Market Outlook-No Signs of Interest Rates Peaking-VRK100-20Sep2011

	Market Outlook

Rama Krishna Vadlamudi, Hyderabad          20 September 2011

In the last two or three weeks, Indian stock market is stuck in a tight range. The benchmark Sensex is moving between 16,000 and 17,500 and Nifty between 4,800 and 5,200. This is a reflection of various negative global factors impacting the sentiment of positive long term growth prospects in India and reasonable stock valuations. The sovereign debt crisis in the eurozone and the US is yet to unfold completely and nobody is having any clear idea what kind of surprises will be tossed up in the next few quarters. One thing is sure we are going to experience further uncertainty regarding the prospect of Greece defaulting on its government debt or Italy facing more trouble.

No signs of interest rates peaking

The primary ‘dharma’ of RBI is price stability. As part of its resolve to control inflation, RBI has expressed its desire to continue with its dear money policy. However, of late, there is a perception in the markets, that the interest rates in India are peaking or near peak. This view appears to be a bit misplaced when: 1) there is pressure on fiscal deficit, and 2) there is no sign of inflation getting under control in near future. Moreover, the Government has recently increased petrol prices by Rs 3.14 per litre, which will feed in to inflation in the next few months. It is not clear whether international crude prices will come down.

During the previous interest rate up-cycle from October 2005 to October 2008, RBI raised repo rate from 6 per cent to 9 per cent – the previous up-cycle lasted for three years. After a peak of 9 per cent, RBI started reducing interest rates dramatically between October 2008 and April 2009 in view of the Lehman Brothers collapse and the concomitant global financial crisis – the immediate past interest down-cycle lasted for barely 18 months in view of the extraordinary circumstances then.

In financial markets, it is a fashion to look for patterns. Based on the past experience, many market experts are of the view that the interest rates are peaking in India. But, it is not always advisable to look for such past patterns playing out in a similar manner in the future also. The current interest rate up-cycle started from March 2010, with RBI increasing repo rate from 4.75 per cent to 8.25 per cent till now. The previous peak rate is 9 per cent which existed between July 2008 and October 2008. The current situation is different from the previous interest rate down-cycle, when RBI reduced interest rates dramatically from 9 per cent to 4.75 per cent in a matter of just six months.

However, Kaushik Basu, Chief Economic Advisor, differs with RBI in respect of interest rate hikes and he argues that there is a need to cut interest rates to give fillip to growth.   

India’s Macro Picture

Last week, Reserve Bank of India raised interest rates by another 25 basis points (0.25 per cent) which is broadly in line with market expectations. GDP growth rate is declining, so is industrial production represented by index of industrial production (IIP). Due to concerns of global slowdown, there are some doubts about exports growth, which are quite robust as of now. Despite RBI raising interest rates by 350 per cent (3.5 per cent) in the last 18 months, the inflation refuses to show any reasonable signs of relenting.

For some time, RBI has been expressing its anxiety about fiscal deficit going out of hand which will put pressure on the growth rate. RBI is of the view that there is a need for fiscal consolidation in view of the deceleration in tax collections and higher expenses on account of fertilizer and oil subsidies. The Indian rupee has weakened to 48.20 against the US dollar from a level of 44.75 on 5 August this year. A weaker rupee increases India’s oil import bill, putting intense pressure on fiscal deficit.

Government raising fuel prices, three times this year, amidst opposition from the people and opposition political parties is a good sign that the central government is serious about curtailing fiscal deficit and bringing some transparency in fuel pricing policy.

To know about the RBI continuous raise of interest rates, just click:

http://ramakrishnavadlamudi.blogspot.com/2011/09/rbi-raises-interest-rates-vrk100.html

Outlook

Overall, the outlook for the stock markets and bond markets in India is not very optimistic considering the pressure on the growth rate – which is impacted negatively by the stubborn inflation and negative global cues. There is no reason to believe at this point of time that the RBI will stop raising interest rates and start decreasing interest rates very soon, unless some serious cooling off happens on the inflation front or some actual debt defaults happening in Greece or some other countries in the eurozone. However, several good quality stocks are available at reasonable prices while the Sensex is hovering is around 17,000 and Nifty at 5,100 for investors who have the patience and risk appetite to hold stocks or equity mutual funds for a period of more than three years.

Disclaimer: The author’s views are personal. He has a vested interest in the stock markets and his views should be taken with a pinch of salt. He may change his views very fast without any notice depending on the market and economic conditions. His views should not be construed as investment recommendation. There is a risk of loss in equity investments. Investors need to consult their certified financial adviser before making any investment decisions.

For author’s articles on financial markets, just click:

www.scribd.com/vrk100

or,

www.ramakrishnavadlamudi.blogspot.com