Thursday, 26 September 2013

Market Dynamics After FOMC meet and RBI Policy Review

Why the FOMC meet cheered markets?

In the FOMC meet on 18th Sep 2013 there was a surprise for the global markets as there was no announcement about any QE tapering as was widely anticipated. This unexpected move had ripple effects on all emerging markets including India and there was a sharp upside seen in Indian markets and there was good reason to cheer too.

The fact that there is no QE tapering for now and the easy money regime in the US will continue till the unemployment rate reduces to 6.5% or less, means that the fears of the emerging markets about monetary tightening in US can rest for now. Why is this causing relief in the markets? There are some pointers here :

  • The easy money regime in US will encourage more dollar inflows into emerging markets like India where there is opportunity for higher growth and better valuations.
  • If the dollar inflows do increase as anticipated, then it will lead to a boost in forex reserves and narrow down the CAD.
  • The boost in dollar inflows will help a lot in stabilising the INR as the main cause of the turbulence in Rupee value initially was the fear of QE tapering and a flight of dollars from the economy. More about this in Rupee and its Value Depreciation.
  • The anticipated dollar inflows will also help lessen the subsidy burden on fuel due to strengthening rupee and also go a long way in plugging the fiscal deficit.

The RBI Policy Anti-Climax :

With so many reasons, it was clear that the markets wanted to rejoice. But, not everybody was joining the party. The RBI monetary policy which closely followed the FOMC meet and the key rates saw some changes :

  • The repo rate was increased by 25 basis points to 7.50%.
  • the MSF was reduced by 75 basis points to 9.50%
  • CRR was untouched at 4% but the daily maintenance has been cut to 95% from 99%.
  • Reverse repo was kept at 6.5%

Clearly, even with no indication of ending monetary stimulus by the US, the RBI wants to take a cautionary stance. The new RBI governor had taken many liberalised measures to stabilise the rupee and instil confidence. So, market participants and observers were not really expecting a rate hike and were rather expecting for some reduction in key rates so that the liquidity situation is eased some more in favour of growth. Why did the RBI take such an apparently tough stand? The following may give some indication :

  • The postponement of QE tapering is being seen by the RBI as some more lead time to fix domestic economic situation before the actual QE tapering happens.
  • The rupee still needs to stabilise.
  • The fiscal deficit is still high and needs to be brought down.
  • The WPI is still hovering around 6% and the CPI is around 9.5%. Both are very high numbers and above the comfortable levels.

Hence, in the light of the above the RBI has decided to take a cautionary approach and not give too much easing till inflationary pressures and currency volatility reduce at the cost of growth and a slowing economy. Surely the RBI can only do so much and the Govt. should play its part in fixing the economy and give proper signals to the RBI so that it can loosen its stand.

Conclusion :

Since the RBI policy review the markets have given a muted performance with a slight negative bias. Investors need to be cautious as economic fundamentals still do not support high valuations. The index is still trading 15 to 16 times its earnings which is still very high. It should be remembered that value buying should be indulged in only when there is a clear case of supporting valuation which may lead to upside in future.