Global cues will drive markets; status quo on rates likely

The 25 basis points (bps, where 100 bps equal 1 percent) hike in the repo and reverse repo rates by the Reserve Bank of India (RBI) is a reinforcement of its anti-inflationary stance. The market reconciled itself to a rate hike post the August inflation numbers of 9.78 percent and its reaction to the rate hike is just a shrugging of the shoulders.

The equity markets were slightly up at close while bond yields were marginally higher post the rate hike. The market will look at a period of policy rates stabilising at levels of 8.25 percent on the repo rate and 7.25 percent on the reverse repo rate with liquidity in the negative zone.

[caption id=“attachment_85852” align=“alignleft” width=“380” caption=“Outlook for credit growth is not positive, given high lending rates. Erik de Castro/Reuters”]  [/caption]

Going forward the market direction will be determined by global issues more than domestic issues. On the domestic side, inflation is expected to stay at close to 9.5 percent levels for the next couple of months before trending down. There is a downside risk to the RBI’s GDP growth forecast of 8 percent, as acknowledged by the central bank.

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Credit growth at 20.1 percent year-on-year as of August 2011 is above the RBI’s target of 18 percent, and this credit growth is driven primarily by oil marketing companies (OMC) paying for losses sustained due to fuel sold at subsidised prices. OMC borrowing has increased by 24 percent from the end of March 2011 to end of August and stands at Rs 1,20,000 crore.

Outlook for credit growth is not positive, given high lending rates (lending rates to corporate and retail borrowers have moved up by 250-400 bps over the last one year due to RBI rate hikes and tight liquidity conditions). The RBI has acknowledged a slowdown in investments due to interest rates, inflation and other structural problems.

The global risk aversion issue is more important to the markets at present. The movements in the Indian rupee (INR), Indian equities and Indian government bonds have been dictated by global trends since the last policy review on 26 July 2011, where the RBI raised policy rates by 50 bps. The INR has tanked by almost 9 percent from levels of Rs 44.10 to Rs 48 (levels at which RBI had to intervene) on the back of volatility in global markets.

The Sensex and Nifty have fallen by over 8 percent while government bond yields are down by 10 bps with the 10-year benchmark bond yields coming off from 8.45 percent to 8.35 percent. Continued volatility in global markets on worries of a debt default by Greece, recession in Europe and growth slowdown in the US will keep domestic markets pressured.

The RBI has adopted a more easy tone on inflation in this policy review. It expects inflation to come off in the first and second quarter of calendar year 2011 on the back of the lagged effects of policy transmission. The central bank has recognised serious risks to global growth and its consequent effects on India. The markets will start to factor in status quo on policy rates in the forth-coming policy reviews.

Arjun Parthasarathy is the Editor of www.investorsareidiots.com, a web site for investors.

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