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Wednesday, March 4, 2015

5 reasons why the stock market sold off after the surprise 25 bps interest rate cut by RBI today

The budget lacked any populist measures, and laid emphasis on fiscal consolidation. Inflation is on a downward slide. Many experts had expected a second interest cut after the budget. So, why did the stock market fail to celebrate? Here are five reasons:

1) It was a case of ‘sell on news’. Though the timing was a bit of a surprise – as was the earlier rate cut in Jan ‘15 - a second rate cut was expected around March-April. After the initial surge today, profit booking set in.

2) Nifty had touched the psychological 9000 mark on Tue. Mar 3. Today (Mar 4), Sensex touched the 30000 level. When an index is at lifetime high with no known resistances, there is a tendency for traders and investors to book profits when the index reaches a nice, round level (i.e. with several zeroes).

It happens for stocks, too. How often have you waited for a stock to touch 200, or 500, or 1000 in order to book profits?

3) Some more PSU divestments are lined up this month. Cash will be required – particularly by DIIs – to invest, and/or bail-out the issues in case of under-subscriptions.

4) The 25 bps rate cut in Jan ‘15 was immediately followed by a reduction in fixed deposit rates by banks, but the interest rate benefit was not passed on to borrowers. PSU banks in particular have a lot of NPAs/restructured assets on their books. They chose to utilise the rate cut to shore up their books. They may do so this time as well.

5) Last – but not the least – is the realisation by RBI that economic growth is still sluggish on the ground, despite the government’s ‘new formula’ of calculating GDP that indicated a higher growth. And investors didn’t like the confirmation about slow growth.

This is what L&T Chairman Anil M Naik said in an interview to Business Standard: “It’s too little, too late. For the economy to bounce back as against crawl back, you need a cut of another 50 basis points. Not just that, banks have to pass it on. If banks don’t pass on, consumer demand will not come back. Our infrastructure is high-cost because interest rates are as much as 12 per cent for some groups, which make projects unviable.”

Q. E. D.

2 comments:

Ramchandra said...

Dear Sir,
Thank you very much for giving insight.
I particularly liked the point number 4. Everyone interested in personal gain and not passing the benefit to bottom. Until and unless we see this, I expect not much effect on RBI action. Sad part of yesterdays announcement was that this will be effective from April due to point number 4.
Regards,
Ramchandra Hegde

Subhankar said...

Thanks for your comments, Ramchandra.

The 'logic' of the move - as explained by a PSU bank chief - was that deposit rates have a lag effect in the sense that lower deposit rates don't affect the older deposits at higher rates till their maturity. Whereas, lower loan rates become effective from day one.

Considering that companies are still hesitant about taking loans at current high rates, the 'logic' is tenuous at best.