Subbarao hemmed in, markets have tailwind

Damned if you do, damned if you don’t.

Don’t cut interest rates because, though core inflation for the last two successive months has come in at sub 5% levels, the average consumer price inflation in the last three years has been 10.2%.

Don’t cut the cash reserve ratio (CRR) because, if there was actually a liquidity deficit, how is it that corporates have pumped in Rs26,000 crore and banks another Rs46,000 crore into liquid schemes of mutual funds in the last three months?

Why cut the repo rate when the credit-deposit ratio is in any case a very healthy 76% and credit growth for the fortnight ended June 1, just shy of 18%?

Cut the CRR because advance tax outflows in the next few weeks will suck out roughly Rs30,000 crore from the system and further drain out liquidity.

Cut the CRR because, while certificates of deposit rates have fallen to roughly 9.5% from the March 2012 highs of 11% plus, they need to fall further to bring down the cost of funds for banks.
After all, if deposit costs don’t fall, how can lending rates fall?

Cut the repo rate because factory output growth has come in at a measly 0.1% in April 2012, from 8% plus levels in fiscal 2011.
Cut interest rates because China has done so by 25 basis points (bps) barely over a week ago even in the wake of falling inflation.

What’s more, Australia has reduced rates by 75 bps cumulatively, twice in less than two months recently.

Clearly, Duvvuri Subbarao is stuck between the hawks and the doves.

Were he to listen to the hawks, the markets will correct this week and the Nifty may breach 5000 on the downside.

However, my sense is the doves will have the last laugh. While the Reserve Bank of India (RBI) governor will not fully abandon a ‘dear money policy’, the tone, guidance and the announcements will be a leap forward to embrace growth.

After all, you don’t need to occupy the highest office on this blessed land to realise that between March 2010 and March 2012, while GDP growth has fallen by a full 200 bps from 8.5% to 6.5% — all thanks to a series of repo rate raises — headline inflation in the same period has fallen only 80 bps from 9.6% to 8.8%.

In other words, the obsession to check runaway inflation has instead checkmated growth.

The markets will obviously salute a 50 bps reduction each in the CRR and the repo rate.

Anything less will be met with a rangebound movement of the indices.

No policy action will cause a downward kneejerk reaction, but the chances of that happening are pretty much remote. In the worst-case scenario, any monetary inaction will be sportingly digested by the markets only because currently the momentum is reasonably strong.

This has to do with the fact that global fund managers with roughly $700 billion under management are overweight China and Brazil but underweight India, Taiwan and Malaysia.

However, in the last few days, slowly but surely, concerns of a sub-7% growth for the June 2012 quarter in China have raised fears of a hard landing and some of the outflows from China are indeed finding a home in Indian equities where last month, global funds have reduced their underweight positions on India from 55% to just 35%.

Not surprising, therefore, is the fact that while foreigners pulled out a whopping $7 billion last month from South Korea and Taiwan, they pulled out only $273 million from Indian equities.

Don’t forget also that foreigners actually bought $1 billion worth of Indian debt in May and more than $300 million already in the current month.

As for Greece, even if Alexis Tsipras of the Syriza party comes to power and rips apart the austerity treaties signed by his predecessors, Greece is more likely to stay in the euro zone, with private creditors taking a larger haircut.

Fears of euro exit can also spur Angela Merkel to hand out a fresh bailout to Greece with fewer strings attached, maybe including a debt moratorium for the next five years.

While a ‘Grexit’ will shave off only €90 billion from Germany’s GDP, it could trigger a chain reaction of potentially far-reaching consequences involving other PIIGS nations, which Germany can ill-afford and this is precisely why Merkel will give Greece another chance, even if it means eating humble crow.

By far, the biggest catalyst for the risk-on trade and hence Indian equities this week will be a dovish guidance and some form of quantitative easing by from the US Federal Reserve on the back of a 0.1% month-on-month fall in industrial production and a 0.2% fall in retail sales in May.

A dovish Ben Bernanke could lead to a rally here that takes the Nifty beyond 5200 this week.

The only impediment to what should be a good week for the Indian bourses is an escalation of violence in Syria and Egypt. That would take away the focus from both Mint Street and Greece. Middle-East geopolitics will then be back to the front and centre.

Till that happens, however, sit back and enjoy the ride because the best is yet to come.

Verma is a market expert and the MD & CEO of Violet Arch Securities, formerly, Alchemy Share and Stockbrokers