Sensex, Nifty can end year at record highs if Fed taper is a non-event

The whole market was expecting a 25 bps repo rate hike by the RBI in its policy review today but was (un)pleasantly surprised when the central bank refrained from a rate hike. The market was prepared for a rate hike with equities correcting from highs, the rupee falling and bond yields rising going into the policy.

The question is was the no-rate hike policy warranted? The markets were well prepared for a rate increase and would have preferred one with a guidance. However, a no-rate hike with an uncertain guidance that it may take action on non-policy dates if the inflation moves higher will keep the markets edgy.

The markets have reacted positively to the RBI policy announcement with equities rising 1 percent, bond yields falling 12 bps and the rupee moving up marginally. Before taking a direction, the markets will await the Fed’s December policy meet outcome later today. The wide expectation is that the US central bank will announce tapering off of its $85 billion monthly bond purchase.

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The RBI cited risk factors to GDP growth that has hit a decade low of 5 percent as the primary reason for holding on to the policy rate. The weak trend in industrial production that has shown zero percent growth during April-October coupled with the government cutting down spending to contain fiscal deficit at 4.8 percent of GDP is adding to concerns about growth.

The central bank stressed on the fact that both CPI and WPI inflation are at uncomfortably high levels at 11.24% and 7.52% levels, respectively, but is willing to live with this given that vegetable prices that are up 60% year on year is primarily contributing to such high inflation levels. Vegetable prices do look to be coming off and if it sustains inflation can print sharply lower going forward.

The RBI at this point of time is more concerned with liquidity being made available to productive sectors of the economy. The central bank has pumped in over Rs 2,000 billion into the economy since September 2013 through the FCNR B swap window. The RBI has conducted OMO purchase auctions and is holding term repo auctions to improve system liquidity. Liquidity at this point of time is in a comfort zone with banks even lending money to the RBI in the daily LAF auction.

The Sensex and Nifty could well end December 2013 at record highs if the Fed taper is seen as a non-event by global markets. Positive economic data emanating out of the US and Europe that has seen fall in unemployment levels, rise in manufacturing, consumer and business confidence and record high levels for equity indices will spur a global market rally even if Fed announces a measured taper. Inflation is well below any kind of threat levels in the US and Eurozone and central banks will keep rates at all time lows going into 2015.

The rupee will benefit from positive flows into Indian equity and bonds. Current account deficit expected at 30 percent below last year’s levels will add comfort to the rupee. Bond yields too will fall on the rupee strength and the RBI maintaining status quo on interest rates.

Arjun Parthasarathy is founder Investors are Idiots.com and INRBONDS.com. Follow him on twitter #investorsidiots