The credit policy announced by India’s central bank i.e the RBI does indicate apprehensions going forward. As expected, without tinkering on the interest rates (RBI has left unchanged the reverse repo, repo, and bank rate at 3.25%, 4.75%, and 6% respectively), RBI increased the Cash Reserve Ratio or CRR by 75 basis points (the move will be implemented in two stages with the first 50 bps hike coming into effect on February 13 while the next 25 bps hike will be effective from February 27. This will result in a mop-up of Rs 36,000 crore or Rs. 360 billion by February end). The message was clear. RBI does not want inflationary expectation to be built up. Not that there is an immediate threat to a built up of non-food, non-oil inflation. The current run up of inflation in India is purely due to food price inflation, which is a supply side issue and it is quite well known that the monetary policy is effective only when one needs to work on demand side pressure and not on supply side issues. Moreover, given the muted rise in credit growth (we would be hard pressed to touch a 16% credit growth this year), the CRR hike is unlikely to have any effect on credit growth. It is more a cosmetic decision aimed at tempering inflationary expectation.
The fact that RBI has not gone for a rate hike is attributable to their apprehension about the growth and more about the economy’s continued dependence of stimulus. Fact is, domestic demand is still heavily dependent on the stimulus. A close look at the IIP numbers show that while there is an admirable growth in consumer durables, consumer non-durables are virtually flat. One would do well to remember that the stimulus measures positively impact the consumer durables. Even an analysis of the Q3’10 (Oct-Dec) corporate performance reveal that while the bottomline has shown strong growth (thanks to lower base effect), the topline is not really moving as desired. This has been the situation in the past two quarters as well, indicating slack domestic demand. At this point in time, any hike in interest rates can spook demand. And there is every likelihood of interest rate rising sooner rather than later, more so given that the RBI expects the inflation to peak at 8.5%. Interest rates need to rise. We cannot have a situation where the real interest rates remain negative.
The most important decision, at this point in time, is to time the exit of stimulus, given the dependence of the economy on the same.
The market seemed to have been buoyed by the positive GDP outlook (7.5% growth) of RBI and recovered all of today’s loss and more. Does it mean the problem days are over? Far from it actually. RBI’s forecast actually seems to be too good to be true. They do not seem to be taking cogniscance of the likely impact of one of the worst monsoon in the last 25 years. Lack of domestic demand is also being ignored.
From the market perspective, the global economic environment continues to be real threat. Double dip recession is quite likely in the US, Europe is not in a great shape either and Greece may not be an isolated instance. Added to that are the likely hawkish regulatory stance that one is definitely going to witness all over the world. This can impact the flow of foreign funds in a big way. We have just seen the trailer during the last few days the market took a beating. Meaning, going forward, flow of foreign funds would be very volatile. One should be prepared for volatile times ahead.
Investment strategy should be more stock specific and definitely not the buy and hold type. Booking profits might make better sense on every rise.