Market
seems to be in a roller-coaster ride with swings on either side getting wild.
The rise which we witnessed in the month of September was fast and furious and
was equally sharp as the decline prior to the rise. Monetary policy these days
have been seriously impacting market direction. Post, the induction of new RBI
Governor, Raghuram Rajan and his first day formal speech triggered a sense of
optimism and the markets flared up on the announcements. The key announcement
was with the FCNR-B (Foreign Currency Non-Resident) bank deposit scheme where
the dollar deposit will be hedged by RBI with swap line fixed at a concessional
rate of 3.5% p. a. for three years or more. This is almost half of one year
forward rates to hedge the currency inflow. Add to it the interest rate
provided in the FCNR deposit of 4.5% to 5.5%. The effective cost of funds for
banks comes around 8.5% to 9% and this does not requires SLR and CRR. Hence,
they can lend this new source of fund at 11% plus and hence a lucrative
proposing which will propel dollar-carry trade. FCNR deposit is estimated to
flock in hoards and many of the bankers are expecting fund flow in range of $10
billion to $20 billion in few weeks as the window remains open till 30th
November 2013. Reasons for non-resident Indians to put money in FCNR deposit
account is because of lucrative returns through leverage which is significantly
higher than the interest return generated in developed countries. This was the
real trigger, apart from the optimism of an experienced and learned personality
like Raghuram Rajan coupled with measures of FCNR deposit and OMC dollar swap,
which led the INR mark a bottom around the 70 mark and retrace back swiftly. Equity market also around that time marked an intermittent bottom around the 5118 mark
in Nifty. After it, Fed Chairman Ben Bernanke’s decision of not tapering
the bond buying programme of $85billion, because of sub-par growth, low
inflation, slowing consumer spending and weaker job market, led to market
opening gap up and kissing the 6000 mark in Nifty in an extremely euphoric
state.
The
RBI policy recently announced was a true shocker with the repo rate hiked by 25
bps to 7.50%. On the other side there was a rollback of its currency
stabilization measure. The Marginal Standing Facility (MSF) which stood at
10.25% now has been rolled back by 75 bps and stands at 9.50%. At present
majority of the banks is borrowing money at the MSF facility which is capped at 2.5% of NDTL, over and above
their requirement of 0.50% of NDTL(Net Demand and Time Liability) from repo window under the LAF(Liquidity Adjustment Facility). It is important to note that the 25 bps hike
in repo rate can be construed that the new RBI Governor is more targeted to
control inflation rather than support growth for macro-economic stability. It sees continuing sluggishness in industrial activity and
services. The pace of new project announcements have slowed and consumption is
weakening, including the rural areas. Consequently, according to the RBI,
growth is trailing below potential. Looking ahead, it believes that brighter
prospects for agriculture, an upturn in exports, and implementation of
infrastructure projects expedited by the Cabinet Committee on Investments (CCI)
will support growth in the second half of the fiscal year. For spurring growth
it is left best at the hand of the government policies for fiscal and
structural reforms. With higher rate decision by the RBI, it also intends to
support the INR by keeping the hope alive for dollar-carry trade and interest
rate arbitrage. This probably will support dollar flows into Indian shores and
thereby aid the current account deficit. But the higher interest rate regime
impedes growth and also raises the risk of corporate defaults for companies
which are highly debt laden. Report indicates that the corporate default will
rise to 4.5% in comparison to around 0.50% three years back. Moreover, it’s
clearly evident from the fact that Non-Performing Assets of banks rising to
above 10% (NPA+Restructured Assets) are a precursor to the ailing health of
Corporate India. If we look at the Corporate Debt Restructuring (CDR) cell
numbers, the stress in the banking system is elevated. Total of 14 cases have
been referred to the CDR cell in the first two months of the second quarter
amounting to Rs. 26,000 cr. And the fact remains that CDR cell cases accounts
only 30% of the total restructuring which happens outside the purview of the
CDR cell. Second interesting thing to note for the banks is their
credit/deposit ratio which remains elevated at 78%. It indicates that the banks
don’t have any other choice except to hike deposit rates and garner more
deposit. Credit growth though have moderated but still remains higher than the
deposit growth and hence banks would be seeking for hiking base rate so as to
adjust with the new cost of funds.
* RHS & LHS in Rs Billion
With the policy stance being taken by RBI, (OMC dollar
swap, FCNR deposit swap fixed at 3.5%, increase in foreign debt ceiling and
gold import curbs) it has stabilized INR. But the hike in repo rate by 25 bps
will certainly mark down the Sensex earnings estimates. Though the earnings of
companies related to good monsoon will certainly be reflected in selected
companies but the sticky inflation situation, rise in input cost, slowing down
of industrial activities and overall anemic economic growth and capex showing
no signs of green shoots are going to weigh down heavily on corporate earnings
and a downgrade risk in corporate earning persists. So our sense is that the
rallies in the equity market are more to do with liquidity flows (likely to
remain robust because of FCNR-B deposit scheme with swap line with RBI at
concessional rates till 30th Nov 2013) and global developments. With
certain major developments like the FCNR deposit, OMC dollar swap, and interest
rate differential will certainly keep the foreign fund flows on robust ground
and support the market which is more of technical in nature rather than any
significant fundamental changes. One year forward P/E of Sensex stands at 14
times, which looks reasonable and mean reversion trade seems to be the
practical conclusion. Though earning downgrade may make the P/E looks bloated.
Tactically, positioning on the long side with well chosen cyclical when the
market falls more than 10% and again seeking defensives when the market rises
more than 10% is the contra-trading
strategy worth applying. Geopolitical tensions with Syria is overblown
and hence crude may cool down in coming months which would be a potential
trigger for the market to scale back to 6300 in Nifty, since the whole
macro-economic dynamics of India changes along with it.
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