The Reserve Bank of India (RBI) governor has managed to surprise the markets yet again. It doesn’t need rocket science to figure out the impact: bond yields moved up sharply and rate-sensitive stocks plummeted.
The central bank’s policy statement is clear that the “overriding priority for monetary policy is to eschew any further intensification of inflationary pressures and to firmly anchor inflation expectations. In this regard, monetary policy has to urgently address aggregate demand pressures, which appear to be strongly in evidence”, it says.
The statement gives a list of such demand pressures, including high credit growth, strong investment demand, merchandise imports and growing fiscal stress. But it acknowledges there is more- than-originally-anticipated moderation in activity in some sectors and the moderation could persist in the short term. That is why it has lowered its real GDP (gross domestic product) growth estimate for the fiscal year to March 2009 to 8% from the earlier 8-8.5%.
It’s evident, therefore, that RBI has decided to hike its policy rate sharply despite this “more-than-originally- anticipated moderation”, implying clearly it has chosen to sacrifice growth to combat inflation.
It is also clear from the tone of the policy statement that the central bank firmly believes inflation is the biggest risk to the economy. Not all central bankers are equally convinced. Xinhua news agency reported that “China’s central bank said Sunday it would seek to create conditions for relatively fast economic growth in the coming months, despite the ongoing threat of inflation”.
RBI doesn’t agree with that policy. And since most observers believe inflation will remain high for quite some time, further rate hikes cannot be ruled out. “Further rate rises are likely to be delivered and this view was supported by the slightly ominous statement from the bank that it still had ‘headroom’ to use its policy tools,” says HSBC economist Robert Prior-Wandesforde.
The inference the markets must draw are that RBI will ensure growth will slow even more than thought earlier. Also, since monetary policy works with a lag, the impact of the current tightening will be felt a year later, which means the slowdown in corporate earnings growth will continue into the next fiscal year. This bear market is not going to get over in a hurry.
Equities will be hit with a double whammy: a slowdown in earnings growth because of the deceleration in the economy and higher interest payments at a time when there’s a compression of the price-earnings multiple as a result of waning risk appetite.
The rate-sensitive sectors will, of course, be hit badly, with the banks being additionally affected by mark-to-market depreciation on higher bond yields.
All companies that have to raise money periodically to fund capital expenditure will also be hit, especially in the real estate and construction sectors, while some companies in the capital goods sector will also be affected. No wonder India was the worst performing market in the Asia-Pacific region on Tuesday.
Another nasty surprise for Ranbaxy investors
Investors in Ranbaxy Laboratories Ltd have been handed a string of surprises this year, including the promoter group’s decision to sell out to Daiichi Sankyo Co. Ltd and allegations that the drug maker had faked reports submitted to the US food and drugs administration.
The uncertainty related to the investigation by US authorities led to a 20% fall in the company’s shares from its peak last month. Ranbaxy’s results for the quarter ended June had another surprise lined up.
The notes to the profit and loss statement points out that the mark-to-market loss on foreign exchange derivatives contracts stood at Rs908 crore (more than $200 million) at the end of the quarter.
If the losses are as high as $200 million, one can imagine how high the total hedge position may be. After all, the rupee depreciated by only about 7% last quarter.HCL Technologies Ltd, which had outstanding hedges of $2.5 billion at the end of the March quarter, has said that it’ll report mark-to-market losses of $65-75 million in the June quarter.
Ranbaxy has said that it doesn’t take speculative positions in the derivatives market, which means its hedge positions are huge. One analyst, who did not wanted to be identified, said it looks like the pharma giant has hedged receivables over multiple years. With the domestic currency moving in the opposite direction, such a hedging policy now looks short-sighted.
For quite some time now, Ranbaxy would not be able to realize a rate that is lower than the current exchange rate of Rs42.70 to a dollar.
The large hedges would only make sense if the rupee appreciates sharply from current levels, but hardly anyone is betting on that under current circumstances.
Still, what’s heartening about the results is the operational performance. That performance has been steady, with earnings before interest, taxes, depreciation and amortization rising by 16% year-on-year.
Revenues rose 13% in rupee terms and margins were stable. Evidently, investors are not as keen on tracking quarterly operational performance, as they are on the developments relating to the US investigation.
Some investors, who are uncomfortable with the uncertainty, have jumped ship, which explains the fall in the company’s shares.
These investors can consider themselves fortunate that there is at least an exit option, unlike Daiichi Sankyo, which has said that its agreement to buy promoter’s shares at Rs737 each—a 55% premium to the current price—is binding and final, subject to regulatory approvals.
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