One policy, two verdicts
To anyone watching the movement of the Indian equity indices on Wednesday, it would have seemed that the Reserve Bank of India (RBI) at best didn’t do anything and at worst was hawkish when it presented its monetary policy on Tuesday afternoon.
The Sensex closed 113 points down and the Nifty ended 25 points weaker on Wednesday, interestingly dragged down by bank shares. The banking indices were down about 0.8%. This seems puzzling given that RBI slashed its repo rate by 25 basis points on Tuesday and also promised a relook at its approach to tackling bad loans of banks, essentially indicating that it may go soft on lenders from here on.
Why did the market shrug off the measures then?
To be fair, the equity market went up in the last hour of trade on Tuesday (the policy was released in the afternoon unlike the earlier practice of a release at 11am). But analysts believe that the token rate cut was just that and a few sentiment-driven deals would have propped up the market after the policy was unveiled. The central bank had taken the wind out of its rate cut sails by reiterating the upside risks to inflation and even talking of a possible rate hike in the future. As for guidance on rates, RBI or the monetary policy committee has been thrifty.
As corporate entities will begin to detail their performance for the September quarter soon, the focus of the market has unwaveringly returned to valuations. Here, analysts believe that depressed credit growth, and the overhang of bad loans are unlikely to disappear soon despite a tweak to RBI’s schemes such as sustainable structuring of stressed assets. Religare Securities expects the September quarter results to continue to be marred by higher provisions and lower profitability.
Now, take a look at the bond market. Yields dropped as much as 10 basis points to over seven-year lows on Wednesday. So far in 2016, yields have fallen by a massive 108 basis points, the biggest drop since the crisis year of 2008. The bond market would like us to believe that inflation has been reined in and the central bank would offer another round of rate cuts before this fiscal year ends. Bond traders also took RBI’s lowered real interest rate as a signal for further rate cuts.
The central bank indicated that it would be content with a real interest rate of 1.25% instead of the earlier band of 1.5-2%. Given that inflation is expected to be 5.3% by March, according to RBI’s staff projections in the monetary policy report, many economists see room for another rate cut. “Both the assessment on the real neutral rate and clarification on inflation targets make us more confident of our 25bp (basis point) rate cut call for the rest of the fiscal year. We see CPI (consumer price index) inflation average 4.75% over the next 12 months, which opens up the space for a 25bp rate cut,” said HSBC in a note on Wednesday.
HSBC was joined by Nomura Securities, Bank of America Merrill Lynch and Kotak Securities in being bullish on bonds.