(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.”

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

Like every budget since the subprime crisis of 2008, the one on March 16 will see the Finance Minister walking a tightrope between fiscal consolidation and growth. The only difference being — this time the government is really constrained to provide a fiscal boost to consumption.

Hence, support to growth can most likely be in the form of a boost to investment by adopting critical reforms and creating an atmosphere conducive enough for private investment to come back. With the markets and the Reserve Bank of India (RBI) breathing down its neck looking for a credible plan on bringing fiscal deficit down in the medium term and concrete steps to encourage private investment, the task is cut out for the government. It is now more a question of political will than anything else.

The results from state elections in Uttar Pradesh, Punjab, Uttarakhand, Manipur and Goa are likely to test the political will and commitment of the government to reforms and fiscal prudence.

Real GDP growth has dipped to 6.1 pct in Q3FY12, the lowest since Q3FY09 — the peak of the subprime crisis. A combination of high inflation, increased cost of capital and the weak global economy resulted in the slowdown in growth. Inflation has shown signs of moderation over the last couple of months, though doubts remain as to its sustainability. Cost of capital has continued to remain high in the wake of tight liquidity, high fiscal deficit and absence of clear direction from the RBI on interest rates.

India Inc will be looking towards the Budget to provide a credible plan on bringing down fiscal deficit and government borrowing to bring interest rates down. Also, investment as a percentage of GDP has moderated from about 33-34 pct to 30 pct levels over the last four years, thereby bringing the sustainable (non-inflationary) rate of growth of the Indian economy to about 7 pct. India Inc expects the government to kick-start reforms to boost private investment in the upcoming budget to bring the sustainable growth rate higher.

Mere lip service may not be enough in this budget. Markets need a concrete plan for execution. If fiscal deficit is projected lower, the assumptions and expectations forming the basis for such projections should be realistic and not over-optimistic. The Budget presented in 2011 had projected fiscal deficit at 4.6 pct of GDP, based on some practically weak assumptions such as a 9 pct GDP growth rate and understated subsidy bills. The reality is that fiscal deficit for FY12 is likely to exceed the budget estimate by a full percentage point.

(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.

(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.

(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.

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

The job of a central bank is not enviable, at least not in a growth-obsessed economy like India. When it does not get hawkish enough, it gets termed as being “behind the curve”, and when it does get hawkish, we implore it to stop for fear of hurting growth.

The Reserve Bank of India (RBI) has been in a similar dilemma of late. On the one hand, rising inflation has forced it to raise rates, whereas on the other, industry captains (banks and business leaders) and certain sections in the government are calling for a pause in rate hikes.

What such people fail to recognise is the fact that growth is going to slow down anyway even if the RBI does not hike rates. High inflation brings down growth all by itself. Instead of asking the RBI to stop, one should think of ways to bring down inflation. There simply cannot be any trade-off between inflation and growth. The choice is clear — ensure price stability and growth will automatically come in an economy like India’s. For the central bank, price stability comes first and it should remain so.

Going back to the books, RBI has already raised rates 10 times starting March 2010, hiking repo rate from 4.75 pct to 7.5 pct and reverse repo rate from 3.25 pct to 6.5 pct. This makes it one of the most aggressive central banks in the world in terms of fighting inflation.

The fact that despite this inflation has refused to come down, points to the structural nature of inflation. The journey that began with high food price inflation in 2009 has culminated in high wage inflation which together with rising input prices, has led to a spike in prices of manufactured goods. And this is what the RBI is most worried about.

To add to woes, questions are being raised on the quality of inflation data that is being doled out. There have been consistent upward revisions in WPI inflation figures since July 2010. Inaccurate data makes the job of a central bank even tougher.

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

Indian equities, after recovering smartly during much of 2009 and 2010, have again started exhibiting high volatility over the last six months. At a global level, this time it is emerging markets which are leading the downside in equities. Even among emerging markets, Indian stocks have looked weaker.

Macroeconomic headwinds in the form of high inflation, fiscal imprudence, corruption and lack of investment growth threaten to dent the premium that Indian markets enjoy over their emerging market peers.

Here’s a look at the various factors that can affect equities in the near future:

Global factors

With none of the headwinds that led to the global financial crisis in 2008 being addressed properly, problems that led to the biggest recession in the last eight decades are not yet behind us. The recovery in equity markets seen in 2009 and 2010 was more due to the flow of cheap money across the globe as a part of the RISK-ON trade. However, there are several issues today that we believe can be the RISK-OFF trade surfacing back, and this will not be good for risky asset classes such as equities and commodities. The following are some of the factors -

High inflation and rising interest rates in emerging markets An ultra-loose monetary policy in developed markets coupled with weakening currencies, particularly in the U.S., Europe and Japan, growing demand from rapidly industrialising nations such as India, China and Brazil coupled with production disruptions across the world have led to a sharp rise in commodity prices and hence inflation.

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

With the Budget less than ten days away from being presented in the Parliament, market is already rife with speculations about what the Finance Minister is likely to propose and what not. Though many people proclaim that over the years the Budget has become more of a non-event for the equity markets, the very same people can be seen putting their precious time and intelligence at work in trying to speculate what it may contain.

Investment Strategies are formed around these speculations and one runs the risk of making or losing money depending upon whether the speculation was right or wrong. In light of the above, it seems that such speculation is entirely unwarranted and illogical. But there is no harm if one does have a wish list. As citizens of a democratic country, it is our duty as well as right to let the powers that be know what we expect from them or wish them to do.

The wishlist can be bifurcated into two parts, one from a common man and second from an investor both of whom are also honest tax payers.

Starting with the ‘common man’, given the current scenario, any wish list for the budget must definitely include inflation. Inflation is the worst form of taxation as it taxes the rich and poor alike. With inflation running close to double digits the common man has been left with very less disposable income which has affected his savings and investments as well as discretionary consumption.

A hike in the basic exemption limit from Rs. 1.6 lakhs to Rs. 2 lakhs coupled with a rejig in the tax slabs in line with the proposed Direct Tax Code (the slab over which a 30% rate of tax is charged should be hiked from Rs. 8 lakhs currently to Rs. 10 lakhs as proposed under the DTC) and a hike in the maximum deduction limit u/s. 80C from Rs. 1.0 lakhs to Rs. 1.2 lakhs and that u/s. 80CCF from Rs. 20000 to Rs. 30000 will go some way in providing relief.

A hike in the limit u/s. 80CCF which is exclusively available for investment in infrastructure bonds will also go some way in ensuring the flow of household savings into productive activities.

(Rajiv Deep Bajaj is the Vice Chairman and Managing Director of Bajaj Capital Ltd. The views expressed in this column are his own and do not represent those of Reuters)

With real interest rates starting to move from negative to neutral, cost of capital rising and stock markets trading in the fair value plus zone, it will be tough to rake in substantial gains from equities in the near term. Prudence suggests that investors diversify their portfolio across asset classes and stagger their equity investments over the next 12-18 months.

The recent FII money fuelled rally in Indian stock markets has taken everybody by surprise. As is the case with most liquidity fuelled rallies, it is tough to predict the top and anticipate the exact time when liquidity flows will start reversing. At the macro level, the significant differential in growth and interest rates between the developed world and the emerging economies such as India, coupled with an ultra-easy monetary policy in developed economies have ensured that cheap money continues to flow from developed world into emerging markets and other riskier asset classes.

The dilemma facing investors today is whether to participate in the rally or to wait on the sidelines. It is tough to arrive at a decision as on one hand the opportunity cost of sitting on the sidelines can be huge as has been seen of late, whilst on the other hand, a plunge into the markets at these levels can be damaging in case the tide turns, as has been seen in the latter half of 2007 and early 2008.

Looking at fundamentals, though they are robust both at a macro as well as micro level, they do not seem to justify the present valuation levels. At least given the valuations, it is tough to see significant gains from here on, in the near term. With the BSE Sensex trading at levels of more than 20,400 which translates into a Price Earnings multiple of more than 19 times based on estimated Sensex EPS for 2010-11, markets seem to be fully pricing in earnings even up to 2011-12, trading at 16 times the expected FY12 EPS.

It is then difficult to imagine what will drive further upside, particularly when inflation is high, interest rates are rising and global growth is expected to slow down in 2011 as compared to 2010.

Looking at the performance of India Inc in terms of earnings growth in the second quarter of the current fiscal, it has been either in line with or slightly better than estimates in most cases.