With the VIX hovering near its lowest level, it is clear that the risk perception of the market is quite low while the Nifty is now only about 20% adrift from its all time high, although the economic conditions were quite different during these periods. Is the market under pricing the risk? Quite so. Here, I will dwell with one of the three factors viz liquidity, corporate performance and government intervention.
Corporate performance – It’s important to note that non food credit growth in India has slowed down substantially. A tapering off of credit flow does not really make for a highly positive corporate outlook.
Commodity prices: After the commodity prices peaked in 2008, they went on a tailspin.
Interest rates: The recent announcement by the RBI clearly indicating a tightening of monetary stance also implies that period of cheap liquidity is over for the Indian corporates. While I am not expecting the interest rates to rise soon, there are enough indications that as inflation picks up, interest rates will also go north. Agreed, the current bout of inflation has a lot to do with excessive food prices on the back of failed monsoon, but I expect the the food prices to moderate at a later stage as the Rabi output enters the market. However, with commodity prices moving up, it will start feeding into inflation. Also, with the monetary policy clearly in a tightening mode, pick up in credit demand will also lead to hardening of interest rates.
Labour cost: Anecdotal evidence also suggests that the thaw in the domestic job market is over. As companies come up with their hiring plans and retention of talent becoming paramount, reduction of work force or implementation of wage freeze is no longer an option now.
Clearly, as cost reduction ceases to be a feasible alternative for the corporates, sustenance of a 20% plus growth rate in corporate bototmline will not be possible, unless there’s a dramatic increase in their topline. This requires a substantial increase in domestic demand which does not seem likely. Added to that, likely increase in interest rates will act as dampener for leveraged consumption that many consumers have been used to during the last few years of cheap financing options that were available.
Hence the expectation of moderating corporate performance.