Valuations are close to long-term averages but given that a good chunk of growth is due to inflation, comparison with historical valuations will be less relevant now says Mr Paul Armstrong, Chief Investment Officer, ING Life Insurance. In an interview with Business Line , Mr Armstrong gives his view on the latest results of companies and what is influencing the markets now.

Do you see more earnings downgrade following the latest results?

While revenue growth remained reasonably strong in many large-caps, margin compression continued and downward earnings revisions continue. However, the market had already reduced its earnings expectations from the ones at the beginning of this fiscal year, and therefore there were only a limited number of stock-specific earnings “shocks.”

Are there any surprises in the performance of various sectors in the latest result?

Select companies from the IT and Consumer Staples sectors surprised positively, while select companies from the banking, capital Goods, auto and healthcare sectors surprised negatively. Asset slippages are a matter of concern in many banks, and so are the concerns surrounding the power sector as regards coal availability and financial condition of State Electricity Boards. State and Central Governments both face increasing pressures to partially bail out most of the ailing State Electricity Boards, which is difficult given their own deficits. The tariffs in some of the states have been increased, but the quantum of increase required is far higher, and could be especially difficult in states where elections are scheduled in 2012. The airlines sector is another ailing sector with debt and losses piling ever higher. After the restructuring/waiver of loans to the agriculture sector in the past, there is a moral hazard for a similar package being imposed on lenders to sectors such as power and airlines.

What is the kind of damage that rupee depreciation has had on the financials of companies? Do you get a sense that many companies have lost out on hedging?

Overseas acquisitions by Indian corporates in recent years had been significantly funded by foreign currency borrowings, primarily because of lower interest rates. Also, these global acquisitions were perceived as a “natural” hedge due to their earnings being in foreign exchange. The sharp depreciation of the rupee – approximately 10 per cent in the two months of August and September alone – has been quite damaging to both large and mid-sized companies due to mark-to-market losses on mis-hedged foreign currency borrowings. Most of the companies appear to have hedged only a small part of their foreign currency borrowings, as the results bear out. While most of these translation losses are on long-term notional and therefore unrealized, there has also been a realized hit in terms of increased interest expenses on the same.

Could the rupee depreciation continue to hurt?

We have seen tepid foreign inflows this year, and an expanding trade deficit as well, and both factors could keep the rupee under pressure in the near-term. If the rupee continues at the current level versus the US dollar or depreciates further for another couple of quarters, we could see further earnings downgrades for such companies.

What is your sense of valuations for FY-12 and FY-13?

There is still some risk of more earnings downgrades for FY13, especially as the “asking rate” for growth in FY13 is rising after the reduced growth expectations for FY12.

Valuations are around long-term averages, but given the lower real growth rates (a significant chunk of the growth could be attributed to the high inflation itself), the comparison with long-term averages is slightly less relevant. Our view is that the earnings for the Sensex are likely to be in the lower-teens for FY12 and mid-teens for FY13.

Do you think markets are entirely influenced by developments in Europe?

We believe that our markets have been influenced by the developments in Europe and US, as well as local growth, inflation and margin-related issues.

India's dependence on the global economy is lesser than that of many other emerging markets, but the perception of global economic developments is currently more influential on the movement of our markets due to higher dependence on foreign capital. A gradual improvement in US economic data and a reducing risk of a disorderly default in Europe are important from the global risk-appetite perspective. A stabilisation in the Euro-zone could result in a revival of risk appetite for emerging market equities. On the domestic front, a reversal of the tightening monetary policy (driven by slower growth and moderation in inflation going forward) is important from the perspective of attracting global inflows into India. Markets could continue to drift until visible catalysts – most importantly, an end to monetary tightening locally – present themselves. In the long-term, domestic influences would be more important for our markets.

There are reports of the government's plan to ask state-run firms, sitting on huge piles of cash, to launch share buyback programmes. What is your view on this proposal?

The Government is likely to fall significantly short of its PSU disinvestment targets, and we have seen media reports suggesting the possibility of cash-rich PSU firms being asked to buy out the Government's stake in some other PSU firms.

We hope that this does not happen, as it would not be in the interest of minority shareholders. However, if there is a share-buyback launched by cash-rich PSU companies where both the Government and the minority shareholders can tender their shares, it would be a positive.

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