India of all the promising economies of the world; is now facing an upheaval task of worst drought in last decade or so. This was the last thing that India needed considering the food inflation measured by CPI already is in double digits. With growing certainty of drought pan India; GDP is expected to be impacted atleast by a percentage point. Government’s target of approximately 6.8% GDP in current fiscal might be in for a rude shock. We might fell well short of that target rather we would be very well between 5%-5.5% for this current fiscal. Implications of drought on the economy would be;
1) Higher food inflation. Already people are facing higher sugar prices. We might further see alleviated prices for rice and wheat as well. Worst part is we are facing severe drought conditions in the Northern parts of India which happens to be the granary of India.
2) Due to many regional elections this fiscal; Government will have to dish out goodies in the form of subsidized food to poor and higher loan waivers to farmers (Congress Government has done this before and a similar move cannot be ruled out). This means; fiscal deficit can widen which will be harder to fill back soon.
3) Higher inflation would mean interest rates won’t remain softer for longer time. To tame inflation sooner or later RBI will have to step in and revise interest rates higher which would hurt capex plans of mid size companies as well as net margins and EPS. Interest sensitive sectors like real estate and automobiles can be the worst hit in this scenario.
4) Government in its current budget and rolled out higher incentives for the rural demand which was expected to drive the economic recovery. However with prevailing draught rural demand will be bleak with farmers having lower spending power due to low farm revenues. This will have a rippling effect; as other industries will also be severely impacted due to lack of demand. Moreover Government’s investment for the current year in rural India will not reap the expected benefits. Consequently Government’s targets for curbing capital deficit over the next 2 years might not be achieved.
5) Even the spending power of common man or non-rural man will deplete with rising cost for food articles; which will impact the overall demand for goods across sectors especially consumer goods. Thus, even consumer durables companies will be under severe pressure. (For instance, companies like Videocon will face inventory pile ups and will resort to production cuts which will result in margin deterioration).
6) FMCG sector profits will go for a toss as they will face double whammy of escalating costs (due to low farm produce) and depleting demand (due to declining spending power of consumers). HLL and Marico for instance will be hit the hardest.
Thus all the above points indicate the current euphoria to be short lived and liquidity driven. Sensex is set for a re-rating based on revised GDP and EPS numbers. Sensex might be subjected to a correction of about 1,000-2,000 points over the next 2 months. Based not only on weakening Indian fundamentals but also China (portfolio manager might reallocate some funds from Indian to Chinese markets which seems to be bottoming out (Shanghai at 3,000 odds) and even developed economies which are seeing revival and still offer lucrative values across different segments. So my call would be to rather sell Indian stocks in the current rally and re-enter at fair valuations. “Temptations make you indulge in things which you wouldn’t have if exercised sensibility”.
Disclosure: No Positions