India Market Weekahead: EU summit, pace of local reforms to drive markets

December 4, 2011

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

After falling to a new two-year low the previous week, the markets reversed a downtrend and benchmark indices logged their best weekly gain since July 2009.

The near 7.4 percent gain for key indices was due to sudden upbeat news flows globally forcing short sellers to cover. We also saw stray FII buying.

Risk appetite improved after the Chinese central bank decided to cut reserve ratio requirements by 50 basis points for the first time in nearly three years to ease credit strains. The markets got a further shot in the arm when the ‘survival instinct’ played out through the coordinated action of the world’s six major central banks coming together to tame a liquidity crunch for European banks by providing cheaper dollar funding by cutting the cost of dollar swap rates. This move is likely to reduce the threat of a major banking sector collapse.

Pressure mounted on the Reserve Bank of India (RBI) to cut cash reserve ratio (CRR) to shore up liquidity after China’s action. With Q2 FY12 economic growth slumping to 6.9 percent from 7.7 percent the quarter before, a CRR cut could be a solution for easing monetary conditions without compromising on inflation and this expectation too played a role in our markets moving higher.

The RBI cut its GDP growth forecast for FY12 to 7.6 percent from 8 percent earlier. As expressed in earlier columns, there has been a decline in the inflation trajectory due to high base effect. RBI expects inflation to fall to 7 percent by March 2012 and expects it to moderate further in the first half of 2012-13. That is possible only if the prices moderate as the base effect would wear off by then.

The rupee recovered to 51.35 levels against the dollar after testing record lows at the beginning of the week. Risk appetite improved and the dollar retreated in global markets following the global central banks move to boost dollar liquidity. Reserve Bank efforts to boost capital investment flows also had some positive impact, although there was still an underlying mood of caution. Going ahead, trends in risk appetite will continue to influence the rupee though it could be difficult to secure more than a limited recovery in the short term.

Longer term we still believe that levels of 45 per dollar are achievable.

The foreign direct investment (FDI) drama resulted in a deadlock over allowing foreign investment in the retail sector, as an all-party meeting failed to reach a consensus. Meanwhile, both houses of parliament have been adjourned till Wednesday. Our politicians, instead of exhibiting a collective survival instinct, have unfortunately shown crab mentality during these testing times.

Coming back to the markets, the week ahead is a truncated one on account of Muharram on Tuesday. The euro zone debt crisis will continue to dominate in the short term, especially with a key European Union (EU) summit meeting on December 9 where investors hope leaders will come up with concrete solutions to the debt crisis.

Tensions will prevail given fears that a failure or an inadequate response would trigger a terminal escalation of the crisis.

Bank of England interest rate decision and ECB interest rate decision are expected on Thursday. There will be strong pressure for the ECB to cut interest rates again and take a more aggressive stance in buying peripheral bonds. The U.S. indices ended flat despite the U.S. unemployment rate dropping to a 2-1/2 year low on caution ahead of the key EU meet.

The mood now seems to have shifted suddenly from sheer hopelessness to expecting a big rally in December, but recent events make it tough for investors to take positions. The Nifty is back on its move to test the upper end of its trading range 4700 – 5200/5250. The long-term fundamentals are being ignored and focus has been shifted to short-term concerns. It has been proved time and again that it’s difficult to beat the markets in the short term and investor sentiments can change overnight. Fear can quickly turn into greed. As long as there is no fundamental change in the India story, there is no denying the fact that foreign money will flow back to India.

I have been saying time and again that for investors trying to build a long-term portfolio, current market sentiment and volatility is providing an ideal platform. Near-term gyration is something that a trader needs to worry about, and should not deter a long-term investor.

This is a market for those who have long-term money to invest and more importantly know what they are investing in. Your patience and confidence could be tested but then there are no free lunches — one needs to work hard for higher returns.

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