1997 crisis will not repeat; outlook downbeat: IIFL Capital Services

23 Mar 2023 , 10:51 AM

Analysts at IIFL Capital Services conclude that a major crisis repeat is unlikely as most countries are better fortified against capital outflows than in 1997, with India registering one of the best improvements. But even so, and despite the possibility of an early pivot by central banks soon (analysts at IIFL Capital Services derive US inflation is near zero sequentially for a few months now), with distinct weaknesses in the US economy, the over-tightening genie is out of the bottle. A sharp slowdown and earnings downgrades are likely, globally and in India. Analysts at IIFL Capital Services prefer companies with idiosyncratic strength in business momentum and add DLF and HDFC Bank in their top picks, while they remove Deepak Fertilizers, and continue to remain Overweight on banks.

AFC will not repeat

Analysts at IIFL Capital Services have looked at GDP growth, FX reserves/external debt, external debt/GDP, current account, FDI/FPI, debt/GDP for government/private/HH, money supply growth, inflation, depth of currency markets for India, China, Malaysia, Indonesia, Thailand, Philippines, South Korea. 1997 saw these countries having high inflation, currencies pegged to USD, inability to respond to a sharp devaluation (45%) of CNY by China, low FX reserves levels, and consequently currency pegs breaking, impairment of GDP growth, etc. However, there has been substantial all-round improvement since, especially for India, and significant capital flight happened during 2022, and an AFC repeat looks very unlikely. That said, there can be sharp incremental outflows back to USD government debt and other safe havens, and domestic monetary conditions will stay tight.

But overtightening genie out of the bottle

This time, the risk is more likely to be a slowdown in the US itself. Analysts at IIFL Capital Services believe, modifying US sequential CPI inflation by using real-time housing/rental levels, they find inflation to have been near zero for five months. Further, PMI having been significantly below 50 for seven out of the last eight months, retail spending having been flat in real terms for two years, despite rising credit card balances and shrinking pool of excess savings generated during COVID are but two indicators of weakness, regardless of low unemployment. It is into this weakness that the US Fed will likely hike by another 25 basis points (since writing this note, the US Fed has hiked, as expected) to avoid signaling helplessness, given several bank failures this month. Even if AE central banks pivot soon, lag effects of hikes thus far, will hurt.

Downside bias remains – shoot for earnings visibility

In these circumstances, naturally, capex talk has subsided, after some optimism over the last two years. Earnings estimates will see downgrades, globally. Further, food inflation may prove persistent, given the higher temperatures in India and draught-like conditions in Europe. On the other hand, for India, there have been very few longer-bear phases; Nifty PER is down by 20% in 17 months. Later in the year, it is not unlikely that China continues its growth post zero COVID (though at a modest rate of 5%, but analysts at IIFL Capital Services will take anything for now), the US Fed pivots and ECB follows suit, and in India, RBI responds too. Analysts at IIFL Capital Services could see sentiment improve. On balance, they would advise portfolio construction with relatively high earnings visibility names, keep overweight on Banks and keep underweight on IT.