Rajesh kumar ;live mint ;Tue 18,June 2013
With dependence on decisions being taken outside the country, Indian markets may remain subdued
The Reserve bank of India (RBI) in its mid-quarter review of the monetary policy on Monday decided to keep policy rates unchanged with a view that currency depreciation can lead to higher inflation. The rupee has lost around 6% against the dollar in the last one month. Depreciation of rupee, other things being equal, means that Indian consumers will have to pay more for imported commodities, such as petroleum products, which will push the general price level.
The review of monetary policy, along with the reading of the economic conditions by the central bank, has left the Indian equity market in a difficult spot. On the one hand, a depreciating rupee will discourage foreign investors to invest—as it affects their dollar returns—and on the other hand, RBI will find it difficult to cut rates as a weaker rupee can create inflationary pressure which will affect growth prospects. Compared with an average of 7.4 % in 2012-13, inflation based on the Wholesale Price Index declined to 4.7% in May, though the consumer price inflation still remains elevated at 9.3%. “Rupee worries are understandable given global market volatility and the hefty need for financing the current account; but inflation worries should be minimal and growth concern should be heightened in our view,” said a post-policy note from Deutsche Bank. However, all are not in agreement. Says Madan Sabnavis, chief economist, CARE Ratings: “The policy serves a dual purpose.” Sabnavis elaborates that since imported inflation affects the core (manufacturing) inflation and India needs foreign money, RBI has done the right thing by not cutting rates.
Clearly, it appears that RBI will first like to see the volatility in the currency market to settle before cutting policy rates further. Therefore, policy direction and market movements in the near-term will heavily depend on foreign factors. The most important being the meeting of the Federal Open Market Committee (FOMC) of the Federal Reserve in the US scheduled for 18-19 June. If the Federal Reserve, as feared, drops a hint of withdrawal or partial rollback of its bond buying plan, there will be renewed pressure on the rupee. The Federal Reserve is currently buying assets worth $85 billion from the market and India has been a significant beneficiary with higher inflows. Though it is widely expected that the US central bank will be cautious and will reduce its target in a gradual manner, the issue is that markets will price it in as quickly as possible in order to adjust to the new realty. Reduction in asset purchase would lead to lower inflows and with India’s dependence on capital flows to fund the current account deficit—the difference between import and export of goods and services—the rupee will be under pressures. Since it is an established fact that the Indian stock market tends to move with the rupee (http://bit.ly/1atdnLp), it will be a difficult drive on the Dalal Street. However, if the Federal Reserve decides to maintain a status quo, there could be a relief rally in both equity and currency market in the short term. But markets will continue to prepare itself for a rollback by the Federal Reserve.
The bumpy road ahead
Indian markets depend heavily on foreign flows. The foreign institutional investor (FII) holding in the Indian markets is about $141 billion (Rs.6.5 trillion) which is worth 10% of the total market capitalization of the Bombay Stock Exchange (Rs.64.8 trillion). FIIs have pulled out about $3.5 billion from the debt market in June and, so far, are net sellers in the equity market as well, though at much lower scale. If FIIs pull out a similar amount from the equity market as they did in the debt market, which will be just about 2% of their total holding, it will be nothing short of a disaster in the stock market. Says Tirthankar Patnaik, director (institutional research), Religare Capital Markets Ltd: “The flow into the equity market is sticky in nature and there is 80% chance that it (FIIs pulling from equity market like they did in the debt market) will not happen.” Though the markets are not factoring in a large-scale pull out by FIIs, but will they continue to buy Indian equity with its associated macro risks? Ajay Bodke, head (investment strategy and advisory), Prabhudas Lilladher Pvt. Ltd: “The growth will be better than last year. The fiscal consolidation will be taken positively by the market and current account deficit is also expected to come down.” However, with a very high dependence on foreign flows, the most important factor that will decide direction in the near term would the outcome of the FOMC meeting.
What it means for you
With challenges on the external front and high dependence on decisions being taken outside the country, things will remain tricky for Indian investors in the equity market. Says Patnaik: “Investors should stick to quality and not chase high beta stocks. What is cheap is likely to remain cheap and this is not the time for cyclical stocks.” Investors with lower risk appetite may chose to wait for clarity to emerge, at least on the external front.
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