Expert Zone
Straight from the Specialists
Investors shouldn’t read too much into repo rate cut
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The last time the Reserve Bank of India (RBI) surprised the markets was when it announced a 75 bps cut in cash reserve ration (CRR) days before its mid-quarter review of monetary policy on March 15. It did so again in its annual monetary policy meeting on April 17, with a 50 bps repo rate cut when the markets were either expecting no rate cut or a 25 bps rate cut at best.
Why did the RBI cut the repo rate by 50 bps, amid growth showing signs of a recovery and the general belief that the worst in industrial growth was already behind us; when food inflation had started rising and with all the suppressed inflation in retail fuel, coal, power and fertiliser prices?
Did it give in to moral persuasion from the government and the industry? Or was it because cutting rates later in the year would have been difficult, if not impossible? As if to mock the rate cut, consumer price inflation for March came in at 9.5 pct the very next day.
As per media reports on April 19, the Commission for Agricultural Costs and Prices (CACP) recommended a hike of 15-40 pct in the minimum support price (MSP) of various kharif crops during FY13. Though these are just recommendations, historically, the actual hike in MSP has almost matched the recommendations. This is again likely to add to food inflation. With the current account deficit likely at 4 pct of GDP in FY12 putting further pressure on domestic currency and the consequent need for overseas inflows to finance the same, a rate cut was the last thing that should have been done.
Also, the uncertainty relating to monsoons, spike in food inflation after the transitional decline in Dec and Jan 2012 and the impending retail fuel price hikes, all create doubts over the continuance of the trend in the foreseeable future.
The RBI Governor said “the reduction in the repo rate is based on an assessment of growth having slowed below its post-crisis trend rate which, in turn, is contributing to a moderation in core inflation. However, it must be emphasised that the deviation of growth from its trend is modest. At the same time, upside risks to inflation persist. These considerations inherently limit the space for further reduction in policy rates.”
‘Sense of disbelief’ in markets to extend current rally
(The views expressed in this column are the author’s own and do not represent those of Reuters)
As they say, it is always darkest before the dawn. Equity markets seem to be the finest proponents of this axiom. They have a habit of surprising investors. What we have seen so far in 2012 sums it up pretty well.
Rewind to December and it seemed that markets might fall into an abyss — falling rupee, rising inflation, tight liquidity, sovereign debt concerns in Europe, FII outflows, rising fiscal deficit and widening current account deficit made a perfect recipe for disaster. Fast forward to the present and we have seen the rupee recover by 10 pct from its lows, inflation down to 7.5 pct, RBI supporting the rupee and infusing liquidity by way of OMOs and a CRR cut, European Central Bank (ECB) on its way to infuse huge chunks of liquidity in the banking system, possibility of U.S. Fed keeping rates low through 2014, FIIs resuming their inflows in Indian equities and current account deficit being expected to narrow due to an import duty hike on gold imports.
Equity markets are up more than 15 pct in 2012 in a rally which at first looked like a short covering rally, but later, due to its sheer ferocity, has made some people think it may be the start of a more sustainable upward move.
Before commenting on whether the rally will continue, let us see what caused this rally. Was it fundamentals? Or was it liquidity?
Prima facie it seems like a liquidity driven rally that started on December 21, the day after the European Central Bank (ECB) lent 489 billion Euros to banks by way of LTRO (Long Term Refinancing Operations) for three years, to buy sovereign debt of troubled EU nations.
Today, markets have built in expectations of another trillion euros worth of liquidity infusion in the next tranche of the LTRO due on February 29. In terms of fundamentals, there have been some signs of hope both on the global as well as domestic front. Growth seems to have surprisingly revived in India as seen from the surge in HSBC PMI indexes in Dec 2011 and Jan 2012, whereas inflation has shown early signs of moderation. Even the RBI monetary policy stance seems to have turned pro-growth.
2012 – Boom or Doom?
(The views expressed in this column are the author’s own and do not represent those of Reuters)
What a year 2011 has been. Except certain commodities such as gold and oil, every other asset class has been hit. With Sensex down more than 20 pct YTD, 10 year g-sec yields up by almost 1 pct and rupee down by almost 14 pct against the dollar, it has been a poor year for investors. This was caused by a bout of strong global risk aversion led by the European sovereign debt crisis, high inflation in emerging markets and consequent monetary tightening, and lack of proper policy action in India. The only salvation came from commodities such as oil (up almost 26 pct in rupee terms) and gold (up almost 38 pct in rupee terms).
Are any of these likely to continue haunting us in 2012? Or will there be a new set of problems? Is the worst already behind us? That’s the million dollar question on everybody’s mind. The irony is few of us, if at all, have the right answers. Still based on evidence available today, one can hazard a guess.
What does 2012 have in store for the investor? There is no doubt that growth has slowed down. The poor industrial growth numbers over the last quarter and the latest second quarter real GDP growth of 6.9 pct (manufacturing growth was a mere 2.7 pct whereas mining output contracted) drive the point home.
Is it going to change in a hurry? Seems improbable. After all, more than a year of continuous rate hikes should have taken its toll on growth. And to top it up, inflation is yet to subside at least on a year on year basis, even though that is not the best way to look at it. The fall in the rupee hasn’t helped either, exacerbating the already high trade deficit and inflation by making imports costlier.
But aren’t we pricing it all in? Aren’t equity valuations cheap and yields already near 2008 highs? True. But stocks can get cheaper still? Markets can remain irrational longer than you can remain solvent. Remember, we are still looking at Sensex valuations with respect to FY13 earnings which price in a 16-17 pct growth over FY12. Whereas FY12 earnings growth is already being revised down to 10 pct, expected FY13 growth can be downgraded further if macro indicators worsen. Also, the Sensex earnings yield (basis forward PE of 13-13.5 as per FY13 earnings estimate) at approx 7.5 pct is still short (approx 0.8 pct) of the one year bond yield. Historically, equity markets have come out of a bear phase once Sensex earnings yields have been higher than bond yields by more than approx 50 pct i.e. the ratio between Sensex forward earnings yield and bond yields has been around 1.5. On this basis, valuations seem to be in a fair zone rather than being screaming cheap. For Sensex yields to become 1.5 times of bond yields today either the Sensex will have to be de-rated further or the bond yields will have to come down significantly. It is unlikely that either of these events happen in isolation. Rather a combination of both, i.e. a price or time correction in stocks coupled with the bond yields coming off significantly seems to be a more plausible scenario going ahead.
The initial part of the year 2012 (probably the first half) thus might continue to see high volatility as a result of the above. But as we move to the latter half of 2012, things should start improving. Bond yields are most likely to have come down quite some distance by that time (assuming that inflation moderates — month on month growth momentum in core WPI inflation is already showing signs of slowing down — and RBI starts cutting rates) and equities should be available at a real bargain by then. The second half of 2012 should thus be much better than the first.
Indian stocks: Paradise for value investors
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The BSE Sensex romance with the 16,000 level seems to have been rekindled, with the Sensex closing below it on August 26, after a gap of more than 18 months during which it touched a high of 21,109 (missing the all-time high of 21,207 by a whisker).
As is the case, when a key sentimental support level is broken, most experts on business TV channels (a strong contrarian indicator) started giving short calls on the market the moment 16,000 was broken. Why is the level so important? What does it mean for the near-term outlook for markets? What should the investors do now? These are some of the questions that must be roiling the mind of every equity investor in India.
For starters, the Sensex closing at 15,848 on Friday is the lowest weekly close after nearly two years. This means investors who had invested in index funds made only 1.66 pct p.a. on an average in the last two years (as on Aug 26). Those in diversified equity funds fared somewhat better getting 5.4 pct p.a. in large cap funds, 9.9 pct p.a. in mid-cap funds and 9.2 pct p.a. in flexi cap funds.
Though positive, these returns are dismal as compared to what is normally expected from equities. In real (inflation adjusted) terms, equities have hardly yielded anything as WPI inflation (and I am not even talking about CPI inflation) has averaged around 9 pct p.a. over this period.
Compare this with 31 pct p.a. from gold, more than 6 pct p.a. from money market and short-term debt funds, 6.75 pct from medium-term debt funds and 6-7 pct from long-term debt funds and one can see that equities have underperformed the other asset classes significantly. Isn’t it then time for stocks to start catching up with their long-term averages (theory of mean reversion)? After all, haven’t stocks proven over time they are the best when it comes to beating inflation and creating long-term wealth? Is it then time equities start outperforming other asset classes?
While the answer to the above questions is in the affirmative, this does not mean that stocks will start rising from tomorrow, as headwinds from global and domestic fronts continue to remain strong. A confluence of global and domestic concerns had led to this sharp fall in the first place and they are yet far from over.
