Positive surprise and if Fed is a non event, record highs on Sensex and Nifty and sharp rise in Rupee is well on cards
The whole market was expecting a 25 bps repo rate hike by the RBI in its policy review today but was (un) pleasantly surprised when the central bank refrained from a rate hike. The market was prepared for a rate hike with equities correcting from highs, the Indian Rupee (INR) falling and bond yields rising going into the policy.
The question is, was the no rate hike policy warranted? Markets were well prepared for a rate hike and would have preferred a rate hike with a guidance (positive or negative). However a no rate hike with an uncertain guidance such as “if inflation trends uncomfortable high we will take action in between policy dates” makes the markets more uncertain leading to higher volatility.
Markets have reacted positively to the RBI policy announcement with equities up by 1%, bond yields down by 12bps and the INR marginally higher. Markets will await the Fed’s 17th-18th December policy meet outcome, where an asset purchase taper is expected, before taking a call on direction.
RBI cited risk factors to GDP growth that is trending at decade low levels of 5% as the primary reason for a lack of rate hike. The weak trend in Industrial Production that has shown zero per cent growth in the April-October 2013 period coupled with the government cutting down spending to contain fiscal deficit at 4.8% of GDP is adding to concerns on growth.
The central bank stressed on the fact that both CPI (Consumer Price Index) and WPI (Wholesale Price Index) inflation are at uncomfortably high levels at 11.24% and 7.52% levels respectively but is willing to live with this given that vegetable prices that are up 60% year on year is primarily contributing to such high inflation levels. Vegetable prices do look to be coming off and if it sustains inflation can print sharply lower going forward.
RBI at this point of time is more concerned with liquidity being made available to productive sectors of the economy. The central bank has pumped in over Rs 2000 billion into the economy since September 2013 through the FCNR B swap window. RBI has conducted OMO (Open Market Operations) purchase auctions and is holding term repo auctions to improve system liquidity. Liquidity at this point of time is in a comfort zone with banks even lending money to the RBI in the daily LAF (Liquidity Adjustment Facility) auction.
The Sensex and Nifty could well end December 2013 at record highs if the Fed taper is seen as a non event by global markets. Positive economic data emanating out of US and Europe that has seen fall in unemployment levels, rise in manufacturing, consumer and business confidence and record high levels for equity indices will spur a global market rally even if Fed announces a measured taper. Inflation is well below any kind of threat levels in the US and Eurozone and central banks will keep rates at all time lows going into 2015.
The Indian Rupee will benefit from positive equity flows and stable bond flows into the country. Current account deficit expected at 30% below last year’s levels will add comfort to INR. Bond yields too will fall on INR strength and RBI maintaining status quo on interest rates.