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This could crush India's rosy outlook

INDRANIL MUKHERJEE | AFP | Getty Images

The investment outlook for Asia's third-largest economy is buoyant, but the start of earnings season could prove to be the thorn in the market's side, forecasts show.

Companies listed on India's benchmark Sensex stock index are expected to record flat quarterly earnings growth for the October-December period, India's third-quarter of the 2015 financial year, according to a report from Citi published on Monday. That would mark the weakest growth in five quarters.

"There's a lot going for India, but it's not this quarter's earnings," economists at the bank said, referring to the country's current status as a top emerging market pick.

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Edelweiss Financial Services also expects companies in India to yield zero growth in profits after tax (PAT), adding that earnings downgrades are likely in the coming months.

A more than 50 percent tumble in Brent crude prices over the past six months has been a blessing for the Indian economy, as India imports over 70 percent of its oil needs. That helped New Delhi rein in consumer price inflation to 5 percent on year in December from double digit levels in 2013, pushing the Sensex up 30 percent in 2014.

However, the same can't be said for Indian oil and gas companies, which account for 13 percent of the Sensex index, excluding oil marketing firms, since lower crude prices hurt the profit margins of energy producers. Citi sees growth in the energy sector declining 11 percent on quarter for the three months that ended in December.

Meanwhile, a stronger rupee is expected to weigh on export-oriented industries such as pharmaceuticals and information technology (IT). Growth in the former sector is seen falling 0.6 percent on quarter, according to Citi, following the currency's 10 percent spike against the euro over the past six months.

"Ideally, this [weakness in oil and export sectors] should have been compensated by domestic- oriented sectors. But, given the weak domestic demand and probable inventory losses, domestic consumption as well as investment-oriented sectors are expected to report stable but subdued earnings growth," Edelweiss said in a report last week.

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Consumer goods output, widely seen as a proxy for consumer demand, has grown in only two of the last 22 months.

The tepid earnings growth in the third quarter may add pressure on Sensex earnings-per-share (EPS) estimates for the full year. EPS grew 11 percent in the first half of the 2015 financial year, i.e. from April to September. Edelweiss expects 14 percent growth for the full fiscal year, which implies Sensex companies have to log 17 percent growth in the second half. Edelweiss says that may be unlikely if third-quarter earnings are flat.

On the bright side

Earnings amongst financials are expected to outperform other sectors on the Sensex as lower bond yields translate to large treasury gains for lenders. State-run banks are among the biggest buyers of government debt in markets and with benchmark 10-year bond yields trading at 17-month lows in late November and December, banks engage in provision write-backs.

Citi sees 22 percent profit growth for financials, which make up roughly one-third of the Sensex's marketcap.

Moreover, the gloom expected in the October-December season isn't expected to last. Edelweiss sees two-year forward EPS estimates for Sensex companies surging an annual 23 percent.