Pharma, textiles are safer bets today

Most people underestimate India's import sensitivity. On an average, World Bank data shows that imports have been around 26 per cent of Gross Domestic Product (GDP) in the last ten years and imports have never fallen below 21 per cent of GDP since 2009-10.

The connection to crude prices is clear. In FY 2010-11, and 2011-12, when the price of the Indian crude basket trended above $100/barrel, imports rose above 30 per cent of GDP.  In 2015-16 and 2016-17, the crude basket was priced at $46-47/barrel and imports fell to 21-22 per cent.

Exports have stagnated in the past six years. Exports peaked at 25.5 per cent of GDP in 2012-13 and dropped below 20 per cent in FY 2015-16 and 2016-17.  "Invisibles" meaning remittances, earnings from tourism, IT services, etc., have kept the trade deficit to manageable proportions. The Current Account Deficit (CAD) has also remained under control due to consistent portfolio inflows.

India's import bill expands by Rs 105 billion for every $1 hike in crude prices. Last fiscal (2017-18), the crude basket ran at $56.43 and the Current Account Deficit was 1.9 per cent of GDP. Crude prices were at $80/ barrel in October and ran at an average of $74.6 for April-October 2018.

In October, estimates indicated the CAD would spiral above 2.5 per cent of GDP for 2018-19, perhaps even touch 3 per cent. The sharp fall in November turned those calculations on their head. The average price for 2018-19 may come in a lot lower than $74.

But crude prices will not snap back below the $50 level. The three largest oil producers in the world, namely the USA, Saudi Arabia and Russia, won't let that happen. The USA is the largest crude producer. But 50 per cent of its production costs over $45/ barrel to extract. If prices drop below $50, US supply will reduce sharply. About 25 per cent of US production came online only after January 2018, when prices (West Texas Intermediate) moved above $60. The Saudis want production cuts to ensure that prices stay above $65. The Russians may be looking at $60-plus, if reports are correct.

So crude prices are likely to remain elevated even if they have declined from peak October levels. The consequences of high crude prices are simple. Exporters may gain from rupee weakness but there are no other apparent upsides. Even companies like ONGC and OIL, which are primary energy producers, are hobbled by government control and poor policy.  The refiners will all see squeezed margins and the PSUs may suffer from price controls as well.

On the export front, at this instant, the traditional hedge of the IT industry looks fragile. None of the IT majors have very strong advisories. The US, which is the key market for infotech, is seeing a selloff across the IT sector. Indian IT American Depository Receipts have also been sold down in the US. The EU operations of IT majors could see business disruption due to Brexit, since they are all headquartered in the UK.

Pharma is a possible play. The mid-range pharma stocks seem to be doing okay. There is room for a turnaround across pharma stocks. However, pharma stocks are still pretty highly-valued and there are uncertainties about US healthcare policy and the usual issues of IP-related litigation.

Textiles are another interesting option for investors who are seeking export exposure. The Q2, 2018-19 results indicate that textiles have recovered to a large extent from the impact of GST in the same quarter of 2017-18. In October 2018, exports of textiles and apparel jumped by 33 per cent year-on-year. There are base effects, again due to Goods and Services Tax (GST), which complicate the issue.

The government has tried to be supportive with the Merchandise Exports from India Scheme. The weaker rupee is a definite factor in boosting exports as well. However, rupee weakness could be "cancelled" out by declines in the currencies of competitors like Bangladesh and Vietnam.

Net-net, the correction in the crude oil market will limit the damage caused by high energy prices. But India will end up with a higher CAD than the 2018-19 Budget estimates. The rupee will be weaker. Pharma and textiles look like safer investments than IT stocks. Textile businesses are priced at lower valuations and could therefore, have a greater upside.

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