The year 2012 will start on a volatile note
State elections in India, government finances, third quarter results of corporates, liquidity and rate cut expectations will ensure volatility across equity, bond and currency markets. Bond auctions of Italy and Spain starting in the first fortnight of January will keep global market volatile. The markets are not going to get any respite in the beginning of 2012 after a tumultuous 2011, which saw risk asset classes being sold off.
India’s largest state Uttar Pradesh goes to polls in February 2012 and the ruling government will not be able to take any measures that are market friendly until the elections get over. The union budget for 2012-12 is being held in March post the completion of the polls in Uttar Pradesh and markets will not have much to go by given muted budget expectations.
Government finances are not giving any cause for comfort with the government making noises of overshooting borrowing targets. The government is to borrow Rs 40,000 crores more from the markets in the January-March 2012 period, over and above the additional Rs 53,000 crores the government is borrowing in the second half of fiscal 2011-12. Government bond yields have risen 25bps from lows on the back of expectations of more supply and are likely to rise more as the government is not able to stick to its budgeted borrowing.
The third quarter results for 2011-12 that will be released in January 2012 will add to volatility in markets. Result expectations are muted and if results do come in worse than expectations equity markets will see more falls. In all likelihood corporate India sales growth will come below 20% levels seen in the second quarter of 2011-12 and margins will continue to fall even after falling by over 400bps in the last quarter. Weak IIP (Index of Industrial Production) numbers, which came in at a negative 5.1% for October 2011 is giving rise to expectations of pressure on corporate sales and profitability. The weak Indian Rupee (INR), which has fallen by over 8% in the September-December 2011 period, will hurt corporates with high import content and with US Dollar (USD) debt.
Liquidity is tight in the money markets and borrowing costs for banks in the money markets have gone up by 50bps-100bps over the last three months. Banks are also facing cost increases of 300bps to 400bps in their domestic and foreign exchange deposits leading to pressure on net interest margins.
The RBI can soothe markets nerves by cutting policy rates. A CRR (Cash Reserve Ratio) cut to improve system liquidity and a repo rate cut to signal a growth oriented monetary stance will help improve sentiments across markets. Inflation expectations have come off with primary article inflation (20% weight in the inflation index) falling to two year lows of 2.8% helping RBI to lower policy rates.
Global markets will watch the demand for bonds of Italy and Spain in their respective bond auctions. Italy is scheduled to borrow over USD 90 billion in January while Spain is scheduled to borrow over USD 30 billion. The cut off yields on the bonds auctioned will be watched and if yields move higher in the auctions, markets will react negatively. Italy and Spain saw borrowing costs come down in the auctions held in December 2011.