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Wednesday, March 30, 2016

Is the stock market rallying only on hopes of a repo rate cut? - a guest post

Sensex and Nifty had touched lifetime highs in Mar '15. A year-long correction led to both indices touching 52 week lows on Feb 29 '16 - losing 25% from their Mar '15 tops.

The stock market did a sudden volte face from the beginning of Mar '16 - as bears (i.e. FIIs) turned bulls and bulls (i.e. DIIs) became bears. What triggered the abrupt change in sentiment?

Was it belated awareness of market players that the global economy was not doing as badly as they thought? Did FIIs get encouraged by the governments decision of sticking to its fiscal deficit targets? Or, was it a mix of both? 

In this months guest post, Nishit argues that expectation of a repo rate cut by RBI in its policy meeting on Apr 5 '16 may be the real reason for the current market rally.

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The Government recently slashed interest rates on Small Savings, thereby dealing a very big blow to Senior Citizens who depend on interest income. Postal Saving Schemes have suffered big cuts. The whole idea was to bring interest rates in line with Bank Fixed Deposit rates and thus make it a level playing field for banks.

The Government should have excluded special schemes - like the Senior Citizen Savings Scheme and the Girl Child scheme - which were specifically targetted at financially vulnerable sections of the population.

The Government has also committed to stick to its fiscal stability road map. With inflation under control, this has set the stage for a 25 basis point (0.25%) rate cut in the RBI policy meeting on April 5th. Optimists are expecting a 50 basis points (0.5%) rate cut.

Reduced Fixed Deposit interest rates are going to put a lot of people in difficulties - especially those who have retired and depend on Fixed Income.

Repo and Reverse Repo rates are most likely to be reduced by 25 basis points now and 25 basis points in June, depending on the progress of the Monsoon. The markets have rallied based on this. The 10 year Government Bond is trading at an yield of 7.51%, which is the lowest in past several years.

The Government will have to kick start several infrastructure projects if demand has to be generated. Only slashing interest rate is not enough. Road projects are a prime example.

Cheap funds for the banks to lend out are just one aspect. What the Government is ignoring is the social aspect as well of welfare schemes.

A stock market rally based only on expectations of an interest rate cut is a temporary phenomenon. Unless backed by pickup in demand and increased Government spending, the rally will fizzle out.

The Government is helping the RBI cut rates, but the transmission of lower rates to borrowers and huge NPAs of PSU banks need to be factored in. The current market rally should last till the RBI policy. What happens next should be a period of consolidation.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money ManthanYou can reach him at nish.stockid@gmail.com)

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