Indian market is slipping on high crude price and inflation. Sanjeev Prasad of Kotak Institutional Equities feels that fiscal deficit could be more than 5.5 per cent if crude prices remain at current levels.
"Fiscal deficit could well be north of 5.5 per cent and closer to 6 per cent if crude prices remain at current levels and the government is not in a position to raise domestic selling prices of diesel, kerosene and LPG," Prasad said in an interview to CNBC-TV18.
Further, Prasad has reiterated a sell rating on Mphasis with a target of Rs 610, due to a disappointing earnings.
Below is a verbatim transcript of Sanjeev Prasad’s interview with CNBC-TV18’s Udayan Mukherjee and Mitali Mukherjee.
CNBC-TV18: How worried are you about what is happening in the macro environment with crude right now and does it change your basic hypothesis about the market?
Sanjeev Prasad: I am clearly worried. If you take average crude price of $105 per barrel through the rest of next year, it could well be higher, looking at the events in the Middle East. Now at best, oil companies can bear about Rs 40,000-50,000 crore which means they are left with somewhere about Rs 90,000 crore which has to borne by the government which means that’s about a percentage point of your GDP.
Effectively, your fiscal deficit which the government may show at about 4.8 per cent as far as the targeted number is concerned in the coming budget could well be north of 5.5 per cent and closer to 6 per cent if crude prices remain at current levels and the government is not in a position to raise domestic selling prices of diesel, kerosene and LPG.
The second part is what happens to the current account deficit which currently we are modeling at somewhere about 2.7 per cent and that’s based on $85 per barrel crude price. Every $1 per barrel increase in crude price adds about $900 million to our current account deficit and imports, which means that if you take $105 per barrel you are looking at about $17 billion additional.
This means effectively another percentage point of the GDP. Your current account deficit could slip to about 3.7 per cent which would put a lot of pressure on the BOP and the currency. Clearly, both on the fiscal deficit as well as the current account deficit, high crude prices is a pretty big overhang and something to get worried about because that will translate into a weaker rupee, much higher borrowing program which means higher interest rates. If the government has the gumption to raise prices then it’s going to impact inflation. Whichever way you look at it, it’s not good news for the Indian market.
CNBC-TV18: You were making the point about oil. The last time you came away from earnings season in the third quarter you thought it didn’t look too bad. Given what has changed on the dynamics with crude, would you have to rework earnings expectations?
Sanjeev Prasad: I don’t think that much because we have already cut down earnings numbers quite significantly. We are looking at about 22 per cent earnings growth for FY2012 at the beginning of the third quarter results season. We have brought it down about 18 per cent. There could be some impact if interest rates continue to be higher than what we have built in.
If the government has a much higher borrowing program then that will feed into higher interest rates over the course of the year. That should impact high debt companies to some extent. However, I don’t see earnings numbers getting that much impacted barring the energy companies which anyway people really don’t care about that much at this point of time.
From a BSE-30 or from a Nifty-50 perspective, I don’t think these stocks will matter that much. Barring BPCL, I don’t think HP and IOC are not even present in the Nifty. I suspect what matters more for this market at this point in time is just a worry on the macro front and what high crude prices mean for the current account deficit and the fiscal deficit.
CNBC-TV18: Do you have MphasiS under coverage? What did you make of those numbers?
Sanjeev Prasad: A rather very poor set of numbers honestly. An 8 per cent quarter on quarter decline. The EBITDA margin has come down about 400 basis points and the disclosure levels have gone from bad to worse. Clearly, this company is struggling at this point in time. If you look at the consensus in the EPS numbers, somewhere about Rs 53 if I remember correctly, that is going to come off pretty sharply.
I guess the stock is getting punished for very bad performance as also disclosures. At this point in time, the mood of the market is that any little mess, particularly, when it comes to corporate government and disclosures, people are going to take a pretty negative view of that. If it’s a midcap, it’s a double whammy in that case.
CNBC-TV18: The one sector which the market is punishing a lot, ever since crude started spiking is the banking sector. Do you think it’s a justified reaction, the fear that the macro problems will eventually filter into higher yields and banks should correct? Are those earnings at risk or is it just sentiment?
Sanjeev Prasad: The concern is pretty much valid but how much of it will translate into earnings numbers we will have to wait and see. If crude stays at about $105 per barrel, you are looking at about a trillion rupees of addition borrowing from the government, assuming it’s not in a position to raise prices during the course of the year. That’s clearly going to feed into higher yields.
In our model assumptions, we have already built in about 8.5 to 8.75 per 10-year G-sec yields. We have tried to factor that into earning numbers but the problem is that sentiment is so weak at this point in time that anything which is perceived negatively in terms of macro pressures, whether it is G-sec yields or fiscal deficit etc people are going to cut their positions quite sharply.
CNBC-TV18: You have tracked Reliance for many years. What did you take away from that big deal with BP and did it change anything for you in terms of where the stock could go?
Sanjeev Prasad: There are two ways to look at it. One is what does it mean for Reliance and the second is what does it mean for India. As far as Reliance’s impact is concerned, it did not mean that much in the sense that we are already valuing the spike blocks including D6 at about $21 billion. If you see the valuation which BP has given for the 23 blocks that comes to about $24 billion.
Keep aside the performance numbers which will anyway flow over a period of time and the NPV of that is pretty small. So, $21 billion for the major block versus $24 billion is not that much of a difference. As far as the sum of the parts value is concerned that doesn’t change much. From Rs 990 which was our earlier valuation has gone up to about Rs 1,010. Not much of a direct impact in terms of the valuation but from a sentiment perspective, it is a pretty big positive because a lot of people were getting very concerned about the E&P portfolio of Reliance, particularly, in respect to D6 and its implication for some of the other blocks.
People will now have some sort of a flow as far as the value of E&P is concerned, maybe somewhere about Rs 300-350 and that’s a positive in one sense. People can then value whatever they want to value for the chemicals refining part. Other good thing from a Reliance perspective is hopefully this will result in ramp up of gas production whenever BP is in a position to look at the data and transfer technology. It’s maybe more of a fiscal 2013 story, in terms of volume ramp up but at least you have a much global play with some amount of expertise looking at details, so that’s a positive.
Coming to the impact on India, there are two positives. One is the direct FDI flow of about $700 billion. That helps at a time when you have very high crude prices. That is equivalent of about $8 per barrel higher crude price. It’s obviously not going to offset the kind of outflows you are going to see if crude remains at current levels but nonetheless, $7.2 billion is a significant amount of money and, hopefully, helps the BOP to some extent.
Secondly, the larger impact of this is India is getting a lot of negative press globally, given our own inflation issues, corruption issues and all the delay which one is seeing in the Cairn-Vedanta deal. People are getting concerned whether India is going to honour valid contracts. At a time when India is facing this negative press, one large global company coming and putting $7.2 billion is a fairly big endorsement and that’s probably the bigger takeaway from this deal.
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