Concerns on Unfunded CAD are overdone

Sep 09 2013, 10:58 IST
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SummaryQ2 will be the most painful quarter we have seen in this downturn

the economy) should grow at well over 3% (our FY14 estimate is 6%, the Q1FY14 figure was 6.6% and the five-year average is 9.1%).

If 75% of the economy grows at a rate significantly north of 3%, Industry would have to contract by 8% for FY14 economic growth to fall to 2%. For the record, Q1FY14 growth in the industrial sector was a measly 0.2%.

That brings me to the second issue of concern at present. At Ambit, we turned buyers of the Indian market in late-May 2012 when the Sensex was around 16,000. On 24th September 2012, emboldened (prematurely as it would turn out) by the UPAs desire to move on with economic reforms, we raised our Sensex target from 19K to 23K. This 23K target was premised on FY14 Sensex EPS of R1,350 (implied y-o-y growth of 14%) and a forward P/E multiple of 17x (in-line with the six year average). Lets revisit this target.

The actual Sensex EPS for FY13 came in at R1,184. At present our sector leads bottom-up FY14 Sensex EPS estimate is R1,282 (implying 8% y-o-y growth). Now assuming further EPS downgrades post the RBIs tight monetary policy biting in Q2, we are likely to end up with FY14 Sensex EPS of R1,243 (5% y-o-y growth).

Multiplying R1,243 by 17x (the ten year trailing P/E is 17.6) gives us a Sensex target of 21,000, below our previous target of 23,000, but still implying 13% upside from current levels.

That being said, I am aware that a number of investors believe that the Sensex cant rally given the gravity of the current account crisis facing India. Whilst the unfunded CAD is a worrisome issue, I believe that these concerns are being overdone.

The CAD in FY13 was recorded at about $90 bn. Assuming that: (i) full year exports growth for FY14 is recorded at 10% y-o-y i.e. a $30bn increment in exports receipts, and (ii) full year imports growth is recorded at 3% y-o-y with the slower imports growth being driven by lower imports of gold, the incremental imports bill for FY14 amounts to an increment of $15bn. This should then mean that Indias CAD for FY14 gets compressed to $75bn (i.e. 90+15-30 $bn). From thereon, a combination of import restrictions on electronic goods, iron & steel and defence goods is likely to compress the CAD by another $15 bn thereby leading the CAD to be recorded at $60 bn.


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