The credit policy and after

June 21, 2011

(The views expressed in this column are the author’s own and do not represent those of Reuters)

The Indian stock markets are in such a state of nervousness these days that the moment somebody shouts ‘Boo’, it triggers a bout of panic selling.

That’s what happened when the RBI announced the anticipated rake hike or when a section of the media reported rumours about the Mauritius tax treaties being revised and capital gains on Mauritius-based funds being taxed.

With more rate hikes expected, are we headed for another prolonged bear phase? Will we see the same kind of GDP growth during 2011-12, as was anticipated before inflationary pressures and the consequent rate hikes hit the economy?

We have seen as many as 10 interest rate hikes since March 2010 but inflation shows no signs of coming under control. While the rate hikes have started hurting the corporate sector, the RBI has observed it is willing to sacrifice growth (in the short-term) in order to bring inflation under control.

Despite a good start to the monsoon, food prices have started rearing their head sharply again, indicating that inflation for the month of June is only going to rise further. It is also important to keep at the back of the mind the fact that the petroleum products price hike had been postponed due to state elections and is imminent.

Rising fiscal deficit is the other concern which hasn’t raised too many eyebrows yet. Pressure arising out of petroleum and other subsidies will ensure that cries for raising diesel, petrol and LPG prices will get stronger, thereby nudging inflation upwards. Consequently, more rate hikes can be expected in the next few months.

Think about it, why would people rush to buy cars when the petrol price is nudging 70 rupees (from around 45-rupee levels just about a year back) and expected to rise further? Why will they not postpone their decision to buy a house when rising interest rates ensure that their 15-year loan gets extended to 20 years, or monthly loan instalments keep rising, making family budgets go haywire.

At a time when monthly surpluses in middle-class India are shrinking due to rise in costs of foodstuffs, spending on comforts and luxuries will clearly tend to take a back seat.

Financial crises in some of the European economies clearly appear to be far from over. The fear of banks globally getting affected due to this crisis will ensure risk aversion, and will keep funds from getting invested into equities, more particularly emerging market equities, for the time being.

A market like India which is largely dependent on FII funds for sustaining upward movement will witness a temporary drying up of sustainable FII liquidity, valuations notwithstanding.

High borrowing costs and an inability to raise adequate funds from equity markets at a decent price would mean that corporate sector growth has to get affected. Fresh capex would come at too high a cost for any company. Typically, the equity and the debt capital markets have an inverse correlation. In a high interest rate regime, equity markets cannot sustain at higher levels for too long.

Importantly, some of the core sectors have already started witnessing a slowdown, gradually getting reflected in the softening IIP numbers. With clear signs of governance deficit and lack of decision making in political circles, achieving GDP growth at the projected 8.5 pct levels will be a serious challenge.

Lower commodity prices and gradually inching down global crude oil prices notwithstanding, there’s too much uncertainty and indecision out there for equity markets in India to rally convincingly. It would be a folly to get carried away if they do. However, bull and bear market cycles have shortened over the years, and a bear phase beyond 2 or 3 quarters looks difficult. At the current level of valuations of several mid-cap and large-cap stocks, each sharp fall in this bear phase would be a good opportunity to buy.

One comment

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Sir,
I have one question pertaining to the article would the Government/ Central Bank make another interest rake hike 1.) when the Government has so many PSU FPO’s in the pipeline

Posted by Dilip_Pinto | Report as abusive