Sentiment has vastly improved in the equity markets since the early days of February. Is this an impact of the Union Budget, or is it because of the ebbing of concerns about Greece? The chart shows the rebound in various markets from the lows they made in February. The Sensex is near the top of the list, but Brazil’s Bovespa index has risen even more, which may not be surprising, considering that the data continues to show that the recovery is broadening—the latest piece of encouraging news is a rise in consumer credit in the US in January, the first increase in a year—and commodities will benefit. Rather unexpected, though, is the 11.2% bounce of the Footsie off its February lows, higher than the rise in the Sensex.
That said, it’s also true that the Sensex did better than other Asian indices and that outperformance is on account of the relief at the end of the uncertainty about the Budget. Not that there was anything in it to enthuse the market, but at least it’s over and done with and it could have been worse. Note the divergent reactions of the equity and debt markets to the Budget—while equities rose, bond prices fell and yields rose. One reason, according to bond dealers, is that the market doesn’t believe the government’s projected deficit figure. They think borrowing will be more than projected because subsidies will be higher.
But there’s another, more fundamental reason for bond markets to be skittish—they are worried that growth will be very strong. That will mean tightening by the Reserve Bank of India (RBI). On the other hand, it’s precisely the prospect of strong growth that is stirring up the stock market. Both the HSBC India Manufacturing Purchasing Managers’ Index (PMI) and the Services PMI for February have shown robust growth. This has led to widespread expectations of a rate increase, with HSBC economist Robert Prior-Wandesforde writing that “the strength of activity points to higher underlying inflationary pressures ahead and RBI is likely to raise the CRR (cash-reserve ratio), repo and reverse rates at its next meeting on 20 April. We are looking for a further 50 bps (basis points) on the CRR (unless liquidity tightens more than expected in the next six weeks) and a 25 bps hike in the repo and reverse repo. In our view, the balance of risks is tilted towards a 50 bps increase in the two policy rates rather than there being no change”. One basis point is one-hundredth of a percentage point
Graphic: Yogesh Kumar/Mint
Which will prevail—the lure of higher growth or the fear of higher interest rates? Growth is likely to have the upper hand for now, not least because policymakers are still worried the recovery is fragile. Interest rates are still too low to have any impact on growth. What also matters is global liquidity. The current spurt in the equity markets can be put down to one simple fact: The Merrill Lynch survey for February had shown that investors were 12% overweight cash. As the concerns over Greece ebbed, that cash is being put to use. As for India, the survey also showed a net 59% of fund managers were underweight. While high valuations have been the deterrent so far, it does mean there’s plenty of room for investors to come in on the back of more positive sentiment.
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