Investors may take rate hike in their stride

Investors may take rate hike in their stride

Mumbai: Equity markets will likely open weak on Monday in response to the surprise rate increases by the Reserve Bank of India (RBI), but the move will have limited impact in the medium term given that investors had already factored in monetary policy tightening by the central bank as it battles to douse inflation, market strategists say.

RBI raised two key policy rates by a quarter of a percentage point each after the stock markets had closed for the weekend on Friday, signalling that it was more concerned about fighting inflation rather than bolstering economic growth.

The timing was a surprise because the move came a month ahead of RBI’s annual policy review, but market participants had already been braced for an increase of up to 150 basis points during the course of the year. One basis point is one-hundredth of a percentage point.

“The timing is a little bit of a surprise and there will be a little bit of shock impact," said Satish Ramanathan, head of equities, who helps manage Rs13,732 crore of assets at Sundaram BNP Paribas Asset Management Co. “But it’s not something that will continue. The liquidity situation is still improving."

Indeed, a glimpse of the market’s short-term reaction when it opens Monday may be gathered from the overnight closing of equity and commodity markets across the US, Europe and Brazil. Markets there fell on concerns that central banks across emerging economies could follow India’s example and higher interest rate hikes could restrain the pace of economic growth.

“Governments are trying to normalize rates and exit," Quincy Krosby, a market strategist for US-based Prudential Financial Inc., which oversees about $667 billion (Rs30.35 trillion) told Bloomberg News on Friday. “That puts the market on notice that they’re going to move rates higher."

India’s benchmark index, the Sensex, closed at 17,578.23 on Friday, up 58 points. The gauge has almost doubled from its year-ago level, but most of the gains were notched up by September 2009.

While investors were expecting the Reserve Bank to raise interest rates during its next monetary policy in April, governor D. Subbarao’s hand may have been forced by higher -than-expected inflation.

The headline inflation number at 9.89% for February was higher than the 8.5% projected by the central bank. What’s more worrying is that the malaise is spreading beyond rising prices for food. Manufactured products’ inflation was clocked at 7.4% for February versus 4.8% a year ago.

“Most of the big (brokerage/fund) houses have factored in 100-150 basis points changes in rate over the course of the year," said Vetri Subramanian, head of equities, who helps manage Rs14,841 crore of investor money at Religare Asset Management Co. Ltd. “From a medium-term point of view, it (rate hike) is not different from expectations."

Indeed, some research heads say that RBI is behind the curve in increasing rates.

“The markets have more than discounted this. The monetary tightening cycles started in January," when RBI increased banks’ reserve requirements by 75 basis points, said Apurva Shah, vice-president and head of research at local brokerage Prabhudas Lilladher Pvt. Ltd. “It needs to raise rates another 50 basis points before it catches up," with (market perception of where interest rates should be), he added.

What gives the bank leeway is the fact that growth projections continue to be on track and credit demand is improving. Credit assessor Standard and Poor’s upgraded its India outlook on Thursday.

“This should also be seen as a measure of confidence in the economy in general," said Vinod Kumar Sharma, head of private broking and wealth management at HDFC Securities Ltd.

Interest rates and equity markets have in the past risen in tandem, he said, adding that rates would have to rise by as much as 1.5 percentage points before they have an effect on investor sentiment.