Earnings: Slower growth

Higher interest rates and inflation might eat into consumer demand and, therefore, companies' profits

At 13,802, the BSE Sensex trades at just under 14 times estimated FY09 earnings, which are expected to grow by about 19 per cent over FY08. At these levels, the narrow market is not expensive and the broad market is far cheaper. However, what's worrying the Street are deteriorating macroeconomic conditions that could mean earnings estimates being revised downwards. Already GDP growth numbers for the current year have been lowered to between 7 and 8 per cent. If corporate earnings grow at a much slower pace than anticipated, say at 15 per cent instead of 19 per cent, the market begins to look that much more expensive.

High inflation and high interest rates will eat into household incomes, allowing them to spend less and perhaps resort to some degree of down trading. Those who might have wanted a home loan or a two-wheeler loan may think again. The sectors that are likely to be impacted the most are banks, automobiles, retail and real estate.

With car and two-wheeler loans more expensive and scarcer too, sales of two-wheelers and cars are unlikely to be very robust this year.

Retailers too are unlikely to do brisk business since inflation in essential items has drilled a hole in the pockets of the consumers. Should companies hold back capacity expansion plans, the demand for construction materials and capital goods too could slow down.

Banks have started increasing interest rates though that may not compensate for the higher cost of borrowing. Since the banks now have to maintain higher cash reverses, the yield on which is negligible, and repo rates have risen, the cost of borrowing will rise. In addition, they will need to raise deposit rates too.

Borrowers, both retail and smaller corporates, are likely to shy away from taking loans at higher interest rates.

Thus, earnings for banks will be hit by slower volume growth, weaker net interest margins, deteriorating credit quality and mark-to market losses in their investment books. (Source: B.S.)