The stock markets have rallied to new highs in the hope the Narendra Modi-led government will kickstart investments and revive the economy; although earnings growth in FY15 may barely hit double digits, at 24,000 levels the Sensex is trading at its long-term average multiple of around 15 times. That in itself is a re-rating of the market, which is why a further re-rating from here on, should ideally call for earnings upgrades. However, any meaningful increase in companies’ profits, would require the economy to recover far more quickly than is now expected. Despite the new government’s best intentions, the road to recovery is going to be a long one, given legacy issues of high inflation, a bloated subsidy bill that pessures the fisc and high interest rates.
Moreover, the pace of the recovery will depend not just on the willingness and the ability of the corporate sector to invest but also on the quantum of investments that the government makes in the infrastructure space. While there is a clutch of companies that may have the financial wherewithal to fund projects, many of them are over-leveraged and will need to cash in on the current bull run to either pare debt or sell assets. Only once their balance sheets are repaired can these companies plan fresh investments. Given that there’s a fair amount of spare capacity, in sectors like cement for instance, companies would wait till they see more demand and pricing power. Moreover, this time around, given they are badly strapped for capital, bankers are likely to be far more cautious while funding projects, so tying up loans will be that more more difficult.
As such, no one is yet willing to bet the economy will grow faster than 5.5% in FY15—on the back of an estimated 4.7% in FY14—and most estimates peg the growth at lower levels. If everything falls into place—stalled projects get going, inflation recedes, spurring consumption demand and the monsoon is a good one—it is possible GDP in FY16 will grow at 6.5% spurring double-digit earnings growth. If the markets are running away it’s because there is complete confidence the government will get it right. But sorting out supply side bottlenecks—the shortage of gas or coal that can fuel power plants—could take time as could clearing projects since that would require the state governments to co-operate. A full-fledged recovery, therefore, seems unlikely before FY17. Perhaps it is time