challenges in its latest note. One significant concern is the prolonged increase in global interest rates, which could impact borrowing costs for businesses and individuals, potentially affecting consumption and investment trends in the Indian market.
Rising global oil prices pose another risk, as they can directly affect India’s oil import bill, potentially squeezing profitability for businesses and leading to increased inflationary pressures. Additionally, the Indian government faces limitations due to lower-than-expected tax collections and current account deficits, which could affect its ability to implement economic support measures and infrastructure projects.
Despite these challenges, Indian equity indices like Sensex and Nifty have seen substantial gains since April, with midcap and small-cap indices showing even stronger growth. Foreign institutional investors (FIIs) have displayed confidence in the Indian market, with significant investments totaling around $19 billion in local equities during this period. However, recent profit booking was observed, partly driven by concerns related to surging crude oil prices and the US Federal Reserve’s hawkish stance on interest rates.
Kotak Institutional Equities also expressed concerns about a potential setback in spending by BFSI (Banking, Financial Services, and Insurance) and other Indian IT services clients. These worries stem from concerns about a more substantial slowdown in the US economy than initially anticipated. While there was optimism regarding revenue recovery in the third quarter of FY24, driven by expectations of a robust US economy, the Federal Reserve’s persistent hawkish approach to interest rates could lead to a less favorable economic environment than the widely expected “soft” landing.
Kotak Institutional Equities acknowledges the growing risks associated with lower-than-expected profitability, which have been exacerbated by the recent surge in global oil prices. This surge has led to a subsequent increase in raw material costs, particularly affecting industries such as automobiles and components (including tires), construction materials, and commodity chemicals.
These sectors had witnessed substantial profit growth in recent quarters, which had prompted optimistic valuations based on the assumption of sustained profitability improvement. However, Kotak expresses uncertainty about whether these companies can continue to raise prices to counterbalance the escalating costs of raw materials, especially given the subdued demand and already elevated levels of profitability.
Furthermore, Kotak’s optimism regarding government spending to address ongoing economic weakness appears to be waning, particularly in terms of stimulating consumption in rural and low-income urban households. This is due to lower-than-expected corporate tax collections and significant losses incurred by public sector oil marketing companies. These factors could potentially limit the government’s ability to increase revenue expenditure, despite the pursuit of aggressive capital expenditure plans.
Despite these challenges, Kotak notes that the bond markets are currently relatively stable. This suggests that despite the aforementioned concerns and uncertainties, there is a level of resilience and confidence in the broader financial markets. However, the brokerage house’s analysis underscores the need for vigilance and careful consideration of these economic and market factors as they continue to evolve, as they can have significant implications for various sectors and industries in the Indian market.
Nomura Research has issued a warning concerning the potential emergence of twin deficits as oil prices approach the $100 per barrel mark. The rising costs of fuel could place considerable strain on oil marketing companies, potentially necessitating a higher government subsidy. This scenario poses a risk to the government’s fiscal deficit target for the fiscal year 2023-24, which stands at 5.9 percent of GDP. Elevated oil prices, coupled with restrictions on rice exports, have the potential to widen the current account deficit significantly. According to Nomura’s estimates, this deficit could expand from 0.2 percent in the first quarter of 2023 to 1.1 percent in the second quarter and a projected 1.9 percent in the second half of 2023.
Meanwhile, Kotak has made adjustments to its recommended large-cap portfolio. They have increased the weights of Britannia Industries (by 20 basis points to 1.5 percent) and Godrej Consumer Products Ltd (also by 20 basis points to 1.5 percent), while reducing the weight of Macrotech Developers Ltd (down by 40 basis points to 1.5 percent). Kotak maintains a positive outlook on the residential real estate sector and suggests that most stocks, except for those in the BFSI (Banking, Financial Services, and Insurance) sector, are currently trading near their 12-month fair values. These adjustments reflect Kotak’s strategic positioning in response to changing market dynamics and their outlook on specific sectors and companies within the Indian market.
