High double digit lending rates, high single digit inflation, high crude and a non-existent pass through mechanism for Diesel, Kerosene and LPG price, excessive pressure on Wage Inflation and the factual reality that most of India is living beyond it's means lends us to believe GDP growth for FY12 may realistically be sub-7 per cent. The big sufferers will be Real Estate, Construction, Infrastructure and Power Gen names. Worse comes to worse even demand for Automobiles of all dimensions and consumer durables too should fall sizeably.

We expect interest rates to rise a further 75-100 bps after the steep rise they have already seen raising fears of a slow-down in the economy. We tried to look at the past impact of a rising interest rate on the economy and the markets. Unfortunately, the history is limited with only one meaningful rising rate environment from Nov-2004. We saw a meaningful slow-down in sales of autos, cement and sales but overall IIP did not slow much. While global liquidity continued to drive markets, we did see a correction after the 4th hike.

Since we had only one steep rising interest rate cycle that coincided with a global world flush with liquidity, these conclusions may not be represented of what happens in future cycles. Indeed, we feel that the impact of rising interest rates will be more pronounced this time as economic environment both globally and in India is not as robust. Some observations from the last interest rate hikes:

1. There was minimal impact on the IIP which did not fall materially.

2. Non-agriculture credit growth slowed after the 3rd hike but not very significantly.

3. Autos slowed after the first hike but started surprisingly CVs and passenger vehicles recovered post the 3rd hike while 2-wheelers continued to lag.

4. Cement and steel had a pronounced slow-down (steel slowed with a lag) suggesting that construction activity did slow.

We feel that the global liquidity scenario was different in this period and hence may not be representative of markets this time.

1. Markets continued their rally though we did see a 30% correction in markets post the 4th hike.

2. Autos under-performed only after the 3rd hike (which means after a lag from the sales slow-down). CV stocks (Tata Motors, Leyland) however started correcting after earlier in the rate increase cycle.

3. Banks stocks actually outperformed till the 3rd hike. Post that at some point NPL worries started to drag stock performance.

4. Capital goods continued to outperform – we think this cycle will be different.