Sensex has declined 8% from its high of 23rd July as rupee depreciated fast due to structural problems. BNP Paribas in its India strategy report explains the factors to consider while investing now

After the recent sharp decline in Sensex, investors should look at high quality cyclical stocks and stocks in auto, engineering, non-banking financial corporations (NBFC) and private sector banks, suggests BNP Paribas in its report on where to invest now. Even as capital expenditure recovery seems pushed back, stocks that depend on consumption, could find support mainly in rural areas, thanks to abundant and well-distributed monsoon. It also believes that a few oil & gas and power utilities provide good prospects.
 

The Sensex has declined 8% from its recent peak on July 23^rd. Its recent correction is much sharper than that in the earlier instances and it opens up the possibility of further declines, taking the market below previous support levels. In fact, the Sensex has been relatively protected by the economy-proof large cap stocks in sectors like IT, pharmaceuticals and consumer goods. Several frontline stocks in financials, engineering, metals and other sectors have declined a lot more. While Sensex is still trading around the 10% band that it's been moving in over the past 8 to 10 months, the mid caps and small caps have been badly hit. Some mid cap stocks have declined between 50% and 80% in 2013 till date, as captured in the chart below.
 

This recent downturn was perhaps overdue, but was triggered by the RBI's liquidity tightening measures to stabilize the Indian rupee. The Indian rupee stabilized only for a couple of days. “But the damage to growth expectations was possibly more permanent” stated the Report by BNP Paribas.
 

The RBI’s liquidity tightening measures don’t seem to be stabilizing the rupee. Unless structural measures to reduce the trade gap are implemented, BNP Paribas believes the rupee will weaken further. In the near term, it seems the rupee will continue to depreciate unless the government imposes import controls or other quantitative restrictions on imports. After all, the main driver of India’s large trade deficit is the fact that India consumes more and produces less. In fact, as BNP Paribas points out, “gold imports and oil imports are often cited as key reasons for India’s large trade gap even though the authorities have adopted strong measures to curb gold imports. However, growing consumer goods and capital goods imports are other strong drivers of the trade gap and have not been addressed adequately. We do not expect currency stability until there’s a coordinated assault on the structural drivers of trade deficit.”
 

“The oil stocks could be adversely impacted from Indian rupee depreciation due to under-recovery and subsidy burden. Also, companies with foreign debt exposure like Bharti Airtel, Adani Power and Tata Power, Power Finance Corp and REC lose out. NBFCs could be impacted if RBI continues with tightening liquidity measures,” stated the report. Liquidity tightening could hurt valuations of the banks and engineering companies as well.
 

In this context, companies with substantial exports, “from sectors like IT and Pharma outperformed significantly and they will continue to outperform in current scenario of depreciated rupee” stated in report. Report also mentioned that auto sectors having earnings in foreign cash flows like Tata Motors and Bajaj Auto may benefit from the weak rupee.