Devangshu Datta: Coping with the unknowns

Last Updated: Mon, Jul 30, 2012 03:16 hrs

Policy making is always a game of incomplete information. However, the number of variables have exploded as the economy has become more globalised. The Reserve Bank of India (RBI) must take a host of known unknowns and unknown unknowns into account before it decides on its monetary policy on Tuesday.

There are some positives. Crude prices are at acceptable levels of around $90/barrel, lower than the 2012-13 Budget assumptions. The Europeans are verbally committed at least, to sorting out their problems. France, Germany and the Euro Central Bank have all given strong assurances about keeping the euro zone together. Foreign portfolio investors appear cautiously positive about both the Indian equity and debt markets.

Global GDP (gross domestic product) growth will be slow through 2013. Hence, oil could stay low for lack of demand. That would take pressure off the twin deficits. It would reduce the trade gap and the subsidy required for petro products and fertilisers. It could also have a positive impact in reducing inflation.

But the Assad regime in Syria is on the verge of collapse. That guarantees uncertainty in the Middle East and oil prices may spike anyhow. On the home front, the monsoon has failed though it is politically unacceptable to admit this yet. So, food inflation is likely to stay high though manufacturing activity is flat, consumption is slowing and core inflation is down. Higher food prices could push up the Wholesale Price Index (WPI).

In the circumstances, does the RBI hike rates (and/or CRR), stay put, or cut? A hike is very unlikely. Cuts, if they happen, are likely to be nominal. Though the RBI can do nothing about food prices, it could be arm-twisted to keep rates high due to monsoon failure.

Most probably, the RBI will stay put, hoping like everyone else, for an end to the policy paralysis in government. As of now, there are few signs of that. The Nationalist Congress Party is flexing its muscles, the Samajwadi Party will block foreign direct investment in retail, everybody else seems to be waiting for a Cabinet reshuffle and there are no signs of animal spirits. There are several signals that growth may slide some more. Investment, especially infrastructure investment, has been slow or non-existent for over two years now. Nor will infrastructure investment recover until assorted messes are sorted out in various sectors and there is a visible reappearance of political will. Companies are sitting on cash and will continue to do so, in the absence of demand or policy direction.

The consumption story is also breaking down. The latest consumer confidence surveys show lower confidence levels. Debt restructuring requests are up. First quarter, 2012-13 results are more or less on expected lines — that is, anaemic. The Society of Indian Automobile Manufacturers has cut its sales projections for the fiscal, which means lower expectations of big ticket individual expenditures.

In January-March 2012, GDP growth hit 5.3 per cent. That was the lowest since Q2, 2003-04. The second half of 2002-03 saw successive quarters when GDP dropped below four per cent. The lagged effect of that recession was enough to cost the National Democratic Alliance a general election in May 2004, despite a sharp uptick in the second half of 2003-04. One wonders if the geriatrics in the United Progressive Alliance recall that period?

The last fortnight saw a sense of drift and of technical realignment in the equity and derivatives markets. Volumes were low and the indices drifted lower. Both foreign and domestic institutions remained net buyers but in reduced volumes.

Expectations for Q1, 2012-13 were not high. Results have been mixed and advisories, cautious. Infosys and Wipro delivered poor results balanced to an extent by good performances from Tata Consultancy Services and HCL Technologies. ICICI Bank surprised on the upside and so did HDFC Bank and YES Bank. But Punjab National Bank, Central Bank, Union Bank and Canara Bank disappointed. Larsen & Toubro was another big loser.

There was a lot of action in the futures & options (F&O) segment. Volumes shot up for several reasons. Traders are realigning exposures in stock futures after the market regulator Securities and Exchange Board of India raised its norms for stock inclusion to the F&O segment. Most of the 51 stocks that are being removed saw dramatic sell offs. This process could continue through August.

The other reason for F&O volume expansion was a more aggressive stance by the Bombay Stock Exchange. India’s oldest exchange has offered a combination of lower F&O charges, incentives to market makers, and so on, in an effort to push volumes. In the equity options segment, it has caught up with the National Stock Exchange and even surpassed it. The Liquidity Enhancement Scheme for brokers ceases to operate in August but there will be continued interest in Sensex derivatives.

Technically, the major market index, the Nifty, dropped below the benchmark 200 day moving average (200 DMA) in the last week and stayed just below it, despite recovery on Friday. This is usually a reliable signal of a long term bear market. Traders can watch for some key levels to be hit or exceeded. The 200 DMA is around 5,100. If the index stays below 5,100, after the credit policy, it could fall till 4,850. On the upside, there’s major resistance between 5,150-5,225. it would be dangerous to bet on a recovery, unless 5,225 is crossed.

Any price recovery that may occur is likely to be driven by renewed overseas optimism. In the circumstances, net losses with occasional pullbacks seems the most likely outcome over the next fortnight. If the Nifty does cross the 5,225 level, long positions in the Bank Nifty and a bet on the rupee hardening (a short USDINR) would offer larger pay offs than the broader market. If the Nifty falls to 4,850 or lower, the Bank Nifty is again likely to be a major influence.

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