Has the RBI policy put a floor under the markets for now?
Since 29 September, the Sensex has gained over 1,000 points, and the Nifty about 268 points
The steeper-than-expected rate cut by the Reserve Bank of India (RBI) on 29 September appears to have put a floor under the domestic equity markets, at least temporarily.
The BSE Sensex and the NSE Nifty have gained on each of the five trading days since the policy (2 October was a holiday) and kicked off the week on a strong note.
From the closing levels of 28 September, a day before the policy announcement, the Sensex has gained 1,169 points (4.56%), and the Nifty about 324 points (4.2%). On Monday, the Sensex closed at 26,785.55, up 564.60 points, or 2.15%, while the Nifty closed at 8,119.30, up 168.4 points, or 2.12%. Both indices closed at their highest levels since 21 August. Selling across global markets had picked up in early August following China’s decision to devalue its currency. The weakness had extended well into September as investors awaited rate decisions by both the US Federal Reserve and the Reserve Bank of India.
Both decisions were short-term positive for the markets, even as they highlighted longer-term growth concerns. The US Federal Reserve deferred a rate hike on 17 September. RBI cut rates by 50 basis points to a four-year low.
One basis point is one-hundredth of a percentage point.
“Global markets are stable. RBI has cut rates. Broader environment and sentiment has become better. It does look like markets have bottomed out for the near term,” said Vikas Khemani, CEO of Edelweiss Securities Ltd.
“I feel the DIIs (domestic institutional investors) will continue to lap up local stocks for now. FIIs (foreign institutional investors) will return as emerging market fund flow situation changes. They will come in once the sentiment for overall emerging market pack becomes better,” said Khemani.
DIIs have been net buyers of Indian shares for all months this year except January, and have stocked up on Indian shares worth Rs.53, 583.16 crore so far this year. While FIIs are net buyers of Indian shares worth $3.6 billion this year, they have been sellers in four out of the last five months.
While RBI governor Raghuram Rajan has maintained that the central bank’s job is not to dole out goodies to the market, investors have certainly grabbed on to the hope that the rate cuts will help both domestic and investment demand.
Proof of that lies in the stocks and indices that have gained the most since 29 September.
The steepest gains have been seen in the BSE Capital Goods Index, which has gained 6.23% since the rate cut. In its monetary policy statement, one of the justifications given by RBI for front-loading its rate cuts was the need to provide greater certainty to those planning investments.
“...investment is likely to respond more strongly if there is more certainty about the extent of monetary stimulus in the pipeline, even if transmission is slow,” RBI had said.
Stocks appear to have rallied on the hope that this will happen. Larsen and Toubro Ltd, seen as a corporate proxy for the investment cycle, has gained 8.43% since last week. Public sector peer Bharat Heavy Electricals Ltd (Bhel) has gained 4.49%.
“We consider L&T as the best play on India’s infra development and economic growth, and a major beneficiary of the $245bn defence and $140bn railway upcoming opportunities,” said Citi Research in a report dated 2 October, adding that the 20% fall seen in the stock in the last three months has valuations down to below historical averages for the stock.
Other firms and sectors that could gain from a pickup in investment have also seen share prices rise. The BSE Metal index has gained 4.28% since last Tuesday, with individual stocks in the index such as Tata Steel Ltd up 7.19% over the period.
A note of caution: any hopes of a significant pickup in private investment may be premature, given that capacity utilization has shown no pickup and remains at close to 70% for now. Also, progress in kicking off stalled projects remains slow.
After declining for five consecutive quarters, stalled projects rose during the quarter ended September 2015, showed data released by the Centre For Monitoring Indian Economy last week.
The rise was to a large extent led by the steel sector, which accounted for over 50% of the increase in stalled projects, noted Pranjul Bhandari, chief India economist, HSBC Securities and Capital Markets (India) Pvt. Ltd, in a report on Monday.
To be sure, new project announcements rose during the July-September period but a quarter of the increase came from the electronic sector where big-ticket plans such as Foxconn’s $5 billion investment have been announced.
“The question which begs answering after the July-September investment data is whether new investments, our ultimate goal, can continue to prosper, even as stalled projects remain frozen. Our answer to this is no. Weak aggregate demand and low capacity utilization are likely to be a drag on a rapid rise in new investment intentions,” concluded Bhandari in her report.
Stocks dependent on consumption demand have also perked up following the rate cut.
The BSE Auto index is up 3.9% since 29 September while the BSE Fast Moving Consumer Goods index is up 3.66%. The hope is that the rate cuts will give a lift to consumer sentiment, which was starting to show signs of fatigue. RBI’s consumer confidence survey had shown a marginal dip between the June and September quarters.
Bank stocks, however, have not done all that well since the policy announcement and have under-performed broader indices with a 2.88% gain. This is due to concerns about a negative impact on the net interest margins of banks as they cut their lending rates. Not all banks have been able to lower their deposit rates by more than the lending rates, which implies a hit on bank lending margins.
State Bank of India (SBI), which cut its base lending rate by 40 basis points to 9.3%, effective 5 October, expects a 10 basis point impact on margins, said Arundhati Bhattacharya, chairperson of SBI, in an interview to CNBC-TV18 on 30 September. SBI shares have been flat since 29 September.
The question to ask is: how long will the upside hold? One immediate trigger to watch for will be corporate earnings which, by all indications, are likely to remain weak.
Ambit Capital expects Sensex companies to post an EPS (earnings per share) growth of 3% in the September quarter, Mint reported on Monday (mintne.ws/1OdyGYD) .
The mood across global markets also remains all important.
It’s been relatively quiet on the global front in the past week or so and that has allowed emerging markets some time to breathe.
Apart from Indian markets, which are up more than 4% since last week, other markets like Brazil (up 7%) and Indonesia (up 5.4%) have also gained.
Weaker-than-expected employment data from the US on Friday also lifted the mood across global markets on the expectation that the Fed will delay an anticipated rate hike beyond this year.
“Eventually, FII selling led by ETFs (exchange-traded funds) and sovereign funds will ease off; long-term investors will differentiate India vis-a-vis other EMs,” said Nilesh Shah, managing director of Kotak Mahindra Asset Management Co. Ltd.
“Domestic flows have been strong. Putting those things together, it has the potential to support the market at current valuations,” said Shah.
“However, market has the potential to surprise people, and it is difficult to predict moves in the short run,” added Shah.