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Sunil Nayanar | January 06, 2004

2004 is here, and if 2003 is anything to go by, things can't possibly be more exciting than now. All signs point to another profitable year for the Indian equity markets.

Big IPOs are lined up to hit the markets in the next few months, interest rates are seemingly destined to remain soft for the foreseeable future, and there are no indications of any scam to mar the party -- all of which can only mean more upside for the indices.

With the India story gaining ground, more and more FIIs are expected to come in and analysts are quietly pencilling in higher corporate earnings numbers. What more can you ask for?

Well, nothing much, except that there are some things which may just catch us by surprise.

While interest rates and FII inflows could throw up some unpleasant surprises, the biggest imponderable is the looming general election.

What if the ruling National Democratic Alliance loses? The Smart Investor takes a look at some of the surprises that 2004 may have in store for investors -- for which they should be ready.

General elections

What if BJP loses?: The chances are that the ruling Bharatiya Janata Party and its allies will continue in power after the general elections to be held later this year -- or may be in the next four months.

There are two risks associated with the polls -- what if the BJP doesn't win?

The assumption is that a BJP/NDA win will see reforms gathering pace, but if a different combination of parties comes to power, uncertainties will rule for a while.

According to analysts, the second scenario seems less likely for the moment -- but that's not the same as saying that it won't happen. After all, even in the recent state-level elections, nobody expected the Congress to lose Rajasthan.

The second worry is short-term. Analysts express concern that the pace of reforms could be sluggish in the run up to the elections.

On the plus side, however, they say that irrespective of a change in government at the Centre, post-election reforms is a certainty -- the only doubt being the rate of change.

"Even if the NDA loses the elections, any negative impact on the markets will only be temporary. The influence of politics on the markets has reduced substantially in recent years," says Jamshed Desai, head of research at Mumbai-based securities firm Taib Securities.

Interest rates

Could they rise?: Just about everybody is certain that interest rates will continue to have a soft bias in the near to medium-term future.

"I expect  interest rates to remain at the current levels as long as there is no substantial shift in the global economic scenario," says Desai.

While there is no cause to disbelieve him, the risk is that as the economy charges ahead with 7 per cent plus growth, interest rates have to move up some time or the other. There are hints that global rates have started to move up, too.

According to a recent Merrill Lynch report, any sharp rise in interest rates could be negative for the economy since it could slow down the consumption boom as well as slow investment spending.

But the report also notes that it could trigger a move by retail investors back to equities. Debt markets also stand to gain from higher interest rates.

Most analysts' worries stem from a rise in global rates, increased growth in corporate loans and the country's high fiscal deficit.


Sale? Which ones?: Nobody expects the government to privatise HPCL and BPCL anytime soon, especially in an election year.

However, there is a fair chance that the government will go ahead with the sale of its residual stakes in many companies. Balmer Lawrie, Engineers India, National Aluminium Company, Rashtriya Chemicals & Fertilisers, Shipping Corporation of India and Madras Fertilisers are some of the companies that are slated for divestment.

According to analysts, if the NDA coalition manages to cling on to power, the ruling party might even go ahead with the divestment of HPCL and BPCL.

The market is eagerly awaiting the Supreme Court's final view on whether or not these companies can be sold without seeking Parliament's consent.

In September 2003, the apex court had stayed the Divestment in both HPCL and BPCL, noting that the government needed parliamentary approval for any such move. Wait and watch.

Corporate earnings

Will US, China slow down?: The going has been good for India Inc last year and the chances are that domestic companies will continue to post impressive performance.

Infrastructure sectors like cement and steel are likely to show better results; so are auto and auto ancillaries.

A good monsoon in 2004 -- or the lack of it -- will have a bearing on FMCG and fertilisers, and for IT 2004 might just turn out to be a better year if the dollar starts strengthening.

Though analysts expect earnings growth to be a major factor in driving the markets, they express concern that a global economic slowdown, especially in China and the US, will have a negative bearing on Indian corporates.

While a slowdown in China is expected to hit commodity prices, a weak US economy will surely have a big impact on software earnings.

FII investments

Will they, won't they?: Foreign institutional investors have been the main drivers of the current rally in the markets. The big question is: will they continue to be as bullish on India in 2004?

There is no reason why they shouldn't, say analysts, but in case of a global liquidity crunch they may choose to be more parsimonious with their money.

"The key factor in FII investments is the strength of the dollar. If the dollar crashes further, there will definitely be a disruption in global equity inflows, which is a very real possibility," warns Desai.

There are other worries, too. Market watchers note that  most of the existing FIIs are cautious on the markets at current levels and are not investing additional money after the current rally.

Merrill Lynch notes that India is one of the biggest overweight markets for global emerging market funds and as a result slower FII flows are expected in Indian markets.

However, Merrill analysts also predict that non-dedicated global investors could still drive flows to Indian markets.

Union Budget

Will it be delayed?: Well, if the government opts for early elections, the budget will shift to mid-year. Despite worries about the fiscal deficit and the rising subsidy bill, nobody's expecting big changes.

"I don't expect the government to do anything dramatic in the budget," says Desai.

Analysts note that the combined fiscal deficit of the Centre and states of 10 per cent of GDP greatly weakens their collective ability to undertake large capital expenditure or investment in the social sector.

The way to reduce the deficit is mainly through tax reform and divestment, they argue. Will that happen this year?


Will prices fall?: The perennial Middle-East crisis could take a turn for the worse, God forbid, and there could be an escalation in oil prices.

While the near-term outlook on oil prices is strong due to winter demand and OPEC output limits, analysts expect a possible fall in oil prices after winter.

Pressure on prices is expected to ease following increased production from Iraq and non-OPEC producers such as Russia.

Oil analysts are of the view that the recent arrest of Saddam Hussein could lead to higher oil production in Iraq, with exports slated to return to normal levels.

Sector watch

Pharma -- MNCs in focus: Generic companies are slated for explosive growth, with the US government planning to lower healthcare costs. The US is putting in place a legislation to increase the use of generics rather than branded drugs.

With more companies getting nods from the USFDA for their production facilities, analysts expect a surge in drug sourcing from India.

According to analysts, the sea change in the Indian pharma scene will happen in 2005, when the product patent regime will be implemented.

This will bring the MNC pharma companies in focus, especially when they launch their global blockbuster drugs. Contract manufacturing and R&D outsourcing to India are also expected to hit big time as 2005 approaches.

Infotech -- Margins may suffer: Most analysts prefer to be neutral on the sector going forward. With demand trends looking very positive, short-term margins are expected to be steady.

However, most analysts are not so sure about long-term margins.

While strong demand is expected to push up prices, visa issues and an appreciating rupee are seen as troublesome by many.

IT service companies are expected to clock strong revenue growth but margin pressures are set to continue. Increased competition is expected to lead to pricing pressures.

Market players are of the view that the sector has been moving more or less in line with the overall Indian market for the past few months, and that is set to continue.

Outsourcing will continue to be the big growth area, although an increased BPO backlash cannot be ruled out.

Autos -- On a fast track: Last year's good monsoons are expected to boost demand for the Indian auto industry. There has been a  considerable improvement in consumer sentiment, as wider choices and easy and cheap financing continues to provide a fillip.

Most segments, including motorcycles, cars and commercial vehicles are expected to do well this year in terms of volume growth.

With most companies achieving better economies of scale and controlling input costs, the segment is poised to continue on its growth path, say analysts.

Consumer goods -- Slow, but steady: The consumer goods sector has also benefited from good monsoons and an improvement in consumer sentiment. A good monsoon and harvest mean better income levels in rural areas, a segment where penetration is relatively low.

However, analysts still expect revenue growth to be in single-digits, albeit slightly higher than the current year's growth of 4-5 per cent.

Meanwhile, higher prices of most commodities are likely to impact many consumer goods categories. But analysts expect companies to implement price hikes to offset this.

Steel -- Global demand is key: The steel sector is expected to do well in 2004, as continued infrastructure spending and construction activity will keep pushing prices higher, say analysts.

Driven by Chinese consumption, prices of steel products have gone up and that too without any apparent pressure on margins. However, a slowdown in global demand and the likelihood of the addition of new capacities may prove a drag.

Cement -- Prices should firm up: Cement prices were more or less stagnant last year, mainly because of an addition to capacity due to de-bottlenecking, and an increase in the proportion of blended cement.

Besides, the fragmented nature of the industry led to intense price competition by the players.

But the good news is that prices are firming up in the south and east and companies are showing improved operational efficiencies, mostly in the area of power costs, with some companies having commissioned captive power plants.

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