Volatility reflects fear, uncertainty of investors.
By Rajiv Theodore
NEW DELHI: Indian markets continued to be pounded Monday, following the trend seen on Friday after the Reserve Bank of India came out with a nasty surprise raising its key policy rate called the repo rate (the rate at which the RBI lends to banks) by 25 basis points (bps) to 7.5% from 7.25% after a monetary policy review.
The 30-share S&P BSE Sensex fell below the psychological 20,000 mark. The 50-unit CNX Nifty fell below the psychological 6,000 level. Both these indices closed at their lowest levels in almost a week. The Sensex also fell 362.75 points or 1.79%, up close to 75 points from the day’s low and off about 299 points from the day’s high.
The market breadth, indicating the overall health of the market, was negative on fears that the RBI governor Raghuram Rajan may raise policy rates again. He has indicated that he is willing to sacrifice growth which is now already languishing at a new low in recent memory in order to tame a truant inflation.
Consumer price inflation was 9.5 per cent for August, meaning the cost of living is rising faster than interest rates. The wholesale price index rose 6.1 per cent. Rajan is expected by many in the market to shift the RBI’s main inflation gauge to consumer prices from wholesale prices, putting India in line with most big economies but pushing up near-term rate expectations.
The unexpected hike came at a time when the country is stumbling through its worst economic crisis since 1991. This has put pressure on New Delhi to ease-off supply-side bottlenecks in the economy, such as poor infrastructure, that keep inflation high even when demand is soft. That is a big task for a weak coalition government, which also faces a general election by May, market pundits say. Some experts expects the RBI to raise the repo rate by another 50 bps in the fiscal year ending in March to take it to 8.00 per cent, followed by a lengthy pause.
Indian markets took the policy decisions badly, with bonds and stocks plunging and dragging the rupee down with them only a day after a Fed-fueled rally. Still, in recent weeks the rupee has recovered some of its losses and the sense of crisis surrounding the currency has eased for now. Many companies are struggling after the central bank’s rupee measures supported the currency, but dried up credit.
“Industry is truly concerned about the policy rate hikes and their adverse impact on the investment sentiment,” Srei Infrastructure Finance Ltd (SREI.NS) said in a statement.
Rajan, the former IMF chief economist who had predicted the global financial crisis, has showed that RBI’s priority had shifted from defending the rupee to fighting inflation. He was anointed the central bank’s head earlier this month amidst media-fanfare and high expectations that he could walk the talk on turning around the economy and rescue the rupee. On Monday, the rupee fell to 62.60.
Lifting rates may also compel Indian households to shift more of their savings towards banks and away from real estate and gold, addressing a trend that has pushed down deposit growth.
A weak economy can provide a “cushion in terms of disinflationary processes at work but also will give us an incentive to then perhaps look to putting greater emphasis on reviving the growth of the economy,” Rajan said.
The country’s growth rate was at its worst at 4.4 per cent in four years. At his first-day press conference earlier this month, Rajan, 50, impressed RBI-watchers with a multi-pronged action plan to bolster the rupee and strengthen financial markets but also warned that he would have to make unpopular decisions, that his job was not to accumulate “likes” on Facebook.
The past week was full of surprises as it led to immense volatility in the Indian equity market. It all started with the unexpected good news from US Federal Reserve Chairman Ben Bernanke that the tapering off of quantitative easing (QE) would not begin immediately. The tapering off was what emerging markets across the world dreaded and this piece of positive news lifted sentiments last Wednesday – that prompted the BSE Sensex to zoom to a 34-month high on Thursday. In a single day foreign institutional investors (FIIs) invested more than half a billion dollars in Indian markets.
But on the following day, Friday, there was unexpected news again as RBI hiked the repo rate when most analysts had been predicting the rate would stay the same or be lowered. The Sensex promptly fell by 382 points ending the week at 20,263.71.
The government has taken some recent measures to show it remains growth-friendly, but with general elections due in May-June 2014, it will ultimately support the RBI view that keeping prices down is all-important. This may hamper market sentiment, but at the same time, the deferring of the withdrawal of quantitative easing by the US has given Indian equity markets a new lease of life.
The Indian market does not mirror the current state of the economy. The economy may have its problems but the markets will move purely on the basis of the money flowing into them. The flow will continue for the next three to six months at best till the tapering off of QE begins. Tapering off cannot be wished away forever. It is bound to happen in the next few months. But these few months are crucial. If the government brings growth back on track the money flow into India will continue despite the QE tapering. Strong growth in India in the mid-2000s saw it being one of the least affected of emerging markets after the Lehman Brothers debacle in 2008.