Kotak flags Indian market hurdles: Oil, rates, and government woes

Kotak identified new challenges for the Indian market in its latest note, including the prolonged global interest rate increase, the risk of rising global oil prices affecting profitability gains, and government limitations

After the record surge, Kotak Institutional Equities identified new challenges for the Indian market in its latest note, including the prolonged global interest rate increase, the risk of rising global oil prices affecting profitability gains, and government limitations due to lower-than-expected tax collections and current account deficits on economic support measures.

Since the start of April, Indian flagship indices, Sensex and Nifty jumped nearly 16 percent each while BSE midcap and SmallCap advanced 36 percent and 41 percent, respectively. FII invested around $19 billion in local equities during this period. However, some profit booking was seen in the last few weeks amid a surge in crude oil and hawkish comments by the US Fed.

Kotak said it anticipates a potential setback in the rebound of spending by BFSI and other Indian IT services clients due to rising concerns of a more substantial slowdown in the US economy than initially expected. The recent increase in valuations of IT services firms was driven by optimism regarding revenue recovery in 3QFY24, primarily due to the robust US economy. However, the US Fed's persistent hawkish approach to interest rates could lead to a less favorable economic situation than the widely anticipated 'soft' landing.

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The brokerage house acknowledges the rising risk of lower-than-expected profitability due to the recent surge in global oil prices and the subsequent increase in raw material costs, particularly affecting industries like automobiles and components (tires), construction materials, and commodity chemicals. These sectors had experienced a significant profit surge in recent quarters, which had led to overoptimistic valuations, assuming sustained profitability improvement. Kotak is uncertain if these companies can further raise prices to offset rising raw material costs, given subdued demand and already elevated profitability levels.

Kotak said it has also diminishing optimism regarding government spending to address the ongoing economic weakness, particularly in rural and low-income urban household consumption. Lower-than-anticipated corporate tax collections and significant losses by PSU oil marketing companies may limit the government's capacity to boost revenue expenditure, despite aggressive capital expenditure. Currently, bond markets remain relatively stable, it said.

Recently, Nomura Research warned of twin deficits as oil nears $100/barrel. Rising fuel costs may strain oil marketing companies, risking a higher government subsidy and jeopardizing the FY24 fiscal deficit target of 5.9 percent of GDP. Elevated oil prices, coupled with rice export limits, could widen the current account deficit from 0.2 percent in Q1 2023 to 1.1 percent in Q2 and an estimated 1.9 percent in H2 2023, according to Nomura.

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Meanwhile, Kotak has made some adjustments to its recommended large-cap portfolio. They increased the weights of Britannia Industries (20 bps to 1.5 percent) and Godrej Consumer Products Ltd (20 bps to 1.5 percent) while reducing the weight of Macrotech Developers Ltd (down 40 bps to 1.5 percent). Kotak maintains a positive view on the residential real estate sector, and most stocks, except for BFSI, which are currently trading near their 12-month fair values.

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