Without real sign of rate cuts, Indian equity rally still fragile

By Reuters Staff
February 6, 2012

Indian equities are among the best emerging markets performers this year, with the Mumbai market having posted its best January rise since 1994. That’s quite a reversal from last year’s 24 percent slump. The bet is faltering economic growth will force the central bank to cut interest rates from a crippling 8.5 percent. So, how safe is the rally?

Some conditions are already in place. Valuations look decent after last year’s drop. There has been a surge in global investors’ appetite for emerging market assets. So Apurva Shah, who helps manage $600 million at the BNP Paribas Mutual Fund in Mumbai, expects positive returns from Indian stocks this year. But for a decent rally to be sustained, interest rates have to fall in order to kickstart faltering growth, he says.

The risk is really the assumption that interest rates and inflation are actually on the way down. We’ve seen the first leg of that happening, but it’s just the beginning. Rates are still way too high. To trigger off any real revival in economic growth they need to fall a lot more.

The market may be pricing Indian interest rates to fall between 75 to 100 basis points this year but there is little indication this will actually happen. The central bank, the most hawkish in the developing world, has cut reserve requirements and voiced concern about growth. But a senior central bank official has made clear only a sustained fall in inflation will prompt a rate cut.

Inflation is indeed easing but elevated food prices, infrastructure bottlenecks, and the government’s seeming inability to cut back on budget spending mean the battle is not over yet.  Shah says that for the time being he is sticking to long positions in consumer stocks with a domestic focus, including consumer banking companies, and shying away from rate-sensitive stocks such as state-controlled wholesale banks. That will change if rates actually start to fall.

There have been a few false starts in the past, so we will want to be doubly sure that it’s actually happening

(By Alessandra Prentice)

No comments so far

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/