• The Q4FY10 earnings of India Inc.
• Indian WPI for the month of March
• RBI’s Q4 credit policy release on 20th April

While inflation is a cause of concern, given the way the food price and other key individual indices are behaving, this will also have a major impact on RBI’s Q4 policy guideline. I believe that there is a strong possibility of at least a 50 bps hike in the key policy rates. This I believe could be a problem story for the ever singing markets of ours.

On the other hand the corporate India is expected to show decent Q4 numbers, however much of this growth I believe is already factored into the stock prices and hence there is nothing much left on the table that should excite the investors. Infosys Q4 results tomorrow morning will set the stage for the rest of India Inc.

Hence, I strongly believe that instead of chasing the markets at a broader level, it makes sense to invest in good stocks with reasonable valuations.

As Mr. Lynch Says
“Often, there is no correlation between the success of a company’s operations and the success of its stock over a few months or even a few years. In the long term, there is a 100 percent correlation between the success of the company and the success of its stock. This disparity is the key to making money; it pays to be patient, and to own successful companies.” – Peter Lynch

Author name: Rahul Sonthalia, Research Head, Kredent

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Some of the key highlights form the policy documents are:

• The share of agriculture in GDP has been declining over time, and as of 2008-09 it was 17.0 per cent. However, experience shows that a deficient rainfall can have a disproportionate impact on overall economic prospects and on the sense of well-being. Poor output will push up prices and depress rural labor incomes. Given the inter-sectoral supply-demand linkages, the knock-on impact on the industrial and services sectors can also be significant.
• Continuing the trend witnessed since Q2 of 2008-09, the two major components of demand, viz., private final consumption expenditure and gross fixed capital formation (with a combined weight of around 88 per cent) decelerated further in Q1 of 2009-10. Government consumption, which had increased sharply in Q3 and Q4 of 2008-09 due to the fiscal stimulus measures and the Sixth Pay Commission payouts, also decelerated in Q1 of 2009-10. While the direct impact of fiscal stimulus is waning, its indirect impact on private consumption and investment will persist for some more time
• The GDP projection for 2009-10 for policy purposes remains unaltered at 6%, made in the First Quarter Review of July 2009.

• Keeping in view the global trend in commodity prices and the domestic demand-supply balance, the baseline projection for WPI inflation at end-March 2010 is placed at 6.5 per cent with an upside bias. This is higher than the 5.0 per cent WPI inflation projected in the First Quarter Review of July 2009 as the upside risks have materialized

• The policy dilemma for India is different in some important respects from that of advanced economies as also other emerging market economies. First, most of these countries do not face an immediate risk of inflation. Indeed, in several advanced economies, the concerns were about a possible deflation, which are just about waning. On the other hand, India is actively confronted with an upturn in inflation – a rising WPI inflation and stubbornly elevated CPI inflation
• An issue of some immediate relevance is the critical need to downsize the government borrowing programme so as to help sustain a moderate interest rate regime. This is crucial for investment demand to pick up on which hinge our long-term economic prospects
• Reversing monetary policy easing stems from the concern about inflation. WPI inflation has turned positive, the base effect which has kept WPI low so far is now gone and CPI inflation has remained stubbornly elevated. On a financial year basis, WPI has already increased by 5.95 per cent. In as much as monetary policy acts with a lag, there is need to act now
• The Reserve Bank’s inflation expectations survey shows that households expect inflation to increase over the next three months as also one year. The lag with which monetary policy operates suggests that there is a case for tightening sooner rather than late

• The balance of judgment at the current juncture is that it may be appropriate to sequence the ‘exit’ in a calibrated way so that while the recovery process is not hampered, inflation expectations remain anchored.

• The ‘exit’ process can begin with the closure of some special liquidity support measures. In this policy government has indeed removed some special liquidity support measures like:

• The statutory liquidity ratio (SLR), which was reduced from 25 per cent of demand and time liabilities to 24 per cent, is being restored to 25 per cent
• The limit for export credit refinance facility [(under section 17(3A) of the RBI Act], which was raised to 50 per cent of eligible outstanding export credit, is being returned to the pre-crisis level of 15%
• The two non-standard refinance facilities: (i) special refinance facility for scheduled commercial banks under section 17(3B) of the RBI Act (available up to March 31, 2010), and (ii) special term repo facility for scheduled commercial banks (for funding to MFs, NBFCs, and HFCs) (available up to March 31, 2010) are being discontinued with immediate effect

• In view of large increase in credit to the commercial real estate sector over the last one year and the extent of restructured advances in this sector, it would be prudent to build cushion against likely non-performing assets (NPAs). Accordingly, it is proposed that to increase the provisioning requirement for advances to the commercial real estate sector classified as ‘standard assets’ from the present level of 0.40 per cent to 1 per cent

Our Analysis:

It is quite evident from the mentioned facts in the credit policy that the central bank will in any circumstances curtain the rise in inflation and on the basis of the overall assessment the first priority among the stance of monetary policy for the remaining period of 2009-10 is to “Keep a vigil on the trends in inflation and be prepared to respond swiftly and effectively through policy adjustments to stabilize inflation expectations.”

Thus we strongly believe that a rate hike is definitely on the cards in third quarter monetary policy for FY2009-10 and hence as already mentioned in the report titled “Credit Policy Eve” one should start booking profits from the rate sensitive sectors like banking, real estate and infrastructure and start moving towards defensive sectors.

Author: Rahul Sonthalia, Analyst, Kredent Group

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Some of the Key Highlights of the documents which we believe will set the tone of the monetary policy are:

Global economy has started exhibiting tentative signs of recovery, but the recovery is, however, widely perceived to remain slow and gradual, with receding but significant downside risks

• The first quarter GDP growth in 2009-10 still points to persistence of slowdown
• Information available on various lead indicators in the second quarter of 2009-10 suggests that because of deficient monsoon, kharif output may be adversely affected
• Deceleration in aggregate demand that was witnessed in the second half of 2008-09 continued during 2009-10. Growth in private consumption demand fell to as low as 1.6 per cent in the first quarter of 2009-10. Investment demand also decelerated further, and the high growth in government consumption demand that was witnessed in the last two quarters of 2008-09 moderated.
• Deficient monsoon and the associated drought like conditions in several parts of the country, and the more recent floods in some other parts, could also dampen rural demand
• External demand continues to be weak. Trade data show that during April-August 2009, merchandise exports and imports declined by 31.0 per cent and 33.4 per cent, respectively, over the corresponding period of the previous yea
• The liquidity conditions remained in surplus on a sustained basis, which was absorbed by the Reserve Bank through reverse repo operations under the Liquidity Adjustment Facility (LAF) and the over night rates hovered around LAF signaling ample liquidity into the system
• The changing inflation environment, however, is being driven by strong escalation in prices of food articles, which have increased by 14.4 per cent (year-on-year) so far. Excluding food items, the WPI inflation remains negative at (-) 3.4 per cent.
• From the stand point of monetary policy, anchoring inflation expectations in the face of sustained high inflation in essential commodities will be a key challenge
• The Reserve Bank’s professional forecasters survey points to downward revision to the growth outlook from 6.5 per cent to 6.0 per cent in 2009-10.
• Emerging inflationary pressures may also persist and escalate further on account of the fading away of the base effect, cost push pressures through wage-price revisions in the face of elevated CPI inflation, challenges in improving the supply situation of essential commodities in the short-run, gradual pressure on global commodity prices along with global recovery, and rising inflation expectations on account of elevated CPI inflation.
• The overall economic outlook is, therefore, a mixture of upside prospects of recovery and downside risks. Managing the trade-off between supporting growth and reining in inflation expectations poses a complex policy challenge.

Summary:

The tradeoff will be costly since the capital markets are moving way beyond the real economy. However, we do not expect a rate hike in the second quarter monetary policy review due to a bleak growth outlook, however the tone in which inflation is presented in this press release by the RBI clearly sets a prelude for a rate hike in the third quarter policy review or even before that.

The way Nifty has behaved over the last 4 trading sessions clearly suggests that markets are factoring in a change in RBI’s stance. Thus we strongly believe that its time in the market to start booking profits and move away from the rate sensitive like banking, infrastructure and real estate.

Author: Rahul Sonthalia, Analyst, Kredent Group

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